PROSPECTUS
[LOGO] SUSSEX BANCORP
983,609 SHARES OF COMMON STOCK
OFFERING PRICE $14.25 PER SHARE
We are the holding company for Sussex Bank, a New Jersey chartered
commercial bank based in Sussex County, New Jersey.
We are offering for sale 983,609 shares of our common stock. Although
our common stock is traded on the American Stock Exchange under the symbol
"SBB", the trading market is not active. The last reported sales price of our
common stock on December 15, 2004 was $14.50.
INVESTING IN OUR COMMON STOCK INVOLVES RISKS. SEE "RISK FACTORS"
BEGINNING ON PAGE 8 TO READ ABOUT FACTORS YOU SHOULD CONSIDER BEFORE YOU MAKE
YOUR INVESTMENT DECISIONS.
NEITHER THE SECURITIES AND EXCHANGE COMMISSION NOR ANY STATE SECURITIES
COMMISSION HAS APPROVED OR DISAPPROVED OF THESE SECURITIES OR DETERMINED IF THIS
PROSPECTUS IS TRUTHFUL AND COMPLETE. ANY REPRESENTATION TO THE CONTRARY IS A
CRIMINAL OFFENSE.
OUR COMMON STOCK IS NOT A SAVINGS ACCOUNT OR SAVINGS DEPOSIT AND IS NOT
INSURED BY THE FDIC OR ANY OTHER GOVERNMENT AGENCY.
PER SHARE TOTAL
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Offering Price ................................... $14.25000 $14,016,428
Underwriting Discounts and Commissions ........... $ 0.78375 $ 770,904
Proceeds to Sussex Bancorp, before expenses ...... $13.46625 $13,245,524
This is a firm commitment underwriting. We will pay underwriting
commissions for the sale of the shares of common stock to the public. The
underwriting commission assumes all shares are sold to the public. We have
granted the underwriters a 30-day option to purchase up to 147,541 additional
shares of common stock at the same price, and on the same terms, solely to cover
over-allotments, if any.
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KEEFE, BRUYETTE & WOODS
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The date of this prospectus is December 15, 2004
[MAP]
WE HAVE NOT AUTHORIZED ANY DEALER, SALESPERSON OR OTHER PERSON TO GIVE
YOU WRITTEN INFORMATION OTHER THAN THIS PROSPECTUS OR TO MAKE REPRESENTATIONS AS
TO MATTERS NOT STATED IN THIS PROSPECTUS. YOU MUST NOT RELY ON UNAUTHORIZED
INFORMATION. THIS PROSPECTUS IS NOT AN OFFER TO SELL THOSE SECURITIES OR OUR
SOLICITATION OF YOUR OFFER TO BUY THE SECURITIES IN ANY JURISDICTION WHERE THAT
WOULD NOT BE PERMITTED OR LEGAL. NEITHER THE DELIVERY OF THIS PROSPECTUS NOR ANY
SALES MADE HEREUNDER AFTER THE DATE OF THIS PROSPECTUS SHALL CREATE AN
IMPLICATION THAT THE INFORMATION CONTAINED HEREIN OR THE AFFAIRS OF THE COMPANY
HAVE NOT CHANGED SINCE THE DATE HEREOF.
[LOGO] SUSSEX BANCORP
983,609 Shares of Common Stock
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PROSPECTUS
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KEEFE, BRUYETTE & WOODS
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December 15, 2004
TABLE OF CONTENTS
PROSPECTUS SUMMARY.............................................................1
THE OFFERING...................................................................5
SUMMARY FINANCIAL DATA.........................................................6
RISK FACTORS...................................................................8
FORWARD-LOOKING STATEMENTS....................................................12
USE OF PROCEEDS...............................................................13
MARKET FOR THE COMMON STOCK...................................................14
CAPITALIZATION................................................................15
MANAGEMENT DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS......................................................16
BUSINESS......................................................................39
MANAGEMENT....................................................................45
DESCRIPTION OF THE COMPANY'S SECURITIES.......................................54
ANTI-TAKEOVER PROVISIONS......................................................55
SUPERVISION AND REGULATION....................................................56
UNDERWRITING..................................................................60
LEGAL MATTERS.................................................................62
EXPERTS.......................................................................62
WHERE YOU CAN GET MORE INFORMATION............................................62
INDEX TO THE CONSOLIDATED FINANCIAL STATEMENTS................................63
[This Page Intentionally Left Blank]
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PROSPECTUS SUMMARY
This summary highlights information contained elsewhere in this prospectus.
Because this is a summary, it may not contain all of the information that may be
important to you. Therefore, you should carefully read this entire prospectus
and other documents to which we refer herein before making a decision to invest
in our common stock, including the risks discussed under the "Risk Factors"
section and our financial statements and related notes.
As used in this prospectus, the terms "Sussex," "the company," "we," "us" and
"our" refer to Sussex Bancorp and its subsidiaries and the term "the bank"
refers to Sussex Bank unless the context indicates another meaning.
WHO WE ARE
We are a one-bank holding company headquartered in Franklin, New Jersey and the
parent company of Sussex Bank. We are a community-oriented financial institution
that offers traditional community bank loan and deposit products and services as
well as an array of fee based financial services products. Our stock is
primarily owned by residents of our market area, with our board and senior
management owning over 25% of our stock. We emphasize our knowledge of local
markets, allow customer access to our senior decision makers and provide
superior and personalized customer service that is generally not available at
larger financial institutions. Our goal is to serve the needs of businesses and
consumers in our marketplace in northwestern New Jersey and, to a lesser extent,
southern New York and northeastern Pennsylvania. The bank is a New Jersey
state-chartered commercial bank formed in 1975 which operates from its main
office and seven branches, all of which are located in Sussex County, New
Jersey.
We target small and mid-size businesses as well as professional practices such
as lawyers, doctors and accountants within our market area. We actively pursue
business relationships with our targeted clientele through the business contacts
of our board of directors and senior management and by capitalizing on our
knowledge of the local marketplace. We engage in lending activities traditional
of community banks. Primarily we are a real estate based lender; approximately
83% of our loans are secured by first or second mortgages on real estate with
43.6% of our loans consisting of commercial real estate loans and 28.7% of our
loans consisting of first or second mortgages on residential properties. To a
lesser extent, we also originate commercial, farm and consumer loans.
We have also sought to increase our non-interest income in order to diversify
and improve our revenues and to make our earnings less dependent on our net
interest margin. In 2001, we acquired Tri-State Insurance Agency, Inc., a full
service insurance agency. We strengthened Tri-State's operations through our
2003 acquisition of the Garrera Insurance Agency. We intend to continue to seek
opportunities to expand our insurance business through acquisitions of books of
business or whole agencies. Our non-interest income for the fiscal year ending
December 31, 2003 was $4.1 million - an increase of $811,000 or 24.6% over the
previous fiscal year, representing 27.6% of our total revenues. See "Results of
Operations - Non-Interest Income" on page 26 for more information.
Through our strategy of serving as a full service community-focused financial
institution, we have maintained and expanded our market share within our Sussex
County, New Jersey marketplace. At June 30, 2004, we had 11.4% of deposits
within Sussex County, New Jersey, ranking us third in market share.
OUR MARKET AREA
All of our banking offices are located in Sussex County, New Jersey and we
maintain loan production offices in Pike County, Pennsylvania, and Orange
County, New York. Our market area is among the most affluent in the nation and
in New Jersey. Sussex County ranks 6th in New Jersey, with median household
income of $71,902 as compared to the state median of $61,779 and the national
median of $46,475. Sussex County's population growth over the next five years is
expected to reach 5.91% as compared to the state growth rate of 3.80% and the
nationwide growth rate of 4.84%. See "Business - Our Market Area" on page 39.
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OUR STRATEGY
Our board of directors has adopted a strategic plan calling for the bank to
build upon our successful track record in Sussex County by applying our business
philosophies in the larger contiguous counties and taking advantage of the
competitive opportunities presented by the consolidation of other banking
institutions in these markets. We believe our community bank philosophy, which
emphasizes a high service, personalized approach, which is generally not offered
by our larger competitors, will be very successful in our target markets. In
addition, our strategic plan is focused on significantly improving the core
profitability of the franchise through improvements in, among other things, our
efficiency and our loan to deposit ratios. We believe that the recent
investments we have made in our infrastructure, certain key hires and our broad
product offering will allow us to successfully expand. We cannot, however,
guarantee the success of our business strategy. Our earnings growth depends upon
our ability to attract and retain high-quality employees, successfully attract
core deposits and maintain cost controls, as well as upon our response to
adverse economic conditions and interest rate trends. See "Risk Factors" on page
8.
BUILDING THE PLATFORM
During the past year, we have accelerated our efforts to position the bank to
take advantage of the opportunities we believe are present in our existing and
target markets. Although this effort has resulted in higher operational and
non-recurring expenses in recent periods, we believe these have been prudent
investments in our future.
In the past year, we have accomplished the following:
o Relocated our corporate offices into a space sufficient to
support and help grow the organization.
o Upgraded and converted our core processing hardware and
software. As part of this conversion and upgrade, we converted
our data processing software to the Jack Henry Associates
system. Jack Henry Associates is a recognized industry leader in
bank data processing.
o Retained Tammy Case as our new Executive Vice President - Loan
Administration. Ms. Case has over 27 years of experience as a
commercial lender, 23 of which were spent within our Sussex
County trade area.
o Initiated a restructuring of our loan department under Ms. Case
designed to increase efficiency and more rationally utilize
personnel to improve our loan processing.
o Established a residential mortgage banking division which
brokers residential home mortgages for funding by third party
investors without recourse and servicing released. Since
commencing operations in August 2003, our mortgage banking
division has brokered $46.5 million in new loans for funding by
third party investors and produced fee income of $622,000
through its first year of operation. While the division brokers
loans both to refinance existing mortgages and to fund new home
purchases, for the nine months ended September 30, 2004, over
56% of the loans brokered were used to fund new purchases.
o Formed Sussex Settlement Services, L.P., a partnership between
the bank and First American Title Insurance Company, through
which the bank now offers title insurance, title abstracts and
searches, credit reports and closing services.
EXPANSION INTO SURROUNDING COUNTIES & OPPORTUNITIES RESULTING FROM
CONSOLIDATION; ACQUISITIONS
We have historically not expanded our franchise out of Sussex County, New
Jersey, although we believe the surrounding counties in New Jersey, Pennsylvania
and New York offer opportunities for our brand of banking services. We believe
our community bank approach, which emphasizes a high degree of customer service
and
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access to senior management and decision makers not available at larger
financial institutions, will allow us to expand and capture new customers.
Sussex County is the home to a number of different banking institutions and
approximately $1.9 billion in aggregate deposits. The table set forth below
provides comparative information on Sussex County, our current primary market
area, and the surrounding contiguous counties:
Median
June 30, 2004 Household Total
Deposits ($M) Income Population
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>> Sussex, NJ $1,905 $71,902 151,480
>> Morris, NJ $11,914 $87,589 484,013
>> Passaic, NJ $8,872 $53,269 499,333
>> Orange, NY $5,023 $58,359 366,959
>> Warren, NJ $1,783 $62,858 110,422
>> Pike, PA $423 $49,689 52,865
These counties have been the home to many financial institutions, including many
community banks, that have been acquired by much larger, out of market
institutions. We do not believe these institutions are able to provide the same
level of service that is provided by community banks such as Sussex. We believe
the business model we have built in Sussex County will work equally well in
these surrounding markets.
Our strategy calls for us to consider alternative routes to expand our market
area. Although we currently have no agreements or understandings to acquire
additional institutions or branches, we would consider purchasing another whole
depository institution or selected branches. In addition, as part of our
strategy of enhancing fee-based income, we would consider acquiring other
financially-related businesses, including additional insurance agencies or books
of insurance business.
While we have confidence in the bank's continued growth, this aspect of our
business strategy is not without risk. Risks includes properly identifying and
pricing potential acquisitions, managing the costs of new growth, attracting and
retaining employees with connections to new market areas and successfully
competing for business in new market areas. See "Risk Factors" on page 8.
IMPROVING CORE PROFITABILITY
Our strategic plan is also focused on improving the core profitability of our
franchise. We believe that this will be accomplished through the following
initiatives.
BALANCE SHEET GROWTH
We believe that as we grow our franchise we will be able to take advantage of
the economies of scale typically enjoyed by larger organizations. We believe
that the investments we have made in our infrastructure and product offerings
are sufficient to support a much larger organization, and therefore believe that
increases in our expense base going forward should be much lower than our
proportional increase in assets and revenues. We believe that the effect of
these trends going forward should improve our profitability.
OPERATIONAL RESTRUCTURING
We believe we currently have opportunities to change our operational structure
and to reduce staffing levels to provide better customer service. An example of
this is a recent effort under the guidance of Tammy Case, our Executive Vice
President-Loan Administration, who reviewed the staffing levels and assignments
within our loan department. The result of this review is more efficient staffing
of the loan department and better processing flow of loan applications.
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BALANCE SHEET REPOSITIONING
Although we have been successful in developing our business in Sussex County,
the business climate of the county is not as strong as some of our surrounding
markets. As a result of this, we believe that by expanding beyond Sussex County,
we will have the opportunity to improve the proportion of loans on our balance
sheet relative to deposits. As this balance sheet mix improves, we expect to see
an increase in our net interest margin that would result in a higher level of
profitability. Furthermore, we may also be able to restructure our liabilities
and reduce our cost of funds.
INCREASE CROSS-SELLING AMONG OUR LINES OF BUSINESSES
In addition to enhancing our non-interest income, we also believe our mortgage
banking and insurance brokerage operations will continue to provide us with
substantial opportunities to cross-sell among the client bases of our different
lines of business. We have been successful in cross-selling loan and deposit
products to our insurance customers and selling insurance products to our
existing bank customers. We have instituted training programs to further enhance
our cross-selling efforts and continue to develop ways to create incentive for
loan officers and insurance producers to continue to cross-sell services to
benefit the bottom-line.
FINANCIAL HIGHLIGHTS
At September 30, 2004, we had $259.7 million in total assets, $147.0 million in
net loans, $223.7 million in total deposits and $16.2 million of stockholders'
equity. Over the five year period ended December 31, 2003, we grew our assets,
loans, and deposits at compound annual rates of 12%, 14%, and 10%, respectively.
Net income for the nine months ended September 30, 2004, amounted to $1.2
million, a 17.8% increase over the same period in 2003. Net income for our
fiscal year ended December 31, 2003, amounted to $1.4 million, a 24.7% increase
over our fiscal year ended December 31, 2002. Over the five year period ended
December 31, 2003, we grew our earnings per share at an average annual rate of
13%. For more information, see "Results of Operations" on page 18.
Our executive offices are located at 200 Munsonhurst Rd., Route 517, Franklin,
New Jersey 07416-0353, our telephone number is (973) 827-2914, and our website
is WWW.SUSSEXBANK.COM.
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THE OFFERING
Common stock offered for sale................................... 983,609 shares, or 34.8% of our shares of common stock
outstanding after the offering
Shares of common stock outstanding after the offering(1)(2)..... 2,825,797 shares
Offering price.................................................. $14.25 per share
Market for the common stock..................................... The common stock is listed on the American Stock
Exchange under the symbol "SBB".
Dividend policy................................................. We have consistently paid cash dividends every year
since 1979, and have issued a number of stock dividends
and stock splits.
Use of proceeds................................................. We will contribute most of the proceeds to the bank to
enable it to continue to grow its loan and investment
portfolio while complying with its regulatory capital
requirements. The bank may use a portion of these
proceeds to finance the establishment or acquisition of
additional branches if we find locations that we believe
will be successful and will provide growth opportunities
for the bank, the acquisition of whole financial
institutions, or the acquisition of non-bank financial
businesses. We do not currently have any agreements to
acquire branches, financial institutions or non-bank
financial business.
Ownership of management......................................... Prior to this offering, our directors and executive
officers owned 25.8% of our stock. Upon completion of
the offering, we expect the ownership of our directors
and executive officers to be approximately 17.7% of our
common stock.
Risk factors.................................................... An investment in the common stock involves certain
risks. Prospective purchasers of the common stock should
consider the information discussed under the heading
"Risk Factors" on page 8.
1 As of September 30, 2004.
2 Unless otherwise indicated, the share information in the table above and in
this prospectus excludes up to 147,541 shares that may be purchased by the
underwriters from us to cover over-allotments. Unless otherwise indicated,
information contained in this prospectus regarding the number of outstanding
shares of common stock does not include 268,570 shares of common stock issuable
upon the exercise of outstanding stock options or an aggregate of 68,083 shares
of common stock reserved for future issuance under our stock option plans.
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SUMMARY FINANCIAL DATA
The summary financial data presented below is derived from, and should be read
in conjunction with, our audited financial statements for the years ended
December 31, 2003, 2002 and 2001, including the related notes, included in this
prospectus. The selected financial data for the periods ended December 31, 2003,
2002, 2001, 2000 and 1999 were derived from our audited consolidated financial
statements for the respective periods. Our summary of consolidated financial
data as of and for the nine months ended September 30, 2004 and 2003 have not
been audited but, in the opinion of our management, contain all adjustments
(consisting of only normal or recurring adjustments) necessary to present fairly
our financial position and results of operations for such periods in accordance
with generally accepted accounting principles. Our results for the nine months
ended September 30, 2004 are not necessarily indicative of our results of
operations that may be expected for the year ended December 31, 2004. The
following summary consolidated financial data should be read in conjunction with
our consolidated financial statements and related notes and our "Management's
Discussion and Analysis" included elsewhere in this prospectus. All per share
data has been restated for the effect of the 5% stock dividends distributed in
July 2000 and November 2003.
AS OF AND FOR THE
NINE MONTHS ENDED
SEPTEMBER 30, AS OF AND FOR THE YEAR ENDED DECEMBER 31,
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2004 2003 2003 2002 2001 2000 1999
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(DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)
SUMMARY OF INCOME:
Interest income $8.595 $7,999 $10,771 $10,860 $11,589 $10,389 $9,115
Interest expense 2,042 2,197 2,860 3,536 5,688 4,837 4,322
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Net interest income 6,553 5,802 7,911 7,324 5,901 5,552 4,793
Provision for loan losses 373 315 405 300 252 229 177
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Net interest income after
provision for loan
losses 6,180 5,487 7,506 7,024 5,649 5,323 4,616
Other income 3,426 2,931 4,103 3,292 1,628 839 889
Other expense 8,011 7,098 9,663 8,634 6,165 5,153 4,558
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Income before 1,595 1,320 1,946 1,682 1,112 1,009 947
income taxes
Income taxes 430 331 505 526 317 242 188
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Net income $1,165 $989 $1,441 $1,156 $795 $767 $759
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Intangible amortization
(included in other expense,
tax effected) $70 $59 $123 $103 $67 $55 $55
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WEIGHTED AVERAGE
NUMBER OF
SHARES: (a)
Basic 1,830,203 1,782,929 1,790,142 1,748,102 1,725,410 1,569,405 1,567,899
Diluted 1,917,746 1,849,197 1,859,409 1,820,724 1,758,483 1,581,392 1,585,250
PER SHARE DATA:
Earnings per share:
Basic $0.64 $0.55 $0.80 $0.66 $0.46 $0.49 $0.48
Diluted 0.61 0.54 0.78 0.64 0.44 0.48 0.48
Cash dividends (b) 0.21 0.20 0.20 0.24 0.18 0.18 0.10
Stock dividends 0% 0% 5% 0% 0% 5% 0%
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AS OF AND FOR THE NINE MONTHS AS OF AND FOR THE YEAR ENDED DECEMBER 31,
ENDED SEPTEMBER 30,
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2004 2003 2003 2002 2001 2000 1999
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BALANCE SHEET:
Loans, net $146,964 $128,115 $132,640 $112,069 $105,005 $100,193 $83,997
Total assets 259,701 235,601 240,617 225,904 203,343 161,629 150,126
Total deposits 223,730 201,806 207,657 189,858 178,554 140,861 138,548
Total stockholders'
equity 16,186 14,037 14,904 13,680 12,237 10,110 9,089
Average assets 246,937 231,263 233,027 214,897 188,785 152,623 143,909
Average stockholders'
equity 15,308 13,926 14,035 12,766 11,838 9,326 9,136
PERFORMANCE RATIOS:
Return on average
assets 0.63% 0.57% 0.62% 0.54% 0.42% 0.50% 0.53%
Return on average
stockholders'
equity 10.17% 9.50% 10.27% 9.06% 6.72% 8.22% 8.31%
Net interest margin 4.07% 3.81% 3.86% 3.82% 3.40% 3.95% 3.63%
Efficiency ratio (c) 80.28% 81.28% 80.43% 81.33% 81.80% 80.63% 80.22%
Other income to net
interest income
plus other income 34.33% 33.56% 34.15% 31.01% 21.62% 13.13% 15.65%
Dividend payout
ratio 33% 36% 25% 36% 39% 37% 21%
CAPITAL RATIOS:
Tier I capital to
average assets 7.35% 6.94% 7.15% 6.66% 4.87% 6.21% 6.16%
Tier I capital to
total risk-weighted
assets 10.79% 10.99% 11.14% 11.77% 8.45% 9.62% 10.41%
Total capital to
total risk-weighted
assets 12.02% 12.38% 12.37% 13.36% 9.46% 10.58% 11.37%
Average equity/average
assets 6.20% 6.02% 6.02% 5.94% 6.27% 6.11% 6.35%
ASSET QUALITY RATIOS:
Non-performing
loans to total
gross loans 0.86% 0.93% 0.99% 1.14% 2.35% 0.55% 0.39%
Non-performing
assets to total
assets 0.69% 0.59% 0.64% 0.66% 1.32% 0.34% 0.22%
Net loan charge-offs
to average total
loans 0.02% 0.04% 0.05% 0.05% 0.08% 0.10% 0.01%
Allowance for loan
losses to total
gross loans at
period end 1.39% 1.27% 1.29% 1.22% 1.08% 0.96% 0.99%
Allowance for loan
losses to
non-performing loans 161.46% 140.72% 130.67% 107.11% 45.83% 176.27% 252.11%
(a) The weighted average number of shares outstanding was computed based on the
average number of shares outstanding during each period as adjusted for
subsequent stock dividends
(b) Cash dividends per common share are based on the actual number of common
shares outstanding on the dates
(c) Efficiency ratio is total other expenses divided by the sum of net interest
income and total other income.
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RISK FACTORS
You should carefully consider the following risk factors and all other
information contained in this prospectus before subscribing for shares of our
common stock. Investing in our common stock involves risks. The risks and
uncertainties described below are not the only ones we face. Additional risks
and uncertainties not presently known to us or that we currently believe are
immaterial also may impair our business. If any of the events described in the
following risk factors occur, our business, results of operations and financial
condition could be materially adversely affected. In addition, the trading price
of our common stock could decline due to any of the events described in these
risks.
You should be aware that certain statements in this prospectus are
forward-looking and are identified by the use of forward-looking words or
phrases such as "intended," "will be positioned," "believed," "expects," is or
are "expected" or "anticipated." These forward-looking statements are based on
our current expectations.
OUR EARNINGS MAY NOT CONTINUE TO GROW IF WE ARE UNABLE TO SUCCESSFULLY ATTRACT
CORE DEPOSITS AND LENDING OPPORTUNITIES AND EXPLOIT OPPORTUNITIES TO GENERATE
FEE-BASED INCOME.
We have experienced significant growth, and our future business strategy is to
continue to expand. Historically, the growth of our loans and deposits has been
the principal factor in our increase in net interest income. In the event that
we are unable to execute our business strategy of continued growth in loans and
deposits, our earnings could be adversely impacted. Our ability to continue to
grow depends, in part, upon our ability to expand our market share, successfully
attract core deposits, and identify loan and investment opportunities as well as
opportunities to generate fee-based income. Our ability to manage growth
successfully will also depend on whether we can continue to efficiently fund
asset growth and maintain asset quality and cost controls, as well as on factors
beyond our control, such as economic conditions and interest rate trends.
OUR GROWTH-ORIENTED BUSINESS STRATEGY COULD BE ADVERSELY AFFECTED IF WE ARE NOT
ABLE TO ATTRACT AND RETAIN SKILLED EMPLOYEES AND MANAGE OUR EXPENSES.
We expect to continue to experience growth in the scope of our operations and
correspondingly in the number of our employees and customers. We may not be able
to successfully manage our business as a result of the strain on our management
and operations that may result from this growth. Our ability to manage this
growth will depend upon our ability to continue to attract, hire and retain
skilled employees. Our success will also depend on the ability of our officers
and key employees to continue to implement and improve our operational and other
systems, to manage multiple, concurrent customer relationships and to hire,
train and manage our employees.
WE DEPEND ON OUR EXECUTIVE OFFICERS AND KEY PERSONNEL TO IMPLEMENT OUR BUSINESS
STRATEGY AND COULD BE HARMED BY THE LOSS OF THEIR SERVICES.
We believe that our growth and future success will depend in large part upon the
skills of our management team, Donald L. Kovach, our President and Chief
Executive Officer and the bank's Chief Executive Officer, Terry Thompson, the
bank's President and Chief Operating Officer, George Harper and George Lista,
the senior management of our Tri-State Insurance Agency, Inc. subsidiary, Samuel
Chazanow, the head of our mortgage lending and banking division, Tammy Case, our
Executive Vice President - Loan Administration and Candace Leatham, our
Executive Vice President - Chief Financial Officer. The competition for
qualified personnel in the financial services industry is intense, and the loss
of our key personnel or an inability to continue to attract, retain and motivate
key personnel could adversely affect our business. We cannot assure you that we
will be able to retain our existing key personnel or to attract additional
qualified personnel. Although we have employment agreements with all of our
executive officers, other than Ms. Leatham, that contain non-compete provisions,
the loss of the services of one or more of our executive officers could impair
our operations. See "Management - Employment Agreements" on page 50.
OUR FAILURE TO ADAPT TO TECHNOLOGICAL CHANGES AND USE TECHNOLOGY TO PROVIDE
PRODUCTS AND SERVICES THAT ARE DESIRED BY CUSTOMERS MAY ADVERSELY EFFECT OUR
BUSINESS.
Many of the bank's competitors have substantially greater resources to invest in
technological improvements and have more experience in managing technological
change. Adoption of rapid technological changes by the banking
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industry or the bank's customers could put the bank at a competitive
disadvantage if we do not have the capital or personnel necessary to implement
such changes.
THERE IS A LIMITED TRADING MARKET FOR OUR COMMON STOCK, AND THIS MAY LIMIT
RESALE OF THE COMMON STOCK OR CAUSE PRICE VOLATILITY.
Although our common stock is listed on the American Stock Exchange under the
symbol "SBB", trading volume is extremely limited. There is no assurance that
you will be able to resell your shares of common stock for an aggregate amount
per share that is equal to or more than the price in the offering should you
need to liquidate your investment. Because our stock is thinly traded, small
transactions could cause volatility in our stock price. Before purchasing, you
should consider the limited trading market for the shares and be financially
prepared and able to hold your shares for an indefinite period and endure
volatility in our stock price. See "Market for the Common Stock" on page 14.
RISKS RELATED TO THE OFFERING:
IN THE FUTURE, WE MAY NEED TO ISSUE ADDITIONAL SHARES OF COMMON STOCK OR
SECURITIES CONVERTIBLE INTO COMMON STOCK TO RAISE ADDITIONAL CAPITAL. IF WE ARE
ABLE TO SELL SUCH SHARES, THEY MAY BE ISSUED AT A PRICE THAT DILUTES THE BOOK
VALUE OF SHARES OUTSTANDING AT THAT TIME.
Although this offering will increase the book value per share of our outstanding
common stock, future offerings may be at a price that dilutes the book value of
shares outstanding at that time. Any need to raise additional capital would most
likely be caused by our regulatory capital requirements. Our future capital
requirements will depend on many factors including:
o the growth in the bank's interest-earning assets;
o loan quality;
o the cost of deposits and any necessary borrowings; and
o the costs associated with our growth, such as increased salaries
and employee benefits expense and office and occupancy costs.
If these or other factors cause the bank's capital levels to fall below the
minimum regulatory requirements, or if the bank's existing sources of cash from
operations are insufficient to fund its activities or future growth plans, we
may need to raise additional capital. If such need arises and we are unable to
raise capital, we may not be able to continue our growth strategy and management
will be required to reorient our long-term strategy for the company. There can
be no assurance that we will be able to generate or attract additional capital
in the future on favorable terms. In addition, future issuances of stock may
cause dilution in our earnings per share and will dilute your ownership
interest.
MANAGEMENT'S USE OF THE PROCEEDS OF THIS OFFERING COULD LOSE VALUE FOR THE
COMPANY AND ADVERSELY AFFECT YOUR INVESTMENT.
Management will have broad discretion with respect to the expenditures of the
net proceeds of this offering and, accordingly, there is no assurance that you
will agree with the uses that we choose to make of these funds. You must rely
upon the judgment of our management regarding the application of the proceeds of
this offering. The net proceeds may be used for corporate purposes that do not
improve our earnings or increase our share price. Pending application of the net
proceeds from this offering, they may be placed in investments that do not
produce income or that lose value. See "Use of Proceeds" on page 13.
OUR CURRENT MANAGEMENT WILL HAVE SIGNIFICANT CONTROL OF THE COMPANY AFTER THE
OFFERING AND WILL BE IN A POSITION TO BLOCK TAKEOVER ATTEMPTS THAT THEY OPPOSE.
Following completion of the offering, our senior officers and directors and
their affiliates will own approximately 17.7% of the outstanding common stock.
As a result, in addition to their day-to-day management roles, our senior
9
officers and directors will be able to exercise significant influence on our
business as shareholders, including influence over election of members of our
Board of Directors and the authorization of other corporate actions requiring
shareholder approval. By voting against a proposal submitted to shareholders,
the directors and senior officers, as a group, may be able to make approval more
difficult for proposals requiring the vote of shareholders, such as some
mergers, share exchanges, asset sales and amendments to the company's
certificate of incorporation.
PROVISIONS UNDER NEW JERSEY LAW, IN OUR CHARTER DOCUMENTS AND OTHER LAWS AND
REGULATIONS APPLICABLE TO US MAY MAKE IT MORE DIFFICULT FOR THIRD PARTIES TO
OBTAIN CONTROL OF THE COMPANY EVEN THOUGH SOME SHAREHOLDERS MIGHT FAVOR SUCH A
DEVELOPMENT.
Provisions of our certificate of incorporation and applicable provisions of New
Jersey law and federal law may delay, inhibit or prevent someone from gaining
control of the company through a tender offer, business combination, proxy
contest or some other method even though some of our shareholders might believe
that a change in control in desirable. For example, our certificate of
incorporation provides for a classified board of directors divided into three
classes serving for successive terms of three years each. Such a provision
serves to entrench management and may discourage a takeover attempt that you
consider to be in your best interest or in which you would receive a substantial
premium over the current market price. See "Anti-Takeover Provisions" on page
55.
RISKS RELATED TO THE BANKING INDUSTRY:
THE SECURITIES OF THE COMPANY ARE NOT FDIC INSURED AND YOU COULD LOSE YOUR
INVESTMENT.
The securities of the company are not savings or deposit accounts or other
obligations of any bank and are not insured by the Federal Deposit Insurance
Corporation, the Bank Insurance Fund or any other governmental agency and are
subject to investment risk, including the possible loss of principal, and you
must be capable of enduring the loss of your entire investment.
WE MAY BE SUBJECT TO HIGHER OPERATING COSTS AS A RESULT OF GOVERNMENT
REGULATION.
We are subject to extensive federal and state legislation, regulation and
supervision that are intended primarily to protect depositors and the Federal
Deposit Insurance Corporation's Bank Insurance Fund, rather than investors.
Legislative and regulatory changes may increase our cost of doing business or
otherwise adversely affect us and create competitive advantages for non-bank
competitors. For more information, see "Supervision and Regulation" on page 56.
OUR BUSINESS MAY BE ADVERSELY AFFECTED BY CHANGES IN LAWS OR REGULATIONS ENACTED
FOR THE PROTECTION OF DEPOSITORS AND THE PUBLIC.
We can give no assurance that future changes in laws and regulations or changes
in their interpretation will not adversely affect our business. The federal and
state laws and regulations applicable to our operations give regulatory
authorities extensive discretion in connection with their supervisory and
enforcement responsibilities, and generally have been promulgated to protect
depositors and the deposit insurance funds and not for the purpose of protecting
shareholders. These laws and regulations can materially affect our future
business. Laws and regulations now affecting us may be changed at any time, and
the interpretation of such laws and regulations by bank regulatory authorities
is also subject to change.
WE ARE IN COMPETITION WITH MANY OTHER BANKS, INCLUDING LARGER COMMERCIAL BANKS
THAT HAVE GREATER RESOURCES, WHICH MAY ADVERSELY AFFECT OUR ABILITY TO GROW AND
OPERATE PROFITABLY.
The banking industry within the New Jersey-New York metropolitan area is highly
competitive. Although we believe that we have been and will continue to be able
to compete effectively with our competition due to our experienced management
and personalized service, if we are wrong, our ability to grow and operate
profitably may be negatively affected.
The bank's principal market area is served by branch offices of large commercial
banks and thrift institutions. We also face competition from other companies
that provide financial services, including consumer loan companies, credit
unions, mortgage brokers, insurance companies, securities brokerage firms, money
market mutual funds,
10
internet banks and private lenders. In addition, in November of 1999, the
Gramm-Leach-Bliley Financial Modernization Act of 1999 (the "GLB Act") was
passed into law. Among other things, the GLB Act permits insurance companies and
securities firms to acquire or form financial institutions, thereby further
increasing the competition we face. A number of our competitors have
substantially greater resources to expend on advertising and marketing than we
do, and their substantially greater capitalization enables them to make much
larger loans. Our success depends a great deal on our belief that large and
mid-size financial institutions do not adequately serve individuals and small
businesses in our principal market area and on our ability to compete favorably
for such customers. In addition to competition from larger institutions, we also
face competition for individuals and small businesses from recently formed banks
seeking to compete as "home town" institutions. Most of these new institutions
have focused their marketing efforts on the smaller end of the small business
market we serve.
OUR EARNINGS MAY BE ADVERSELY AFFECTED BY CHANGES IN INTEREST RATES.
We may not be able to effectively manage changes in interest rates that affect
what we charge as interest on our earning assets and the expense we must pay on
interest-bearing liabilities, which may significantly reduce our earnings. In
addition, there are costs associated with our risk management techniques, and
these costs could be material. Fluctuations in interest rates are not
predictable or controllable and, therefore, there can be no assurances of our
ability to continue to maintain a consistent positive spread between the
interest earned on our earning assets and the interest paid on our
interest-bearing liabilities. For more information, see "Financial Condition -
Interest Rate Sensitivity" on page 34.
IF THE BANK EXPERIENCES GREATER LOAN LOSSES THAN ANTICIPATED, IT WILL HAVE AN
ADVERSE EFFECT ON OUR NET INCOME AND OUR ABILITY TO FUND OUR GROWTH STRATEGY.
The risk of nonpayment of loans is inherent in banking. If we experience greater
nonpayment levels than anticipated, our earnings and overall financial
condition, as well as the value of our common stock, could be adversely
affected.
We cannot assure you that our monitoring, procedures and policies will reduce
certain lending risks or that our allowance for loan losses will be adequate to
cover actual losses. Loan losses can cause insolvency and failure of a financial
institution and, in such an event, our shareholders could lose their entire
investment. In addition, future provisions for loan losses could materially and
adversely affect our results of operations. Any loan losses will reduce the loan
loss reserve. A reduction in the loan loss reserve will be restored by an
increase in our provision for loan losses. This will cause our earnings to be
reduced and reduced earnings could have an adverse effect on our stock price.
RECENT LEGISLATION TO ADDRESS CORPORATE ACCOUNTING IRREGULARITIES WILL CAUSE US
TO INCUR SIGNIFICANT EXPENSE.
In response to highly publicized accounting restatements and alleged
improprieties by some corporate officers of certain large publicly-held
companies, in July 2002, President Bush signed into law the Sarbanes-Oxley Act
of 2002. Additional regulations have been promulgated by the Securities and
Exchange Commission (the "SEC") and were effective beginning August 29, 2002.
Under this law and the regulations adopted by the SEC to implement various
provisions of the law, publicly-traded companies are subject to significant
additional and accelerated reporting regulations and disclosure. These
regulations also impose significant new responsibilities on officers, auditors,
boards of directors and in particular, audit committees. Compliance with the new
laws and regulations has begun to increase our expenses; this could have a
material adverse effect on our financial results in the future. For more
information, see "Sarbanes-Oxley Act" on page 58.
11
FORWARD-LOOKING STATEMENTS
This prospectus contains forward-looking statements within the meaning of
Section 27A of the Securities Act of 1933, as amended. These forward-looking
statements are not historical facts, but rather are predictions and generally
can be identified by use of statements that include phrases such as "believe,"
"expect," "anticipate," "estimate," "intend," "plan," "foresee" or other words
or phrases of similar import. Similarly, statements that describe our future
financial condition, results of operations, objectives, plans, goals or future
performance and business also are forward-looking statements. These
forward-looking statements involve known and unknown risks, uncertainties and
other facts, including those described in the "Risk Factors" and the
"Management's Discussion and Analysis of Financial Condition and Results of
Operations" sections and other parts of this prospectus that could cause our
actual results to differ materially from those anticipated in these
forward-looking statements.
Important facts that may cause actual results to differ from those contemplated
by forward-looking statements include, for example:
o the success or failure of our efforts to implement our business
strategy;
o the effect of changing economic conditions;
o changes in government regulations, tax rates and similar
matters;
o our ability to attract and retain quality employees; and
o other risks which may be described in our future filings with
the SEC.
We do not promise to update forward-looking information to reflect actual
results or changes in assumptions or other factors that could affect those
statements other than material changes to such information.
12
USE OF PROCEEDS
We estimate that the net proceeds from the sale of the 983,609 shares that we
are offering will be approximately $13.1 million, assuming an offering price of
$14.25 per share and deductions of estimated sales commissions and offering
expenses of approximately $958 thousand.
We intend to immediately use approximately one-half of the net proceeds as an
equity contribution to the bank. The bank will use this additional capital to
(i) expand the bank's loan and investment portfolios and (ii) to provide
regulatory capital to support the bank's growth and additional branch locations.
The remainder of the proceeds will be held by the company and used to fund
growth through potential acquisitions, for general corporate purposes and to
provide additional equity contributions to support the bank's growth. Until used
in these ways, the proceeds retained by the company will be invested in short
term United States Treasury and governmental agency debt.
At the current time, we do not have any agreements nor are we engaged in any
negotiations to make any acquisitions, but we are constantly evaluating
opportunities to do so.
We believe the net proceeds from this offering will support our business plan
for at least eighteen (18) months.
13
MARKET FOR THE COMMON STOCK
Our common stock trades on the American Stock Exchange, under the symbol
"SBB". As of December 31, 2003, the company had approximately 699 holders of
record of the common stock.
The following table shows the high and low closing price, by quarter,
for the common stock, as well as dividends declared, for the last two fiscal
years:
2004 HIGH CLOSING PRICE: LOW CLOSING PRICE: DIVIDENDS DECLARED:
---- ------------------ ----------------- -------------------
4th Quarter $16.00 $13.78 $0.070
(through December 15, 2004)
3rd Quarter $17.20 $15.20 $0.070
2nd Quarter $20.95 $16.20 $0.070
1st Quarter $18.87 $15.80 $0.070
2003 HIGH CLOSING PRICE: LOW CLOSING PRICE: DIVIDENDS DECLARED:
---- ------------------ ----------------- -------------------
4th Quarter $16.71 $13.50 $0.000
3rd Quarter $15.30 $11.70 $0.067
2nd Quarter $12.20 $10.25 $0.067
1st Quarter $10.70 $10.15 $0.067
2002 HIGH CLOSING PRICE: LOW CLOSING PRICE: DIVIDENDS DECLARED:
---- ------------------ ----------------- -------------------
4th Quarter $11.70 $10.20 $0.067
3rd Quarter $10.97 $10.55 $0.057
2nd Quarter $10.82 $10.60 $0.057
1st Quarter $10.68 $ 9.97 $0.057
In addition to the cash dividends disclosed above, the company distributed a 5%
stock dividend in November 2003. The market prices and dividends disclosed above
have been restated to reflect this stock dividend.
14
CAPITALIZATION
The following table sets forth our consolidated capitalization as of September
30, 2004, on an actual basis and on a pro forma basis as adjusted to give effect
to this offering, at an offering price of $14.25 per share and no exercise of
the underwriter's over-allotment option. You should read this information
together with our consolidated financial statements and related notes, which are
included elsewhere in this prospectus.
SEPTEMBER 30, 2004
ACTUAL AS ADJUSTED
------ -----------
(DOLLARS IN THOUSANDS, EXCEPT
PER SHARE DATA)
Long-term debt:
Borrowings - FHLB $10,000 $10,000
Junior subordinated debentures 5,155 5,155
-----------------------------------
Total Long-term debt $15,155 $15,155
-----------------------------------
Stockholders' equity:
Common stock, no par value, per share, 5,000,000 shares authorized, $9,987 $23,045
1,842,188 shares outstanding and 2,825,797 shares outstanding as adjusted
Retained earnings 5,821 5,821
Accumulated other comprehensive income 378 378
-----------------------------------
Total Stockholders' Equity: $16,186 $29,244
-----------------------------------
Total Capitalization $31,341 $44,399
================ ===============
The company and the bank both meet the capitalization standards applicable to
them under federal regulations. The following table sets forth our capital
ratios as of September 30, 2004, and as adjusted to give effect, after deducting
offering expenses, to the sale of the common stock offered by this prospectus,
as well as the minimum required regulatory capital.
AMOUNT RATIO
ACTUAL: ADJUSTED: ACTUAL: ADJUSTED: MINIMUM RATIO:
------- --------- ------- --------- --------------
The company:
Leverage Capital $18,203 $31,261 7.35% 11.99% 4%
Tier 1 - Risk Based $18,203 $31,261 10.79% 18.26% (1) 4%
Total Risk Based $20,283 $33,341 12.02% 19.48% (1) 8%
The bank:
Leverage Capital $17,638 $24,167 (2) 7.13% 9.51% 4%
Tier 1 - Risk Based $17,638 $24,167 (2) 10.49% 14.27% (1) 4%
Total Risk Based $19,718 $26,247 (2) 11.72% 15.50% (1) 8%
(1) Assumes net proceeds of the offering are invested in assets with a 20% risk
weighting.
(2) Assumes one-half of net proceeds are contributed to the bank.
15
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
THE FOLLOWING PRESENTS MANAGEMENT'S DISCUSSION AND ANALYSIS OF OUR FINANCIAL
CONDITION AND RESULTS OF OPERATIONS AND SHOULD BE READ IN CONJUNCTION WITH THE
FINANCIAL STATEMENTS AND RELATED NOTES INCLUDED ELSEWHERE IN THIS PROSPECTUS.
THIS DISCUSSION CONTAINS FORWARD-LOOKING STATEMENTS THAT INVOLVE RISKS AND
UNCERTAINTIES. OUR ACTUAL RESULTS COULD DIFFER SIGNIFICANTLY FROM THOSE
ANTICIPATED IN THESE FORWARD-LOOKING STATEMENTS AS A RESULT OF VARIOUS FACTORS,
INCLUDING THOSE DISCUSSED IN "RISK FACTORS" BEGINNING ON PAGE 8 AND
"FORWARD-LOOKING STATEMENTS" ON PAGE 12 IN THIS PROSPECTUS. ALL PER SHARE DATA
HAS BEEN ADJUSTED TO GIVE RETROACTIVE EFFECT TO THE 5.0% STOCK DIVIDENDS PAID IN
JULY 2000 AND NOVEMBER 2003.
CRITICAL ACCOUNTING POLICIES
Our accounting policies are fundamental to understanding Management's Discussion
and Analysis of Financial Condition and Results of Operations. Our accounting
policies are more fully described in Note 1 of the Notes to Consolidated
Financial Statements for December 31, 2003 included herein. The preparation of
financial statements in conformity with generally accepted accounting principles
requires management to make estimates and assumptions about future events that
affect the amounts reported in our consolidated financial statements and
accompanying notes. Since future events and their effect cannot be determined
with absolute certainty, actual results may differ from those estimates.
Management makes adjustments to its assumptions and judgments when facts and
circumstances dictate. The amounts currently estimated by us are subject to
change if different assumptions as to the outcome of future events were made. We
evaluate our estimates and judgments on an ongoing basis and predicate those
estimates and judgments on historical experience and on various other factors
that are believed to be reasonable under the circumstances. Management believes
the following critical accounting policies encompass the more significant
judgments and estimates used in preparation of our consolidated financial
statements.
ALLOWANCE FOR LOAN LOSSES. The provision for loan losses charged to operating
expense reflects the amount deemed appropriate by management to provide for
known and inherent losses in the existing loan portfolio. Management's judgment
is based on the evaluation of individual loans, past experience, the assessment
of current economic conditions, and other relevant factors. Loan losses are
charged directly against the allowance for loan losses and recoveries on
previously charged-off loans are added to the allowance.
Management uses significant estimates to determine the allowance for loan
losses. Consideration is given to a variety of factors in establishing these
estimates including current economic conditions, diversification of the loan
portfolio, delinquency statistics, borrowers' perceived financial and managerial
strengths, the adequacy of underlying collateral, if collateral dependent, or
present value of future cash flows, and other relevant factors. Since the
sufficiency of the allowance for loan losses is dependent, to a great extent on
conditions that may be beyond our control, it is possible that management's
estimates of the allowances for loan losses and actual results could differ in
the near term. Although we believe that we use the best information available to
establish the allowance for loan losses, future additions to the allowance may
be necessary if certain future events occur that cause actual results to differ
from the assumptions used in making the evaluation. For example, a downturn in
the local economy could cause increases in non-performing loans. Additionally, a
decline in real estate values could cause some of our loans to become
inadequately collateralized. In either case, this may require us to increase our
provisions for loan losses, which would negatively impact earnings.
Additionally, a large loss could deplete the allowance and require increased
provisions to replenish the allowances, which would negatively affect earnings.
In addition, regulatory authorities, as an integral part of their examination,
periodically review the allowance for loan losses. They may require additions to
the allowance based upon their judgments about information available to them at
the time of examination. Future increases to our allowance for loan losses,
whether due to unexpected changes in economic conditions or otherwise, would
adversely affect our future results of operations.
Historically, our estimates and assumptions have provided results that did not
differ materially from actual results. For example, net charge-offs were $29
thousand for the nine months ended September 30, 2004 and $57 thousand for each
of the years ended December 31, 2003 and 2002. The provision for each of these
periods was $373 thousand, $405 thousand and $300 thousand, respectively.
Additionally, net charge-offs to average loans for the
16
nine months ended September 30, 2003 and for the years 2003 and 2002 were 0.02%,
0.05% and 0.05% respectively. The difference between our provisions and our net
charge offs reflects loan growth and management's judgment of the value of known
or inherent risks in our loan portfolio.
STOCK-BASED COMPENSATION. As permitted by Statement of Financial Accounting
Standards ("SFAS") No. 123, the company accounts for stock-based compensation in
accordance with Accounting Principals Board Opinion ("APB") No. 25. Under APB
No. 25, no compensation expense is recognized in the income statement related to
any option granted under the company stock option plans. The pro forma impact to
net income and earnings per share that would occur if compensation expense was
recognized, based on the estimated fair value of the options on the date of the
grant, is disclosed in the notes to the consolidated financial statements. The
company intends to continue to account for stock-based compensation in this
manner unless there is more specific guidance issued by the Financial Accounting
Standards Board ("FASB") or unless a clear consensus develops in the financial
services industry on the application of accounting methods.
On March 31, 2004, the Financial Accounting Standards Board issued an Exposure
Draft, Share-based Payment, which is a proposed amendment to SFAS No. 123. The
Exposure Draft would eliminate the ability to account for share-based
compensation transactions using APB No. 25, and generally would require all
share-based payments to employees, including grants of employee stock options,
to be recognized as an expense in the income statement at their grant-date fair
values. The stock-based compensation expense, net of tax, that would have been
included in the determination of net income if the fair value based method
computed using the Black-Scholes option pricing model had been applied to all
awards totaled $103 thousand and $32 thousand for the nine months ended
September 30, 2004 and 2003, respectively, and $47 thousand and $23 thousand for
the years ended December 31, 2003 and 2002, respectively. See also Note 1 of the
Notes to the Consolidated Financial Statements of December 31, 2003 and Note 5
of the Notes to the Consolidated Financial Statements for September 30, 2004
included herein.
Assuming adoption of the new guidance on July 1, 2005, compensation expense, net
of tax, related to outstanding stock option grants as of September 30, 2004 that
are being recognized over the vesting period is estimated to be $51 thousand in
2005, $94 thousand in 2006 and $51 thousand in 2007. The estimate is based on
the fair value of option grants computed using the Black-Scholes option pricing
model. FASB expects to issues its final standard in the fourth quarter of 2004.
GOODWILL. The company has recorded goodwill of $2.1 million at September 30,
2004 related to the acquisition of Tri-States Insurance Agency on October 1,
2001. The company performs its annual goodwill impairment test in the fourth
quarter of each calendar year. A fair value is determined for the reporting
unit, the insurance agency. If the fair value of the reporting unit exceeds the
book value, no write-down of goodwill is necessary. If the fair value is less
than the book value, an additional test is necessary to assess the proper
carrying value of goodwill. The company determined that no impairment write-offs
were necessary during 2003 and 2002.
Business unit valuation is inherently subjective, with a number of factors based
on assumptions and management judgments. Among these are future growth rates,
discount rates and earnings capitalization rates. Changes in assumption and
results due to economic conditions, industry factors and reporting unit
performance could result in different assessments of the fair value and could
result in impairment charges in the future. No events have occurred since the
2003 annual impairment test that indicate potential for impairment.
INVESTMENT SECURITIES IMPAIRMENT EVALUATION. Management evaluates securities for
other-than-temporary impairment at least on a quarterly basis, and more
frequently when economic or market concerns warrant such evaluation.
Consideration is given to (1) length of time and the extent to which the fair
value has been less than cost, (2) the financial condition and near-term
prospects of the issuer, and (3) the intent and ability of the company to retain
its investment in the issuer for a period of time sufficient to allow for any
anticipated recovery in fair value.
In March, 2004, the FASB's Emerging Issues Task Force ("EITF") reached a
consensus on EITF Issue No., 03-1, "The Meaning of Other-Than-Temporary
Impairment and Its Application to Certain Investments" ("EITF 03-1"). EITF 03-1
provides guidance regarding the meaning of other-than-temporary impairment and
its application to investments classified as either available-for-sale or
held-to-maturity under FASB Statement No. 115, "Accounting for Certain
Investments in Debt and Equity Securities", and to equity securities accounted
for under the cost method.
17
Included in EITF 03-1 is guidance on how to account for impairments that are
solely due to interest rate changes, including changes resulting from increases
in sector credit spreads. This guidance was to become effective for reporting
periods beginning after June 15, 2004. However, on September 30, 2004, the FASB
issued a Staff Position that delays the effective date for the recognition and
measurement guidance of EITF 03-1 until additional clarifying guidance is
issued. This additional guidance is expected to be issued during and be
effective for the fourth quarter of 2004. We are not able to assess the impact
of the adoption of EITF 03-1 until final guidance is issued.
RESULTS OF OPERATIONS
SEPTEMBER 30, 2004 AS COMPARED TO SEPTEMBER 30, 2003:
For the nine months ended September 30, 2004, net income was $1.2 million, an
increase of $176 thousand, or 17.8%, from the $989 thousand reported for the
same period in 2003. Basic earnings per share were $0.64 for the nine months
ended September 30, 2004 compared to $0.55 for the nine-month period ended
September 30, 2003, an increase of 16.4%. Diluted earnings per share were $0.61
for the nine months ended September 30, 2004 compared to $0.54 from the first
nine months of 2003, an increase of 13.0%.
The results reflect an increase in net interest income, a result of both
increasing interest income and decreasing interest expense, coupled with
increases in non-interest income, primarily due to an increase in mortgage
banking fees from our residential lending division, partially offset by
increases in non-interest expenses associated with additions to staff and higher
related salary and benefit expenses.
INTEREST INCOME
Total interest income increased $368 thousand, or 14.1%, to $3.0 million for the
quarter ended September 30, 2004 from $2.6 million for the same period in 2003.
This increase was primarily attributable to an increase of $157 thousand, or
24.5%, in interest on securities on a fully taxable equivalent basis from the
third quarter of 2003 to the same period in 2004. While the average balance of
total securities decreased $848 thousand, the average rate earned increased 88
basis points, from 3.34% for the three months ended September 30, 2003 to 4.22%
for the quarter ended September 30, 2004. The decrease in the total securities
portfolio reflects the reallocation of funds to meet increasing loan demand. The
increase in yield was accomplished through selling $7.3 million in lower
yielding securities and purchasing $6.9 million in higher yielding securities,
combined with the slowing of prepayments on mortgage-backed securities during
the third quarter of 2004. Comparing the average balance in the loan portfolio
for the quarter ended September 30, 2003 to the same quarter in 2004, the
average balance in loans increased $17.7 million, or 13.9%, while the interest
earned on total loans increased $224 thousand, or 11.0%. The average rate earned
on loans decreased 15 basis points from 6.33% for the quarter ended September
30, 2003 to 6.18% for the same period in 2004, as customers have refinanced and
locked in lower fixed rate loans during a time of historically low market
interest rates.
For the nine months ended September 30, 2004, interest income increased $596
thousand, or 7.5%, to $8.6 million from the $8.0 million reported for the same
period in 2003. Total average interest-earning assets increased $12.6 million,
or 5.9%, to $223.8 million from $211.3 million, as average loan balances
increased $19.2 million, or 15.7%, and average other interest earning assets
decreased $6.2 million, or 43.6% from the first nine months of 2003 to the same
period in 2004. This repositioning of average balances in higher yielding loans
has increased the average rate earned 9 basis points from 5.20% in the first
nine months of 2003 to 5.29% in the same period in 2004.
The increases in our loan portfolio in both the three and nine month periods
reflects our continuing efforts to enhance our loan origination capacity. In
particular, we have enhanced our loan department through the hiring of
additional lending staff and originators.
INTEREST EXPENSE
The company's interest expense for the third quarter of 2004 stayed stable
compared to the third quarter of 2003, increasing $8 thousand to $689 thousand
from $681 thousand in the third quarter of 2003 as the average balance of
18
interest bearing liabilities increased $12.7 million, or 6.9% to $197.7 million
in the current third quarter from $185.0 million during the same year ago
period. This was accomplished through a 7 basis point reduction in the average
rate paid on interest bearing liabilities from 1.46% for the three months ending
September 30, 2003 to 1.39% for the same period in 2004. Growth in interest
bearing deposits of $14.3 million was offset by a net reduction of $1.6 million
in other interest bearing liabilities. Average money market deposits increased
$13.0 million, or 367.8%, while the average rate paid increased 65 basis points
from 0.56% in the third quarter of 2003 to 1.21% in the third quarter of 2004.
Several large municipal accounts transferred balances from our public fund NOW
account to a newly offered public fund money market account. This account
permits customers to automatically transfer excess funds from non-interest
bearing transaction accounts into a variable rate interest bearing money market
account. The company believes this account will provide an alternative to higher
rate time deposits traditionally used to attract public deposits. To initially
attract municipal accounts, a higher incentive rate was offered on the public
fund money market account. As municipal balances were transferred from NOW
accounts, the NOW accounts average balance decreased $3.3 million, or 7.2%, in
the current third quarter compared to the year ago third quarter. Average
borrowed funds decreased $1.8 million, or 14.6%, to $10.5 million in the third
quarter of 2004 from $12.3 million in the third quarter of 2003, due to the
maturity of advances from the Federal Home Loan Bank ("FHLB"). At September 30,
2004, the company's borrowed funds consisted of three convertible notes from the
FHLB totaling $10.0 million. In the third quarter of 2002, the company issued
$5.2 million in junior subordinated debentures. The debentures bear a floating
rate of interest, which averaged 5.05% in the third quarter of 2004, up 28 basis
points from 4.77% in the third quarter of 2003.
For the nine months ended September 30, 2004 interest expense decreased $155
thousand, or 7.0%, to $2.0 million from $2.2 million for the first nine months
of 2003, as the balance in average interest-bearing liabilities increased $12.0
million, or 6.5% to $196.6 million from $184.6 million between the same two
periods. The average rate paid on total interest-bearing liabilities has
decreased by 20 basis points from 1.59% for the first nine months of 2003 to
1.39% for the same period in 2004. The reduction in rates reflects both a
restructuring of the deposit portfolio, as lower costing total interest bearing
deposit balances have increased and higher costing net other interest bearing
liabilities have decreased, and current lower market rates of interest.
The following table presents, on a fully taxable equivalent basis, a summary of
the company's interest-earning assets and their average yields, and
interest-bearing liabilities and their average costs and shareholders' equity
for the nine months ended September 30, 2004 and 2003. The average balance of
loans includes non-accrual loans, and associated yields include loan fees, which
are considered adjustment to yields.
NINE MONTHS ENDED NINE MONTHS ENDED
(DOLLARS IN THOUSANDS) SEPTEMBER 30, 2004 SEPTEMBER 30, 2003
--------------------------------------------------------------------------------------------------------------------------
EARNING ASSETS:
AVERAGE INTEREST AVERAGE AVERAGE INTEREST AVERAGE
BALANCE (1) RATE (2) BALANCE (1) RATE (2)
--------------------------------------------------------------------------------------------------------------------------
Securities:
Tax exempt (3) $22,109 $905 5.47% $17,804 $755 5.67%
Taxable 52,691 1,368 3.47% 57,378 1,328 3.10%
--------------------------------------------------------------------------------------------------------------------------
Total securities 74,800 2,273 4.06% 75,182 2,083 3.70%
Total loans receivable (4) 140,980 6,522 6.18% 121,824 6,008 6.59%
Other interest-earning assets 8,044 71 1.17% 14,263 131 1.22%
--------------------------------------------------------------------------------------------------------------------------
Total earning assets 223,824 $8,866 5.29% 211,269 $8,222 5.20%
Non-interest earning assets 25,012 21,520
Allowance for loan losses (1,899) (1,526)
----------------------------------------------------- -----------
Total Assets $246,937 $231,263
===================================================== ===========
Sources of Funds:
Interest bearing deposits:
NOW $45,671 $152 0.45% $44,786 $190 0.57%
Money market 11,392 93 1.09% 4,044 23 0.76%
Time 57,051 891 2.09% 52,892 958 2.42%
Savings 66,505 324 0.65% 64,586 403 0.83%
19
NINE MONTHS ENDED NINE MONTHS ENDED
(DOLLARS IN THOUSANDS) SEPTEMBER 30, 2004 SEPTEMBER 30, 2004
--------------------------------------------------------------------------------------------------------------------------
INTEREST BEARING LIABILITIES:
AVERAGE INTEREST AVERAGE AVERAGE INTEREST AVERAGE
BALANCE (1) RATE (2) BALANCE (1) RATE (2)
--------------------------------------------------------------------------------------------------------------------------
Total interest bearing deposits 180,619 1,460 1.08% 166,308 1,574 1.27%
Borrowed funds 10,832 395 4.79% 13,267 437 4.34%
Junior subordinated debentures 5,155 187 4.78% 5,000 186 4.92%
--------------------------------------------------------------------------------------------------------------------------
Total interest bearing liabilities 196,606 $2,042 1.39% 184,575 $2,197 1.59%
Non-interest bearing liabilities:
Demand deposits 32,923 30,475
Other liabilities 2,100 2,287
----------------------------------------------------- -----------
Total non-interest bearing liabilities 35,023 32,762
Stockholders' equity 15,308 13,926
----------------------------------------------------- -----------
Total Liabilities and Stockholders' Equity $246,937 $231,263
===================================================== ===========
----------------------------------------- ---------------------- ----------------------
Net Interest Income and Margin (5) $6,824 4.07% $6,025 3.81%
========================================= ====================== ======================
(1) Includes loan fee income
(2) Average rates on securities are calculated on amortized costs
(3) Full taxable equivalent basis, using a 39% effective tax rate and adjusted
for TEFRA (Tax and Equity Fiscal Responsibility Act) interest expense
disallowance
(4) Loans outstanding include non-accrual loans
(5) Represents the difference between interest earned and interest paid, divided
by average total interest-earning assets
NET INTEREST INCOME
On a fully taxable equivalent basis, the net interest income for the third
quarter of 2004 increased $371 thousand, or 18.3%, over the same period last
year to $2.3 million from $1.9 million. This increase was largely rate driven,
as the yield on total earning assets increased 37 basis points to 5.41% in the
third quarter of 2004 from 5.04% in the same period of 2003, as the rate paid on
total interest bearing liabilities decreased 7 basis points. The net interest
margin increased, on a fully taxable equivalent basis, by 43 basis points to
4.20% in the third quarter of 2004 compared to 3.77% the year earlier.
Net interest income for the nine months ended September 30, 2004, on a fully
taxable equivalent basis, increased $799 thousand, or 13.2%, to $6.8 million in
the current year period compared to $6.0 million in the same period last year.
The net interest margin increased, on a fully taxable equivalent basis, 26 basis
points from 3.81% for the first nine months of 2003 to 4.07% for the nine months
of 2004. Comparing the first nine months of 2003 to the first nine months of
2004, the increase in the net interest margin was a combination of changes in
rate on securities and interest bearing deposits and changes in volume in total
loans.
The table at the top of the following page reflects the impact on net interest
income of changes in the volume of earning assets and interest bearing
liabilities and changes in rates earned and paid by the Company on such assets
and liabilities. For purposes of this table, nonaccrual loans have been included
in the average loan balance. Changes due to both volume and rate have been
allocated in proportion to the relationship of the dollar amount change in each.
20
NINE MONTHS ENDED SEPTEMBER 30, 2004 V. 2003
INCREASE (DECREASE) DUE TO CHANGE IN:
(DOLLARS IN THOUSANDS) VOLUME RATE TOTAL
------ ---- -----
Securities:
Tax exempt $193 ($43) $150
Taxable (156) 196 40
----------------------------------------------------------------------------------------------------------------------
Total securities (1) 37 153 190
Total loans receivable (2) 1,084 (570) 514
Federal funds sold and time deposits with other banks (55) (5) (60)
----------------------------------------------------------------------------------------------------------------------
Total net change in income on interest-earning assets 1,066 (422) 644
----------------------------------------------------------------------------------------------------------------------
Interest-bearing deposits:
NOW 6 (44) (38)
Money market 57 13 70
Savings 18 (97) (79)
Time 103 (170) (67)
----------------------------------------------------------------------------------------------------------------------
Total interest bearing deposits 184 (298) (114)
Borrowed funds (103) 61 (42)
Junior subordinated debentures 8 (7) 1
----------------------------------------------------------------------------------------------------------------------
Total net change in expense on interest-bearing liabilities 89 (244) (155)
----------------------------------------------------------------------------------------------------------------------
Change in net interest income $977 ($178) $799
======================================================================================================================
(1) Fully taxable equivalent basis, using 39% effective tax rate and adjusted
for the TEFRA (Tax and Equity Fiscal Responsibility Act) interest expense
disallowance.
(2) Includes loan fee income.
PROVISION FOR LOAN LOSSES
For the three months ended September 30, 2004 the provision for loan losses was
$120 thousand compared to $70 thousand for the quarter ended September 30, 2003,
an increase of $50 thousand or 71.4%. The provision for loan losses was $373
thousand for the nine months ended September 30, 2004 as compared to $315
thousand for the same period last year, an increase of $58 thousand or 18.4%.
This increase reflects growth in the company's loan portfolio of $19.2 million
from $129.8 million at September 30, 2003 to $149.0 million at September 30,
2004. Also, during this period there was a change in the composition of the loan
portfolio. Commercial and industrial loans, non-residential real estate loans,
and construction and land development loans increased while one to four family
residential property loans and consumer loans decreased. The provision for loan
losses reflects management's judgment concerning the risks inherent in the
company's existing loan portfolio and the size of the allowance necessary to
absorb the risks, as well as the average balance of the portfolio over both
periods. Management reviews the adequacy of its allowance on an ongoing basis
and will provide additional provisions, as management may deem necessary.
NON-INTEREST INCOME
For the third quarter of 2004, total non-interest income increased by $195
thousand, or 21.3%, to $1.1 million in the third quarter of 2004 from $914
thousand in the same period in 2003. This increase in non-interest income in the
third quarter of 2004 over the third quarter of 2003 is primarily attributable
to an increase of $125 thousand in commission income, to $130 thousand, from the
company's new residential lending division, which began operation in the third
quarter of 2003 and which brokered $10.3 million in loans for funding by third
party investors in the third quarter of 2004 . In addition, an increase of $42
thousand in investment brokerage fees and an increase of $14 thousand in
insurance commissions and fee income earned by the company's insurance
subsidiary contributed to the increase in non-interest income.
For the nine months ended September 30, 2004, non-interest income increased $495
thousand, or 16.9%, to $3.4 million from $2.9 million in the same period in
2003. Most of this increase is from the company's new residential lending
division, which began operations in August of 2003. Mortgage banking fees were
$456 thousand for the first nine months of 2004, compared to $49 thousand for
the same period in 2003. The mortgage banking division brokered $34.0 million in
loans during the nine months ended September 30, 2004. Our mortgage banking
division
21
brokers loans for funding by third party investors, with servicing released to
the investor or its designees. The company began brokering residential mortgages
in August 2003 with the establishment of the residential lending division. Prior
to brokering residential mortgages, the company had been directly originating or
selling closed residential loans and retaining servicing rights. Our brokering
activities have produced a greater volume of loan applications and closings than
did our direct origination activities. Our shift to brokerage activities,
coupled with the greater volume of closings, has produced greater revenue for
our residential mortgage banking division than was produced by our direct
origination activities. See "Business- Lending Activities -Mortgage Banking."
Insurance commissions increased $97 thousand, or 6.1%, to $1.7 million from $1.6
million in the year ago period, and investment brokerage fees increased $25
thousand, or 13.0%, to $217 thousand during the first nine months of 2004
compared to $192 thousand in the same period of 2003. Of the $68 thousand
increase in other income recorded in the first nine month period of 2004 over
the same period of 2003, $57 thousand is from income recorded on a bank owned
life insurance policy purchased in January of 2004.
NON-INTEREST EXPENSE
For the quarter ended September 30, 2004, non-interest expense increased $366
thousand, or 15.4%, to $2.7 million in the current quarter from $2.4 million in
the third quarter of 2003. This increase is attributed to the increase of the
company's salaries and employee benefits of $193 thousand, or 14.1%, for the
addition of nineteen full time equivalent employees and commissions paid on the
residential mortgage banking activity. Occupancy expense has increased $71
thousand, or 46.1%, from third quarter of 2003 to the same period in 2004, due
to a new lease agreement for administrative and operations office space at
Sterling Plaza, Franklin, New Jersey, which is being rented to accommodate the
company's growth and expansion needs. Furniture and equipment expense has
increased $48 thousand from the third quarter of 2003 to the same period in 2004
from the purchase of computer hardware and software made in connection with a
major hardware upgrade and system conversion in May of 2004.
For the nine months ended September 30, 2004, non-interest expense increased
$913 thousand, or 12.9%, to $8.0 million in the current period from $7.1 million
for the first nine months of 2003. Salaries and employee benefits increased $656
thousand, or 16.4%, relating to general staff increases and costs associated
with an increased number of commission based employees. Occupancy expense
increased $161 thousand, or 33.7%, for the first nine months of 2004 over the
same period in 2003 for the lease and occupancy of new administrative and
operations offices at Sterling Plaza in Franklin, New Jersey.
Although insurance commissions and fees increased year to year over both the
three month and nine month periods, our insurance operations reported reduced
earnings in both the three and nine month periods of 2004 compared to 2003. For
the nine months ended September 30, 2004, our insurance operations earned income
before income taxes of $115 thousand, a decline from the $165 thousand earned in
the year ago period, and for the three months ended September 30, 2004, our
insurance operations recorded a $21 thousand loss before income taxes, compared
to earnings of $68 thousand in the year ago period. The decline in reported net
earnings of our insurance operations reflects increased amortization expense of
$26 thousand from the purchase of the book of business on an acquired insurance
agency in 2003. Under the terms of the 2003 purchase, the amortization expense
will increase to approximately $28 thousand per quarter by the first quarter of
2005 and then end in December of 2005. In addition, net income from insurance
operations declined in 2004, by $53 thousand in the third quarter and $18
thousand for the nine months, reflecting the higher commission rates paid to
producers on newly booked business as Tri-State continued to increase its
insurance originations.
INCOME TAXES
Income tax expense increased $52 thousand to $143 thousand (26% effective tax
rate) for the three months ended, September 30, 2004 compared to $91 thousand
(22% effective tax rate) for the same period in 2003. Income taxes increased $99
thousand for the nine months ended September 30, 2004 to $430 thousand (27%
effective tax rate) as compared to $331 thousand (25% effective tax rate) for
the nine months ended September 30, 2003. These increases in income taxes
resulted from an increase in income before taxes of $139 thousand, or 34.2%, for
the three month period ended September 30, 2004 compared to the same quarter
ended in 2003 and an increase in income before taxes of $275 thousand, or 20.8%,
for the nine month period ended September 30, 2004 as compared to the same
period in 2003. The effective tax rate is below the statutory tax rate due to
tax-exempt interest on securities and earnings on the investment in life
insurance.
22
DECEMBER 31, 2003 AS COMPARED TO DECEMBER 31, 2002:
For the year ended December 31, 2003, the company's net income was $1,441,000,
an increase of $285 thousand, or 24.7%, over the $1,156,000 earned in 2002.
Basic net income per share, as adjusted for the 2003 5% stock dividend, was
$0.80 for 2003, compared to basic net income per share of $0.66 in 2002. Diluted
net income per share for 2003 was $0.78, compared to diluted net income per
share of $0.64, in 2002. The change in per share earnings reflects an increase
in net income partially offset by an increased number of average shares
outstanding during 2003, as the company's weighted average basic shares
outstanding increased to 1,790,142 from 1,748,102.
The company's results for 2003 were affected by increases of $587,000 in net
interest income and $811,000 in non-interest income, partially offset by an
increase of $1,029,000 in total other expenses, and $105,000 in provision for
loan losses.
The results reflect an increase in net interest income, a result of both
increasing interest income and decreasing interest expense, coupled with
increases in non-interest income primarily due to an increase in mortgage
banking fees from our residential lending division, partially offset by
increases in non-interest expenses associated with additions to staff and higher
related salary and benefit expenses.
COMPARATIVE AVERAGE BALANCES AND AVERAGE INTEREST RATES
The following table reflects the components of our daily average balances for
the years ended December 31, 2003, 2002 and 2001 and presents the daily average
interest rates earned on assets and the daily average interest rates paid on
liabilities for such periods and the company's net interest income and net
interest margin. Rates are computed on a tax-equivalent basis.
(DOLLARS IN THOUSANDS) YEAR ENDED DECEMBER 31, 2003 YEAR ENDED DECEMBER 31, 2002 YEAR ENDED DECEMBER 31, 2001
-----------------------------------------------------------------------------------------------------------------------------
AVERAGE INTEREST AVERAGE AVERAGE INTEREST AVERAGE AVERAGE INTEREST AVERAGE
BALANCE (1) RATE (2) BALANCE (1) RATE (2) BALANCE (1) RATE (2)
-----------------------------------------------------------------------------------------------------------------------------
Earning Assets:
Securities:
Tax exempt (3) $18,903 $1,049 5.55% $12,523 $686 5.48% $7,014 $371 5.29%
Taxable 56,733 1,783 3.14% 45,838 2,127 4.64% 38,164 2,183 5.72%
-----------------------------------------------------------------------------------------------------------------------------
Total securities 75,636 2,832 3.74% 58,361 2,813 4.82% 45,178 2,554 5.65%
-----------------------------------------------------------------------------------------------------------------------------
Total loans receivable (4) 124,165 8,093 6.52% 108,219 7,734 7.15% 103,017 8,092 7.86%
Other interest-earning assets 13,099 156 1.19% 30,045 505 1.68% 27,734 1,027 3.70%
-----------------------------------------------------------------------------------------------------------------------------
Total earning assets $212,900 $11,081 5.20% $196,625 $11,052 5.62% $175,929 $11,673 6.64%
Non-interest earning assets $21,697 $19,553 $13,904
Allowance for loan losses (1,570) (1,281) ($1,048)
----------------------------------------- ------------ ----------
Total Assets $233,027 $214,897 $188,785
========================================= ============ ==========
Sources of Funds:
Interest bearing deposits:
NOW $45,965 $249 0.54% $34,829 $282 0.81% $17,885 $226 1.26%
Money market 3,970 28 0.72% 4,272 42 0.98% 7,029 185 2.63%
Savings 64,831 511 0.79% 61,405 777 1.27% 50,334 1,377 2.74%
Time 53,146 1,251 2.35% 57,186 1,750 3.06% 65,486 3,398 5.19%
-----------------------------------------------------------------------------------------------------------------------------
Total interest bearing deposits 167,912 2,039 1.21% 157,692 2,851 1.81% 140,734 5,186 3.68%
Borrowed funds 12,772 573 4.49% 12,192 553 4.54% 10,000 502 5.02%
Junior subordinated
debentures 5,000 248 4.96% 2,383 132 5.54% 0 0 0.00%
-----------------------------------------------------------------------------------------------------------------------------
Total interest bearing
liabilities $185,684 $2,860 1.54% $172,267 $3,536 2.05% $150,734 $5,688 3.77%
(1) Includes loan fee income
(2) Average rates on securities are calculated on amortized costs
(3) Full taxable equivalent basis, using a 39% effective tax rate and adjusted
for "TEFRA" (Tax and Equity Fiscal Responsibility Act) interest expense
disallowance
23
(DOLLARS IN THOUSANDS) YEAR ENDED DECEMBER 31, 2003 YEAR ENDED DECEMBER 31, 2002 YEAR ENDED DECEMBER 31, 2001
-----------------------------------------------------------------------------------------------------------------------------
AVERAGE INTEREST AVERAGE AVERAGE INTEREST AVERAGE AVERAGE INTEREST AVERAGE
BALANCE (1) RATE (2) BALANCE (1) RATE (2) BALANCE (1) RATE (2)
-----------------------------------------------------------------------------------------------------------------------------
Non-interest bearing liabilities:
Demand deposits $31,112 $27,469 $25,412
Other liabilities 2,196 2,395 801
----------------------------------------- ------------ ----------
Total non-interest bearing
liabilities 33,308 29,864 $26,213
Stockholders' equity 14,035 12,766 $11,838
----------------------------------------- ------------ ----------
Total Liabilities and
Stockholders' Equity $233,027 $214,897 $188,785
======== ============ ==========
--------------------- --------------------- ---------------------
Net Interest Income and Margin (5) $8,221 3.86% $7,516 3.82% $5,985 3.40%
=============================================================================================================================
(4) Loans outstanding include non-accrual loans
(5) Represents the difference between interest earned and interest paid, divided
by average total interest-earning assets
NET INTEREST INCOME
Net interest income is the difference between interest and fees on loans and
other interest-earning assets and interest paid on interest-bearing liabilities.
Net interest income is directly affected by changes in volume and mix of
interest-earning assets and interest-bearing liabilities that support those
assets, as well as changing interest rates when differences exist in repricing
dates of assets and liabilities.
Net interest income, on a fully taxable equivalent basis (a 39% tax rate),
increased by $705 thousand, or 9.4% in 2003 to $8.2 million compared to $7.5
million in 2002. Total interest income, on a fully taxable equivalent basis,
increased by $29 thousand to remain at $11.1 million for the years ended
December 31, 2003 and 2002 as the rate earned on average earning assets declined
by 42 basis points to 5.20% for the year ended December 31, 2003 from 5.62% for
the prior year. Average earning assets increased by $16.3 million, or 8.3% to
$212.9 million from $196.6 million for the year ended December 31, 2002,
partially offsetting the decline in rates. Interest expense decreased by $676
thousand, or 19.1% to $2.9 million from $3.5 million for the year ended December
31, 2002 as a result of declines in market rates of interest. The average rate
paid on interest bearing liabilities declined by 51 basis points to 1.54% for
the current year from 2.05% for the year ended December 31, 2002. The decrease
in rate on both earning assets and interest bearing liabilities reflects the
stable rate environment that occurred during 2003, as the Federal Reserve kept
interest rates at their current levels and assets and liabilities repriced to
those levels.
Interest income on total loans increased from $7.7 million in 2002 to $8.1
million in 2003, an increase of $359 thousand or 4.7%. Average loans increased
by $15.9 million, or 14.7% to $124.2 million from $108.2 million for the year
ended December 31, 2002, offset by a decrease in the average rate earned to
6.52% for the year ended December 31, 2003 from 7.15% for the prior year. As
discussed above, the low rate environment in 2003 caused the decline in yield on
the loan portfolio, as older, higher rate loans were replaced by new loans
bearing the current low rates.
Total interest income on securities, on a fully taxable equivalent basis,
increased by $19 thousand to remain at $2.8 million for both years ended
December 31, 2003 and 2002, as the increase in the average balance of investment
securities was offset by a reduction in yield on the portfolio. The rate
environment continued to remain low in the mortgage backed securities market
with consumers taking advantage of refinancing opportunities. Higher rate
mortgage backed securities during 2003 continued to pre-pay due to the low rate
environment. The average yield on tax-exempt securities increased by 7 basis
points, which was offset by a decrease of 150 basis points earned on taxable
investment securities. The yield on the total securities portfolio fell to 3.74%
in the current year from 4.82% for the year ended December 31, 2002.
24
Interest income on other interest-earning assets, primarily federal funds sold
and, to a lesser extent, interest bearing deposits in other financial
institutions, decreased by $349 thousand, or 69.1% to $156,000 from $505,000.
The decrease primarily occurred due to the company's average balance in federal
funds sold decreasing by $14.2 million to $9.6 million for the year 2003
compared to $23.8 million in 2002 and a 51 basis point decrease in the average
yield on federal funds sold during the same periods.
Total interest expense decreased from $3.5 million in 2002 to $2.9 million for
2003, a decrease of $676 thousand or 19.1%. The decrease is attributable to the
company's ability to lower the interest rate paid on its liabilities to lower
current rates and a continued change in the company's deposit mix toward demand
and NOW accounts and away from time deposits. During 2003, the company's average
interest-bearing liabilities increased by $13.4 million, or 7.8% to $185.7
million compared to $172.3 million in 2002. The increase in deposits occurred
due to the company's continued focus on low cost demand and NOW accounts.
Average NOW deposits increased by $11.1 million to $46.0 million from $34.9
million, while the yield on NOW accounts declined to .54% in 2003 from .81% in
2002. Savings deposits increased by $3.4 million to $64.8 million from $61.4
million, while the yield on savings deposits declined to .79% in 2003 from 1.27%
in 2002. The average balance of time deposits decreased by $4.0 million to $53.1
million in 2003 from $57.1 million in 2002, while the yield on time deposits
declined to 2.35% in 2003 from 3.06% in 2002, a decrease of 71 basis points. The
average rate paid on all the company's interest bearing liabilities decreased to
1.54% in 2003 compared to 2.05% in 2002. This reflects the continued decline in
market rates during 2003. In addition, the company's average non-interest
bearing deposits increased by $3.6 million, or 13.3% in 2003 from year end 2002.
The net interest margin was 3.86%, an increase from the net interest margin of
3.82% in 2002 reflecting a 42 basis point decrease in yield on total earning
assets from 5.62% in 2002 to 5.20% in 2003, compared to a 51 basis point decline
in rate on total interest bearing liabilities.
The following table reflects the relative impact on net interest income of
changes in the volume of earning assets and interest-bearing liabilities and
changes in rates earned and paid by the company on such assets and liabilities.
For purposes of this table, non-accrual loans have been included in the average
loan balance. Changes due to both volume and rate have been allocated in
proportion to the relationship of the dollar change in each.
DECEMBER 31, 2003 V. 2002 DECEMBER 31, 2003 V. 2002
INCREASE (DECREASE) DUE TO CHANGES IN: INCREASE (DECREASE) DUE TO CHANGES IN:
(DOLLARS IN THOUSANDS) RATE VOLUME TOTAL RATE VOLUME TOTAL
---- ------ ----- ---- ------ -----
Securities:
Tax exempt $354 $9 $363 $302 $13 $315
Taxable 437 (781) (344) 396 (452) (56)
----------------------------------------------------------------------------------------------------------------------
791 (772) 19 698 (439) 259
Total securities (1)
Total loans receivable (2) 1,078 (719) 359 396 (754) (358)
Federal funds sold and time deposits
with other banks (230) (119) (349) 79 (601) (522)
-----------------------------------------------------------------------------------------------------------------------
Total net change in income on
interest-earning assets 1,639 (1,610) 29 1,173 (1,794) (621)
----------------------------------------------------------------------------------------------------------------------
Interest-bearing deposits:
NOW 76 (109) (33) 158 (102) 56
Money market (3) (11) (14) (148) 5 (143)
Savings 42 (308) (266) 256 (856) (600)
Time (137) (362) (499) (510) (1,138) (1,648)
-----------------------------------------------------------------------------------------------------------------------
Total interest bearing deposits (22) (790) (812) (244) (2,091) (2,335)
Borrowed funds 26 (6) 20 102 (51) 51
Junior subordinated debentures 131 (15) 116 132 - 132
-----------------------------------------------------------------------------------------------------------------------
Total net change in expense on
interest-bearing liabilities 135 (811) (676) (10) (2,142) (2,152)
-----------------------------------------------------------------------------------------------------------------------
Change in net interest income $1,504 ($799) $705 $1,183 $348 $1,531
=======================================================================================================================
(1) Fully taxable equivalent basis, using 39% effective tax rate and adjusted
for TEFRA (Tax and Equity Fiscal Responsibility Act) interest expense
disallowance.
(2) Includes loan fee income.
25
PROVISION FOR LOAN LOSSES
The provision for loan losses in 2003 was $405 thousand compared to a provision
of $300 thousand in 2002, an increase of $105 thousand or 35.0%. The increase
reflects growth in the company's loan portfolio of $21.0 million from $113.4
million for the year ended December 31, 2002 to $134.4 million at December 31,
2003. Also, during this period there was a change in the composition of the loan
portfolio. Commercial and industrial loans, non-residential real estate loans,
and construction and land development loans increased while one to four family
residential property loans and consumer loans decreased.
NON-INTEREST INCOME
The company's non-interest income is primarily generated through insurance
commission income earned through the operation of Tri-State, service charges on
deposit accounts, ATM and debit card fees and mortgage banking fees.
The company's non-interest income increased by $811 thousand, or 24.6%, to $4.1
million for the year ended December 31, 2003 from $3.3 million for the prior
year. The increase in non interest income included an increase of $374 thousand
in commission income from Tri-State, $110 thousand in service charges on deposit
accounts, and $133 thousand from net realized gain on sale of securities. With
the addition of the real estate lending division, mortgage banking fee income
increased by $199 thousand to $213 thousand, representing approximately $171
thousand in residential mortgage banking fees and $42 thousand in income on
commercial loans sold. Our residential mortgage lending division, which brokers
loans for funding by third party investors, commenced operations in August 2003.
The division brokered $12.4 million in loans during 2003.
NON-INTEREST EXPENSE
Total non-interest expense increased from $8.6 million in 2002 to $9.7 million
in 2003, an increase of $1 million, or 11.9%. The increase in non-interest
expense reflects operating expenses associated with Tri-State, which are
primarily volume driven based on the amount of premium income, as well as other
expenses associated with the company's continued growth. In 2003, salaries and
employee benefits, the largest component of non-interest-expense, increased by
$838 thousand or 18.1%. This increase reflects customary increases for the
bank's and Tri-State's existing staff and increased staffing needs associated
with the company's growth. In addition, all other expenses increased by $191
thousand reflecting the company's growth and associated costs.
INCOME TAX EXPENSE
The company's income tax provision, which includes both federal and state taxes,
was $505 thousand and $526 thousand for the years ended December 31, 2003 and
2002, respectively. The decrease in the tax provision was due to increased
tax-exempt income.
FINANCIAL CONDITION
SEPTEMBER 30, 2004 AS COMPARED TO DECEMBER 31, 2003; DECEMBER 31, 2003 COMPARED
TO DECEMBER 31, 2002:
Total assets increased to $259.7 million at September 30, 2004, a $19.1 million,
or 7.9% increase from total assets of $240.6 million at December 31, 2003.
Increases in total assets include increases of $14.3 million, or 11.1% in net
loans, $ 7.4 million, or 211.4% in interest bearing time deposits with other
banks, $1.0 million in premises and equipment and $2.7 million, or 73.0% in
other assets, partially offset by a $3.9 million, or 5.1% reduction in
securities available for sale and a $2.4 million, or 15.5% decline in cash and
cash equivalents. Asset increases were financed through an increase in total
deposits of $16.1 million, or 7.8% from $207.7 million at year-end 2003 to
$223.7 million at September 30, 2004. Total stockholder's equity increased $1.3
million from $14.9 million at December 31, 2003 to $16.2 million at September
30, 2004.
At December 31, 2003, the company had total assets of $240.6 million compared to
total assets of $225.9 million at December 31, 2002, an increase of $14.7
million, or 6.5%. Net loans increased to $132.6 million at December 31,
26
2003 from $112.1 million at December 31, 2002. Total deposits increased to
$207.7 million at December 31, 2003 from $189.9 million at December 31, 2002.
LOANS
The loan portfolio comprises the largest part of the company's earning assets.
Total loans at September 30, 2004 increased $14.7 million, or 10.9% to $149.0
million from $134.4 million at year-end 2003. During the nine-month period
ending September 30, 2004, new originations have exceeded payoffs both through
scheduled maturities and prepayments. The company continues to see significant
prepayment activity as borrowers seek to refinance loans in the current low
interest rate environment. The company is emphasizing the origination of
commercial, industrial, and non-residential real estate loans to increase the
yield in its loan portfolio and reduce its dependence on loans secured by 1-4
family properties. The company has also increased its activity in the loan
participation market. The majority of the originated and sold participations are
commercial real estate related loans which exceed the company's legal lending
limit. The balance in construction and land development loans increased $7.5
million, or 86.4%, non-residential real estate loans increased $5.8 million, or
9.8%, loans secured by farmland increased $3.5 million or 59.5% and commercial
and industrial loans increased $1.7 million, or 14.0% from December 31, 2003 to
September 30, 2004. Residential 1-4 family real estate loans have decreased $3.8
million, or 8.1% as residential mortgage applicants are being referred to our
residential mortgage division for origination by third party investors.
Loans, net of the allowance for loan losses and deferred loan fees, increased
from $112.1 million at December 31, 2002 to $132.6 million at December 31, 2003,
an increase of $20.6 million, or 18.4%. The increase in the company's loan
portfolio during 2003 was concentrated in loans secured by non-residential
mortgages and other commercial loans. Loans secured by commercial properties
increased by $18.1 million, or 44.2%, to $59.2 million at December 31, 2003 from
$41.0 million at December 31, 2002. Commercial and industrial loans increased by
$1.4 million, or 12.8%, to $12.4 million at December 31, 2003 from $11.0 million
at December 31, 2002. Loans secured by 1-4 family residential properties
decreased by $2.9 million to $46.6 million at December 31, 2003 from $49.5
million at December 21, 2002, representing 34.7% of the loan portfolio. This
decrease reflects the flat rate environment that we are currently experiencing,
as prepayments exceed new loan origination held in portfolio.
The increase in loans was funded during 2003 by an increase in the company's
demand deposits, NOW deposits and savings deposits, as well as a reduction in
federal funds sold. The end of year loan to deposit ratios for 2003 and 2002
were 64.7% and 59.7%, respectively.
The following table summarizes the composition of the company's loan portfolio
by type for each of the periods presented.
SEPTEMBER 30, DECEMBER 31,
(DOLLARS IN THOUSANDS) 2004 2003 2003 2002 2001 2000 1999
----------------------------------------------------------------------------------------------------------------------
Commercial and
industrial loans $14,131 $12,045 $12,392 $10,985 $8,065 $4,968 $3,811
Non-residential real
estate loans 64,962 54,750 59,182 41,035 34,811 27,529 19,759
One to four family
residential
property loans 42,827 48,654 46,587 49,517 51,338 55,138 50,305
Construction and land
development loans 16,134 6,428 8,656 8,310 8,515 8,960 7,074
Consumer loans 1,511 1,438 1,430 2,189 2,245 2,780 2,295
Other loans 9,570 6,375 6,114 1,335 1,086 1,718 1,519
----------------------------------------------------------------------------------------------------------------------
Total gross loans $149,135 $129,690 $134,361 $113,371 $106,060 $101,093 $84,763
======================================================================================================================
27
The maturity ranges of the loan portfolio and the amounts of loans with
predetermined interest rates and floating rates in each maturity range, as of
September 30, 2004 and December 31, 2003, are presented in the following table.
SEPTEMBER 30, 2004 DECEMBER 31, 2003
------------------ -----------------
(DOLLARS IN THOUSANDS) DUE UNDER DUE 1-5 DUE OVER DUE UNDER DUE 1-5 DUE OVER
ONE YEAR YEARS FIVE YEARS ONE YEAR YEARS FIVE YEARS
----------------------------------------------------------------------------------------------------------------------
Commercial and industrial
loans $4,057 $7,063 $3,011 $5,896 $3,264 $3,232
Non-residential real estate
loans 6,017 6,267 52,678 5,521 2,493 51,168
One to four family
residential property
loans 1,461 5,837 35,529 8,619 16,937 21,031
Construction and land
development 11,074 4,930 130 1,421 2,036 5,199
Consumer loans 342 1,021 148 388 611 431
Other Loans 79 111 9,380 819 1,449 3,846
----------------------------------------------------------------------------------------------------------------------
Total loans $23,030 $25,229 $100,876 $22,664 $26,790 $84,907
======================================================================================================================
Interest rates:
Predetermined $4,280 $13,658 $50,770 $7,932 $16,248 $35,694
Floating $18,750 $11,571 $50,106 $14,732 $10,542 $49,213
----------------------------------------------------------------------------------------------------------------------
Total Loans $23,030 $25,229 $100,876 $22,664 $26,790 $84,907
======================================================================================================================
SECURITIES
The company's securities portfolio is comprised of securities that not only
provide interest income, including tax-exempt income, but also provide a source
of liquidity (as all securities are classified as available for sale, as
discussed below), diversify the earning assets portfolio, allow for management
of interest rate risk, and provide collateral for public fund deposits and
borrowings. The portfolio is composed primarily of obligations of U.S.
Government agencies and government sponsored entities, including collateralized
mortgage obligations issued by such agencies and entities, and tax-exempt
municipal bonds.
The company has no securities classified as held to maturity or as trading
securities. Securities not classified as securities held to maturity or trading
securities are classified as securities available for sale, and are stated at
fair value. Unrealized gains and losses on securities available for sale are
excluded from results of operations, and are reported as a separate component to
stockholders' equity, net of taxes. Securities classified as available for sale
include securities that may be sold in response to changes to interest rates,
changes in prepayment risk, the need to increase regulatory capital or other
similar requirements. Management determines the appropriate classification of
securities at the time of purchase. At both September 30, 2004 and December 31,
2003, all of the company's securities were classified as available for sale.
Securities, available for sale, at fair value, decreased $3.9 million, or 5.1%
from $76.5 million at year-end 2003 to $72.6 million at September 30, 2004. The
Company purchased $24.2 million in new securities in the first nine months of
2004, $7.3 million of securities were sold and $20.6 million in available for
sale securities matured, were called and were repaid. There was a $217 thousand
net increase in unrealized gains in the available for sale portfolio; an $11
thousand realized gain on the sale of available for sale securities and $456
thousand in net amortization expenses recorded during the first nine months of
2004. There were no held to maturity securities at September 30, 2004 or at
December 31, 2003.
The company's securities increased by $3.8 million, or 5.2% from $72.7 million
at December 31, 2002 to $76.5 million at December 31, 2003. The net increase in
securities at December 31, 2003 was due to the company investing $56.1 million
in new purchases offsetting $45.9 million in called securities, scheduled
maturities and pay-downs, as well as $4.9 million in securities sales. Year-end
balances increased in state and political tax-exempt
28
securities by $5.8 million to $21.5 million.
The following table shows the carrying value of the company's security portfolio
at each of the periods presented. Securities available for sale are stated at
their fair value.
(dollars in thousands) September 30, December 31,
------------------------------------------------------------- -----------------------------------------------
Available for sale 2004 2003 2003 2002 2001
------------------------------------------------------------- -----------------------------------------------
U.S. Treasury securities $ - $ - $ - $ - $1,531
U.S. Government agency 11,249 13,122 14,658 13,612 7,295
State and political
subdivisions 21,633 21,493 21,542 15,785 7,626
Mortgage-backed securities 36,214 32,041 34,972 35,554 20,745
Corporate securities 2,613 8,191 4,479 6,886 4,661
Equity securities 903 883 894 883 854
------------------------------------------------------------- -----------------------------------------------
Total available for sale $72,612 $75,730 $76,545 $72,720 $42,712
============================================================= ===============================================
The contractual maturity distribution and weighted average yield of the
company's securities portfolio at September 30, 2004 and December 31, 2003 are
summarized in the following table. Securities available for sale are carried at
amortized cost in the table for purposes of calculating the weighted average
yield received on such securities. Weighted average yield is calculated by
dividing income within each maturity range by the outstanding amount of the
related investment and has not been tax-effected on the tax-exempt obligations.
September 30, 2004 Due under 1 Year Due 1-5 Years Due 5-10 Years Due over 10 Years
(dollars in thousands) Amount Yield Amount Yield Amount Yield Amount Yield
-----------------------------------------------------------------------------------------------------------------------
Available for sale:
U.S. Government agency $500 6.74% $9,768 2.45% $999 2.53% $ - -
State and political subdivisions 959 1.95% - - 1,502 4.28% 18,744 4.24%
Mortgage-backed securities - - 380 3.52% 11,710 3.89% 23,991 3.92%
Corporate securities 1,010 6.31% 1,520 6.01% - - - -
Equity securities - - - - - - 900 4.35%
-----------------------------------------------------------------------------------------------------------------------
Total available for sale $2,469 4.70% $11,668 2.95% $14,211 3.84% $43,635 4.07%
=======================================================================================================================
December 31, 2003 Due under 1 Year Due 1-5 Years Due 5-10 Years Due over 10 Years
(dollars in thousands) Amount Yield Amount Yield Amount Yield Amount Yield
-----------------------------------------------------------------------------------------------------------------------
Available for sale:
U.S. Government agency $1,499 6.63% $11,370 2.13% $1,782 2.07% $ - -
State and political subdivisions 755 1.80% - - 2,865 3.85% 17,594 3.76%
Mortgage-backed securities - - 374 3.64% 9,408 3.50% 25,274 3.89%
Corporate securities 1,756 4.56% 2,555 6.16% - - - -
Equity securities - - - - - - 899 4.35%
-----------------------------------------------------------------------------------------------------------------------
Total available for sale $4,010 4.81% $14,299 2.89% $14,055 3.39% $43,767 3.85%
=======================================================================================================================
As of September 30, 2004, the company also holds $690,000 in Federal Home Loan
Bank of New York stock that it does not consider an investment security.
Ownership of this restricted stock is required for membership in the Federal
Home Loan Bank of New York.
29
CASH AND CASH EQUIVALENTS
At September 30, 2004, the company had no Federal funds sold, a decrease from
$4.2 million at year-end 2003, as excess liquidity was used to fund loan
originations and interest-bearing deposits with other banks. Cash and cash due
from banks increased by $1.8 million from $11.3 million at year-end 2003 to
$13.1 million at September 30, 2004. During the first nine months of 2004, these
funds were provided by the increase in total deposits and have been used to fund
increased loan demand.
The company's cash and cash equivalents decreased by $10.6 million, or 40.6% for
the year ended December 31, 2003, to $15.5 million from $26.1 million at
December 31, 2002. The decrease reflects the company's reduction in federal
funds sold balance, as these funds were used to fund loan demand and purchase
investment securities.
PREMISES AND EQUIPMENT; OTHER ASSETS
Premises and equipment increased by $1.0 million, or 21.9%, from $4.7 million at
December 31, 2003 to $5.7 million on September 30, 2004. This increase was due
to a renovation project at the main office location in Franklin, New Jersey,
leasehold improvements at the company's new administrative and operations
facility and the company's purchase of new computer hardware and software
attributed to a network upgrade and system conversion. Other assets increased
from $3.7 million on December 31, 2003 to $6.4 million on September 30, 2004, an
increase of $ $2.7 million, or 73.0%. This $2.7 million increase was generated
from the purchase of a $1.5 million bank owned life insurance policy in January
of 2004, the prepayment of the Company's expenses and insurance policies and
deferred tax asset balances increasing during this nine month period.
DEPOSITS
Total deposits increased $16.1 million, or 7.7%, to $223.7 million during the
first nine months of 2004 from $207.7 million at December 31, 2003. Non-interest
bearing deposits increased $5.2 million, or 16.4% to $36.9 million at September
30, 2004 from $31.7 million at December 31, 2003, interest-bearing and savings
deposits increased $5.5 million, or 4.6%, to $125.0 million at September 30,
2004 from $119.5 million at year end and total time deposits increased $5.4
million, or 9.5% from $56.5 million at December 31, 2003 to $61.9 million at
September 30, 2004. Non-interest bearing business and interest bearing business
deposit balances increased $3.3 million, or 14.6% from $22.4 million at December
31, 2003 to $25.7 million at September 30, 2004 and non-core Interest on Lawyers
Trust Account ("IOLTA") accounts and public fund account balances have recorded
a $5.8 million, or 25.9% increase in the first nine months of 2004 to $28.1
million at September 30, 2004 from $22.3 million at year end 2003. Management
continues to monitor the shift in deposits through its Asset/Liability
Committee.
Total average deposits increased $13.9 million from $185.1 million at year-end
2002 to $199.0 million at year-end 2003, a 7.5% increase. Average savings, NOW
and money market accounts increased to $114.8 million, an increase of $14.3
million, or 14.2% from $100.5 million at year-end 2002. Average time deposits
decreased to $53.1 million compared to $57.2 million at year-end 2002. The
increase primarily in savings and interest bearing transaction deposits reflects
the company's continued offering of low cost accounts through a marketing
program. The company also continues to actively bid on municipal deposits along
with its efforts to cultivate commercial deposit relationships with its
commercial loan customers.
30
The average balances and weighted average weights paid on deposits for the nine
month periods ended September 30, 2004 and September 30, 2003 are presented
below.
FOR THE NINE MONTHS ENDED SEPTEMBER 30,
2004 AVERAGE 2003 AVERAGE
(DOLLARS IN THOUSANDS) BALANCE RATE BALANCE RATE
----------------------------------------------------------------
Demand, non-interest bearing $32,923 -- $30,475 -
NOW accounts 45,671 0.45% 44,786 0.57%
Money market accounts 11,392 1.09% 4,044 0.76%
Savings 66,505 0.65% 64,586 0.83%
Time 57,051 2.0% 52,892 2.42%
-----------------------------------------------------------------------------------------------------------------
Total deposits: $213,542 $196,783
================ =================
The average balances and weighted average rates paid on deposits for 2003, 2002
and 2001 are presented below.
FOR THE YEAR ENDED DECEMBER 31,
2003 AVERAGE 2002 AVERAGE 2001 AVERAGE
(DOLLARS IN THOUSANDS) BALANCE RATE BALANCE RATE BALANCE RATE
---------------------------------------------------------------------------
Demand, non-interest bearing $31,112 -- $27,469 -- $25,412 --
NOW accounts 45,965 0.54% 34,829 0.81% 17,885 1.26%
Money market accounts 3,970 0.72% 4,272 0.98% 7,029 2.63%
Savings 64,831 0.79% 61,405 1.27% 50,334 2.74%
Time 53,146 2.35% 57,186 3.06% 65,486 5.19%
-----------------------------------------------------------------------------------------------------------------
Total deposits: $199,024 $185,161 $166,146
========= ========== =========
The remaining maturity for certificates of deposit rates paid on deposits of
$100,000 or more as of September 30, 2004 and as of December 31, 2003 is
presented in the following table.
(DOLLARS IN THOUSANDS) SEPTEMBER 30, 2004 DECEMBER 31, 2003
-----------------------------------------------------------------
3 months or less $11,686 $5,245
3 to 6 months 4,046 1,101
6 to 12 months 2,189 1,986
Over 12 months 2,689 3,689
-----------------------------------------------------------------
Total: $20,610 $12,021
=================================================================
LOAN AND ASSET QUALITY
Non-performing assets consist of non-accrual loans and all loans over ninety
days delinquent and foreclosed real estate owned ("OREO"). At September 30,
2004, non-accrual loans increased by $110 thousand, or 9.2% to $1.3 million, as
compared to $1.2 million at December 31, 2003. There were no loans ninety days
past due and still accruing or renegotiated loans at September 30, 2004. The
company had $514 thousand in OREO properties at September 30, 2004 and $223
thousand at December 31, 2003.
The company's non-accrual loans decreased to $1.2 million at December 31, 2003
from $1.3 million at December 31, 2002. At December 31, 2003, the company's
restructured loans amounted to $150 thousand. Restructured loans are put on
accrual basis if the customer demonstrates the ability to repay the debt under
the terms of the renegotiation by a period of performance, by financial
statements or other evidence of ability to service debt.
31
The company seeks to actively manage its non-performing assets. The company had
$223 thousand in OREO properties at December 31, 2003 and $187 thousand at
December 31, 2002. In addition to active monitoring and collecting on delinquent
loans management has an active loan review process for customers with aggregate
relationships of $250,000 or more if the credit(s) are unsecured or secured, in
whole or substantial part, by collateral other than real estate and $1,000,000
or more if the credit(s) are secured in whole or substantial part by real
estate.
Management continues to monitor the company's asset quality and believes that
the non-accrual loans are adequately collateralized and anticipated material
losses have been adequately reserved for in the allowance for loan losses.
The following table provides information regarding risk elements in the loan
portfolio at each of the periods presented (dollars in thousands):
SEPTEMBER 30, DECEMBER 31,
(DOLLARS IN THOUSANDS) 2004 2003 2003 2002 2001 2000 1999
-----------------------------------------------------------------------------------------------------------
Non-accrual loans:
Commercial $728 $344 $343 $256 $ - $5 $ -
Consumer 4 11 - 21 16 5 -
Construction - 71 - 145 1,512 - -
Mortgage 555 748 834 836 966 542 332
-----------------------------------------------------------------------------------------------------------
Total nonaccrual loans $1,287 $1,174 $1,177 $1,258 $2,494 $552 $332
Loans past due 90 days and still
accruing - - - 36 - - -
Restructured loans - - 150 - - - -
Total non-performing loans $1,287 $1,174 $1,327 $1,294 $2,494 $552 $332
Foreclosed real estate 514 223 223 187 187 - -
-----------------------------------------------------------------------------------------------------------
Total non-performing assets $1,801 $1,397 $1,550 $1,481 $2,681 $552 $332
===========================================================================================================
Non-performing loans to total
loans 0.86% 0.93% 0.99% 1.14% 2.35% 0.55% 0.39%
Non-performing assets to total
assets 0.69% 0.59% 0.64% 0.66% 1.32% 0.34% 0.22%
-----------------------------------------------------------------------------------------------------------
ALLOWANCE FOR LOAN LOSSES
The allowance is allocated to specific loan categories based upon management's
classification of problem loans under the bank's internal loan grading system
and to pools of other loans that are not individually analyzed. Management makes
allocations to specific loans based on the present value of expected future cash
flows or the fair value of the underlying collateral for impaired loans and to
other classified loans based on various credit risk factors. These factors
include collateral values, the financial condition of the borrower and industry
and current economic trends.
Allocations to commercial loan pools are categorized by commercial loan type and
are based on management's judgment concerning historical loss trends and other
relevant factors. Installment and residential mortgage loan allocations are made
at a total portfolio level based on historical loss experience adjusted for
portfolio activity and current conditions. Additionally, all other delinquent
loans are grouped by the number of days delinquent with this amount assigned a
general reserve amount.
At September 30, 2004, the allowance for loan losses was $2.1 million, an
increase of 19.8% from the $1.7 million at year-end 2003. The provision for loan
losses was $373,000 and there were $36,000 in charge offs and $7,000 in
recoveries reported in the first nine months of 2004. The allowance for loan
losses as a percentage of total loans was 1.39% at September 30, 2004 compared
to 1.29% on December 31, 2003. The increase reflects growth in the company's
loan portfolio of $14.6 million from $134.4 million at December 31, 2003 to
$149.0 million at September 30, 2004. Also, during this period there was a
change in the composition of the loan portfolio. Commercial and industrial
loans, non-residential real estate loans, and construction and land development
loans increased while one to four family residential property loans decreased.
32
The provision for loan losses was $405,000 and $300,000 for the years 2003 and
2002, respectively. The increase reflects growth in the company's loan portfolio
of $21.0 million from $113.4 million at December 31, 2002 to $134.4 million at
December 31, 2003. Also, during this period there was a change in the
composition of the loan portfolio. Commercial and industrial loans,
non-residential real estate loans, and construction and land development loans
increased while one to four family residential property loans decreased.
The allowance for loan losses represented 1.29% of total loans receivable at
December 31, 2003 as compared to 1.22% at December 31, 2002. Management
regularly assesses the appropriateness and adequacy of the loan loss reserve in
relation to credit exposure associated with individual borrowers, overall trends
in the loan portfolio and other relevant factors, and believes the reserve is
reasonable and adequate for each of the periods presented.
Total charge-offs were $62,000 for 2003 compared to $59,000 in 2002. Total
charge-offs as a percent of average loans were 0.05% for both years 2003 and
2002.
The table below presents information regarding the company's provision and
allowance for loan losses for each of the periods presented.
NINE MONTHS ENDED YEAR ENDED DECEMBER 31,
SEPTEMBER 30,
(DOLLARS IN THOUSANDS) 2004 2003 2003 2002 2001 2000 1999
-------------------------------------------------------------------------------------------------------------
Balance at beginning of year $1,734 $1,386 $1,386 $1,143 $973 $837 $655
-------------------------------------------------------------------------------------------------------------
Provision charged to
operating expenses 373 315 405 300 252 229 177
-------------------------------------------------------------------------------------------------------------
Recoveries of loans
previously charged-off:
Commercial - - - - 1 8 7
Consumer 3 1 1 2 - 1 3
Real estate 4 - 4 - - 2 -
-------------------------------------------------------------------------------------------------------------
Total recoveries 7 1 5 2 1 11 10
-------------------------------------------------------------------------------------------------------------
Loans charged-off:
Commercial 15 - - - - - -
Consumer 17 19 31 19 26 - 15
Real estate 4 31 31 40 57 104 -
-------------------------------------------------------------------------------------------------------------
Total charge-offs 36 50 62 59 83 104 15
-------------------------------------------------------------------------------------------------------------
Net charge-offs 29 49 57 57 82 93 5
-------------------------------------------------------------------------------------------------------------
Balance at end of year $2,078 $1,652 $1,734 $1,386 $1,143 $973 $837
=============================================================================================================
Net charge-offs to average
loans outstanding 0.02% 0.04% 0.05% 0.05% 0.08% 0.10% 0.01%
Allowance for loan losses
to year-end loans 1.39% 1.27% 1.29% 1.22% 1.08% 0.96% 0.99%
The table located on the top of the next page sets forth details concerning the
allocation of the allowance for loan losses to the various categories for each
of the periods presented. The allocation is made for analytical purposes and it
is not necessarily indicative of the categories in which future credit losses
may occur. The total allowance is available to absorb losses from any segment of
loans.
33
ALLOWANCE FOR LOANS LOSSES AT
-----------------------------------------------------------------------------------------------------------------------------
SEPTEMBER 30, DECEMBER 31,
-----------------------------------------------------------------------------------------------------------------------------
2004 2003 2002 2001 2000 1999
------------------------------------ ----------------------------------------------------------------------------------------
% of % of % of % of % of % of
(dollars in Gross Gross Gross Gross Gross Gross
thousands) Amount Loans Amount Loans Amount Loans Amount Loans Amount Loans Amount Loans
------------------------------------ ----------------------------------------------------------------------------------------
Commercial $628 30.22% $494 9.22% $396 9.69% $233 7.60% $159 4.91% $95 4.50%
Consumer and other
loans 27 1.30% 109 5.62% 45 3.11% 37 3.14% 44 4.45% 7 4.50%
Real estate,
construction
and development:
Commercial 1,267 60.97% 990 50.49% 681 43.52% 656 40.85% 553 36.09% 359 31.66%
Residential 156 7.51% 141 34.67% 264 43.68% 217 48.41% 217 54.55% 376 59.34%
------------------------------------ ----------------------------------------------------------------------------------------
Total $2,078 100.00% $1,734 100.00% $1,386 100.00% $1,143 100.00% $973 100.00% $837 100.00%
==================================== ========================================================================================
The increases in the allowance for loan losses to total loans over the period
1999 to 2004 reflects growth in the company's loan portfolio and the change in
the composition of the loan portfolio. Commercial loans have increased while
consumer loans have decreased.
BORROWINGS
Long-term borrowings consist of long term advances from the Federal Home Loan
Bank. These advances are secured under terms of a blanket collateral agreement
by a pledge of qualifying investment securities and certain mortgage loans. As
of September 30, 2004 and December 31, 2003, the company had $10.0 million in
notes outstanding at an average interest rate of 4.79% and $11.0 million in
notes outstanding at an average interest rate of 4.49%, respectively. By
comparison, at December 31, 2002, the company had $15.0 million in notes
outstanding with an average interest rate of 4.54%.
The following table summarizes short-term borrowings which consists of federal
finds purchased and weighted average interest rates paid:
NINE MONTHS ENDED YEAR ENDED
(DOLLARS IN THOUSANDS) SEPTEMBER 30, 2004 DECEMBER 31, 2003
------------------ -----------------
Average daily amount of short-term borrowings outstanding during the period $76 $-
Weighted average interest rate on average daily short-term borrowings 1.78% -
Maximum outstanding short-term borrowings outstanding at any month-end $2,385 -
Short-term borrowings outstanding at period end $2,385 -
Weighted average interest rate on short-term borrowings at period end 2.04% -
The company had no short-term borrowings outstanding at December 31, 2003.
INTEREST RATE SENSITIVITY
An interest rate sensitive asset or liability is one that, within a defined time
period, either matures or experiences an interest rate change in line with
general market interest rates. Interest rate sensitivity is the volatility of a
company's earnings from a movement in market interest rates. Interest rate "gap"
analysis is a common, though imperfect, measure of interest rate risk. We do not
employ gap analysis as rate risk management tool, but rather we rely upon
earnings at risk analysis to forecast the impact on our net interest income
instantaneous 100 and 200 basis point increases and decreases in market rates.
In assessing the impact on earnings, the rate shock analysis assumes that no
change occurs in our funding sources or types of assets in response to the rate
change.
34
Our board of directors has established limits for interest rate risk based on
the percentage change in net interest income we would incur in differing
interest rate scenarios. Through year end 2003, we sought to remain relatively
balanced, and our policies called for a variance of no more than 25% of net
interest income, at a 100 and 200 basis point increase or decrease. At December
31, 2003 the percentage of change were within policy limits.
Our financial modeling simulates our cash flows, interest income and interest
expense from earning assets and interest bearing liabilities for a twelve month
period in each of the different interest rate environments, using actual
individual deposit, loan and investment maturities and rates in the model
calculations. Assumptions regarding the likelihood of prepayments on residential
mortgage loans and investments are made based on historical relationships
between interest rates and prepayments. Commercial loans with prepayment
penalties are assumed to pay on schedule to maturity. In actual practice,
commercial borrowers may request and be granted interest rate reductions during
the life of a commercial loan due to competition from financial institutions and
declining interest rates.
The following table sets forth our interest rate risk profile at September 30,
2004 and December 31, 2003. The interest rate sensitivity of our assets and
liabilities, and the impact on net interest income, illustrated in the following
table would vary substantially if different assumptions were used or if actual
experience differs from that indicated by the assumptions.
SEPTEMBER 30, 2004 DECEMBER 31, 2003
CHANGE CHANGE GAP AS A CHANGE CHANGE IN GAP AS A
IN NET IN NET % OF IN NET NET % OF
INTEREST INTEREST TOTAL INTEREST INTEREST TOTAL
(DOLLARS IN THOUSANDS) INCOME MARGIN ASSETS INCOME MARGIN ASSETS
--------------------------------------------------------------------------------------------------------------------
Down 200 basis points ($681) (0.26%) 13.13% ($513) (5.93%) 10.68%
Down 100 basis points (193) (0.07%) 7.45% (150) (1.73%) 6.24%
Up 100 basis points (52) (0.02%) -2.01% (209) (2.41%) (8.68%)
Up 200 basis points (165) (0.06%) -3.19% (493) (5.70%) (10.26%)
LIQUIDITY
It is management's intent to fund future loan demand primarily with deposits and
maturities and pay downs on investments. In addition, the bank is a member of
the Federal Home Loan Bank of New York and as of September 30, 2004, had the
ability to borrow up to $15.8 million against its one to four family mortgages
and selected investment securities as collateral for borrowings. The bank also
has available an overnight line of credit and a one-month overnight repricing
line of credit, each in the amount of $12.3 million at the Federal Home Loan
Bank and an overnight line of credit in the amount of $4.0 million at the
Atlantic Central Bankers Bank. Although historically a seller of Federal funds,
at September 30, 2004 the Company had $2.4 million in overnight Federal funds
purchased. On September 29, 2004 the Company purchased a ninety day time deposit
for $3.4 million as a short-term investment strategy to offset a customer's time
deposit of the same maturity. Since October 5, 2004 the Company has returned to
a selling position. The Company also has long-term borrowings totaling $10.0
million secured by the pledge of its one to four family mortgages and selected
securities. These borrowings consist of three notes that mature on December 21,
2010 with a convertible quarterly option which allows the Federal Home Loan Bank
to change the note to then current market rates. The interest rates on these
three borrowings range from 4.77% to 5.14%.
At September 30, 2004, the amount of liquid assets remained at a level
management deemed adequate to ensure that contractual liabilities, depositors'
withdrawal requirements, and other operational and customer credit needs could
be satisfied. At September 30, 2004, liquid investments totaled $13.1 million,
and all mature within 30 days.
At September 30, 2004, the company had $72.6 million of securities classified as
available for sale. Of these securities, $27.4 million have $320 thousand of
unrealized losses and therefore are not available for liquidity purposes because
of management's intent to hold them until market price recovery.
The following table represents the company's contractual obligations to make
future payments at each of the periods presented:
35
PAYMENTS DUE BY PERIOD AT SEPTEMBER 30, 2004
-------------------------------------------------------------------------------------------------------------
(DOLLARS IN THOUSANDS) LESS THAN MORE THAN
TOTAL ONE YEAR 1-3 YEARS 3-5 YEARS 5 YEARS
-------------------------------------------------------------------------------------------------------------
Borrowings $12,385 $2,385 $ - $ - $10,000
Operating lease obligations 798 230 329 115 124
Purchase obligations 247 247 - - -
Time deposits 61,850 50,609 7,676 3,049 516
Junior subordinated debentures 5,155 - - - 5,155
-------------------------------------------------------------------------------------------------------------
Total $80,435 $53,471 $8,005 $3,164 $15,795
=============================================================================================================
PAYMENTS DUE BY PERIOD AT DECEMBER 31, 2003
-------------------------------------------------------------------------------------------------------------
(DOLLARS IN THOUSANDS) LESS THAN MORE THAN
TOTAL ONE YEAR 1-3 YEARS 3-5 YEARS 5 YEARS
-------------------------------------------------------------------------------------------------------------
Borrowings $11,000 $1,000 $ - $ - $10,000
Operating lease obligations 944 236 399 177 132
Purchase obligations 746 746 - - -
Time deposits 56,481 40,325 13,499 2,287 370
Junior subordinated debentures 5,000 - - - 5,000
-------------------------------------------------------------------------------------------------------------
Total $74,171 $42,307 $13,898 $2,464 $15,502
=============================================================================================================
OFF-BALANCE SHEET ARRANGEMENTS
The company's financial statements do not reflect off-balance sheet arrangements
that are made in the normal course of business. These off-balance sheet
arrangements consist of unfunded loans and letters of credit made under the same
standards as on-balance sheet instruments. These unused commitments, at
September 30, 2004 totaled $31.4 million. This consisted of $11.3 million in
home equity lines of credit, $8.1 million in commercial construction lines of
credit, $7.6 million in commercial lines of credit, $3.4 million in commitments
to grant commercial and residential loans and the remainder in other unused
commitments. At December 31, 2003, these commitments consisted of $10.4 million
in commercial construction lines of credit, $7.3 million in commercial lines of
credit, $7.1 million in home equity lines of credit, $6.2 million in commitments
to grant commercial and residential loans and the remainder in other unused
commitments. These instruments have fixed maturity dates, and because many of
them will expire without being drawn upon, they do not generally present any
significant liquidity risk to the company.
Management believes that any amounts actually drawn upon can be funded in the
normal course of operations.
JUNIOR SUBORDINATED DEBENTURES
As a result of the adoption of FASB Interpretation No. 46, "Consolidation of
Variable Interest Entities, and Interpretation of ARB No. 51," we deconsolidated
our wholly-owned subsidiary Sussex Capital Trust I, referred to as the "Trust",
from our consolidated financial statements as of March 31, 2004. We have not
restated prior periods. The impact of this deconsolidation was to increase our
junior subordinated debentures by $5.2 million and reduce our trust capital
securities line item by $5.0 million that had represented the trust preferred
securities of the Trust. Our equity interest in the trust subsidiary of $155
thousand, which had previously been eliminated in consolidation, is now reported
in "Other assets" as of September 30, 2004. For regulatory reporting purposes,
the Federal Reserve has indicated that the preferred securities will continue to
qualify as Tier 1 Capital subject to previously specified limitations, until
further notice. The adoption of FIN 46 did not have an impact on our results of
operations or liquidity.
36
CAPITAL RESOURCES
Total stockholders' equity increased $1.3 million to $16.2 million at September
30, 2004 from $14.9 million at year-end 2003. Activity in stockholders' equity
consisted of a net increase in retained earnings of $781 thousand derived from
$1.2 million in net income earned during the first nine months of 2004, offset
by $384 thousand for the payments of cash dividends. Other increases were $257
thousand in issuance of common stock and exercise of stock options and $137
thousand for shares issued through the dividend reinvestment plan. An unrealized
gain on securities available for sale, net of income tax, increased
stockholders' equity by $130 thousand.
Stockholders' equity inclusive of accumulated other comprehensive income, net of
income taxes, was $14.9 million at December 31, 2003, an increase of $1.2
million over 2002. The growth in stockholders' equity was generated through
earnings retention and the reinvesting of dividends by its participants in the
company's dividend reinvestment plan.
On July 11, 2002, the company raised an additional $4.8 million, net of offering
costs, in capital through the issuance of junior subordinated debentures to a
statutory trust subsidiary. The subsidiary in turn issued $5.0 million in
variable rate capital trust pass through securities to investors in a private
placement. The interest rate is based on the three-month LIBOR rate plus 365
basis points and is adjusted quarterly. Beginning October 7, 2004, the new
quarterly rate of interest on the debentures will be 5.72%. The rate is capped
at 12.5% through the first five years, and the securities may be called at par
any time after October 7, 2007, or if the regulatory capital or tax treatment of
the securities is substantially changed. These trust preferred securities are
included in the company's and the bank's capital ratio calculations.
The company's and the bank's regulators have classified and defined bank holding
company capital Tier I capital which includes tangible stockholders' equity for
common stock and certain stock and other hybrid instruments, and Tier II
capital, which includes a portion of the allowance for loan losses, certain
qualifying long-term debt and preferred stock which does not qualify for Tier I
capital.
The company's and the bank's regulators have implemented risk-based guidelines
which require banks and bank holding companies to maintain certain minimum
capital as a percent of such assets and certain off-balance sheet items adjusted
for predefined credit risk factors (risk-adjusted assets). Banks and bank
holding companies are required to maintain Tier I capital as a percent of
risk-adjusted assets of 4.0% and Tier II capital as of risk-adjusted assets of
8.0%, at a minimum. At September 30, 2004 the company and the bank both meet the
well-capitalized regulatory standards applicable to them. In addition to the
risk-based guidelines discussed above, the company's and the bank's regulators
require that banks and bank holding companies which meet the regulator's highest
performance and operational standards maintain a minimum leverage ratio (Tier I
capital as a percent of tangible assets) of 4.0%. For those banks and bank
holding companies with higher levels of risk or that are experiencing or
anticipating growth, the minimum will be proportionately increased. Minimum
leverage ratios for each bank and bank holding company are established and
updated through the ongoing regulatory examination process.
The following table presents the capital ratios at September 30, 2004, for the
company and the bank, as well as the minimum regulatory requirements.
ACTUAL FOR CAPITAL ADEQUACY
MINIMUM
(DOLLARS IN THOUSANDS) AMOUNT RATIO AMOUNT RATIO
-------------------------------------------------------------------------------------------------------------
The Company:
Leverage Capital $18,203 7.35% $>9,907 4%
=
Tier 1 - Risk-Based 18,203 10.79% >6,751 4%
=
Total Risk-Based 20,283 12.02% >13,502 8%
=
The Bank:
Leverage Capital 17,638 7.13% >9,900 4%
=
Tier 1 - Risk-Based 17,638 10.49% >6,728 4%
=
Total Risk-Based 19,718 11.72% >13,456 8%
=
37
EFFECT OF INFLATION
Unlike most industrial companies, virtually all of the assets and liabilities of
a financial institution are monetary in nature. As a result, the level of
interest rates has a more significant impact on a financial institution's
performance than the effects of general levels of inflation. Interest rates do
not necessarily move in the same direction or change with the same magnitude as
the price of goods and services, which prices are affected by inflation.
Accordingly, the liquidity, interest rate sensitivity and maturity
characteristics of the company's asset and liabilities are more indicative of
its ability to maintain acceptable performance levels. Management of the company
monitors and seeks to mitigate the impact if interest rate changes by attempting
to match the maturities of assets and liabilities to gap, thus seeking to
minimize the potential effects of inflation.
38
BUSINESS
GENERAL
WHO WE ARE
We are a one-bank holding company headquartered in Franklin, New Jersey and the
parent company of Sussex Bank. We are a community-oriented financial institution
that offers traditional community bank loan and deposit products and services as
well as an array of fee based, financial services products. Our stock is
primarily owned by residents of our market area, with our board and senior
management owning over 25% of our stock. We emphasize our knowledge of local
markets, customer access to our senior decision makers and provide superior and
personalized customer service that is generally not available at larger
financial institutions. Our goal is to serve the needs of businesses and
consumers in our marketplace in northwestern New Jersey and, to a lesser extent,
southern New York and northeastern Pennsylvania. The bank is a New Jersey
state-chartered commercial bank formed in 1975 which operates from its main
office and seven branches, all of which are located in Sussex County, New
Jersey.
We target small and mid-size businesses as well as professional practices such
as lawyers, doctors and accountants within our market area. We actively pursue
business relationships with our targeted clientele through the business contacts
of our board of directors and senior management and by capitalizing on our
knowledge of the local marketplace.
We have also sought to increase our non-interest income in order to diversify
and improve our revenues and to make our earnings less dependent on our net
interest margin. In 2001, we acquired Tri-State Insurance Agency, Inc., a full
service insurance agency. We strengthened Tri-State's operations through our
2003 acquisition of the Garrera Insurance Agency. We intend to continue to seek
opportunities to expand our insurance business through acquisitions of books of
business or whole agencies. Our non-interest income for the fiscal year ending
December 31, 2003 was $4.1 million - an increase of $811 thousand or 24.6% over
the previous fiscal year, representing 27.6% of our total revenues.
Through our strategy of serving as a full service community-based financial
institution, we have maintained and expanded our market share within our Sussex
County, New Jersey marketplace. At June 30, 2004, we had 11.4 percent of
deposits within Sussex County, New Jersey, ranking us third in market share.
OUR MARKET AREA
All of our banking offices are located in Sussex County, New Jersey, and we
maintain loan production offices in Pike County, Pennsylvania, and Orange
County, New York. Our market area is among the most affluent in the nation and
in New Jersey. Sussex County ranks 6th in New Jersey, with median household
income of $71,902 as compared to the state median of $61,779 and the national
median of $46,475. Sussex County's population growth over the next five years is
expected to reach 5.91% as compared to the state growth rate of 3.80% and the
nationwide growth rate of 4.84%.
OUR STRATEGY
Our board of directors has adopted a strategic plan calling for the bank to
build upon our successful track record in Sussex County by applying our business
philosophies in our larger contiguous counties and, taking advantage of the
competitive opportunities presented by the consolidation of other banking
institutions in these markets. We believe our community bank philosophy, which
emphasizes a high service, personalized approach, which is generally not offered
by our larger competitors, will be very successful in our target markets. In
addition, our strategic plan is focused on significantly improving the core
profitability of the franchise through improvements in, among other things, our
efficiency and our loan to deposit ratios. We believe that the recent
investments we have made in our infrastructure, certain key hires and our broad
product offering will allow us to successfully expand.
39
LENDING ACTIVITIES
GENERAL. We emphasize a range of lending services, including real estate,
commercial, and equity-line consumer loans to individuals and small- to
medium-sized businesses and professional firms that are located in or conduct a
substantial portion of their business in our market area. Our underwriting
standards vary for each type of loan, as described below. While we generally
underwrite the loans in our portfolio in accordance with our own internal
underwriting guidelines and regulatory supervisory limits, in certain
circumstances we have made commercial loans which exceed either our internal
underwriting guidelines, supervisory limits, or both. We enter into
participation agreements with other financial institutions to purchase the
portion of these commercial loans that exceed our lending limits. We have
focused our lending activities primarily on the small business and consumer
markets in the Northern New Jersey and in Pike County, Pennsylvania and Orange
County, New York. By focusing on this customer base we have been able to enjoy
the benefits of the tremendous business and residential growth experienced in
these market areas in the recent past. The addition of the residential mortgage
banking division, which brokers loans for funding by third party investors, has
given us an opportunity to establish lending and marketing staffs in New York
and Pennsylvania.
REAL ESTATE MORTGAGE LOANS. The principal component of our loan portfolio is
loans secured by real estate mortgages. We obtain a security interest in real
estate whenever possible, in addition to any other available collateral, in
order to increase the likelihood of the ultimate repayment of the loan. At
September 30, 2004, loans secured by first or second mortgages on real estate
made up approximately 83% of our loan portfolio, with 43.6% of our loan
portfolio consisting of commercial real estate loans, 28.7% of loans secured by
first or second mortgages on residential properties, and 10.8% consisting of
construction and land development loans.
These loans will generally fall into one of four categories: commercial real
estate loans, construction and development loans, residential real estate loans,
or home equity loans. Most of our real estate loans are secured by residential
or commercial property. Interest rates for all categories may be fixed or
adjustable, and will more likely be fixed for shorter-term loans. We generally
charge an application fee for each loan. Other loan fees consist primarily of
late charge fees. Real estate loans are subject to the same general risks as
other loans and are particularly sensitive to fluctuations in the value of real
estate. Fluctuations in the value of real estate, as well as other factors
arising after a loan has been made, could negatively affect a borrower's cash
flow, creditworthiness, and ability to repay the loan.
o COMMERCIAL REAL ESTATE LOANS. At September 30, 2004, our
individual commercial real estate loans ranged in size from less
than $10 thousand to $2.4 million, with an average loan size of
approximately $287 thousand. These loans generally have a five
year interest rate re-pricing with payments based on longer
amortization. We evaluate each borrower on an individual basis
and attempt to determine the business risks and credit profile
of each borrower. We attempt to reduce credit risk in the
commercial real estate portfolio by emphasizing loans on
owner-occupied office and retail buildings where the
loan-to-value ratio, established by independent appraisals, does
not exceed 85%. We also generally require that a borrower's cash
flow exceeds 125% of monthly debt service obligations. In order
to ensure secondary sources of payment and liquidity to support
a loan request, we typically review all of the personal
financial statements of the principal owners and require their
personal guarantees. At September 30, 2004, commercial real
estate loans (other than construction loans) amounted to $65.0
million, or approximately 43.6% of our loan portfolio. Loans
secured by commercial real estate may be in greater amount and
involve a greater degree of risk than one to four family
residential mortgage loans. Payments on such loans are often
dependent on the successful operation or management of the
mortgaged properties.
o CONSTRUCTION AND DEVELOPMENT REAL ESTATE LOANS. We offer
adjustable and fixed rate residential and commercial
construction loans to builders and developers and to consumers
who wish to build their own homes. At September 30, 2004, our
construction and development real estate loans ranged in size
from approximately $20 thousand to $1,250 thousand, with an
average loan size of approximately $278 thousand. The duration
of our construction and development loans generally is limited
to twelve (12) to eighteen (18) months, although payments may be
structured on a longer amortization basis. Construction and
development loans generally carry a higher degree of risk than
long-term financing of existing properties because repayment
depends on the ultimate completion of the project and usually on
the sale of the property.
40
We attempt to reduce the risk associated with construction and
development loans by obtaining personal guarantees where
possible and by keeping the loan-to-value ratio of the completed
project at or below 80%. At September 30, 2004, total
construction loans amounted to $16.1 million, or 10.8% of our
loan portfolio.
o RESIDENTIAL REAL ESTATE LOANS AND HOME EQUITY LOANS. We
originate traditional long term residential mortgages. These
loans are underwritten and documented for sale in the secondary
market. We also offer second mortgage residential real estate
loans and home equity lines of credit. At September 30, 2004,
our individual residential real estate loans ranged in size from
$1 thousand to $356 thousand, with an average loan size of
approximately $52 thousand. Generally, we limit the
loan-to-value ratio on our residential real estate loans to 80%.
We offer fixed and adjustable rate residential real estate loans
with terms of up to 30 years. We also offer home equity lines of
credit. At September 30, 2004, our individual home equity lines
of credit ranged in size from $1 thousand to $200 thousand, with
an average of approximately $28 thousand. Our underwriting
criteria for, and the risks associated with, home equity loans
and lines of credit are generally the same as those for first
mortgage loans. We generally limit the extension of credit to
80% of the available equity of any property. We generally limit
the extension of credit to 90% of the available equity of each
property, although we may extend up to 100% of the available
equity. At September 30, 2004, residential real estate loans
(other than construction loans) amounted to $42.8 million, or
28.7% of our loan portfolio. Included in the residential real
estate loans was $7.9 million, or 5.3% of our loan portfolio, in
home equity loans. Risks associated with loans secured by
residential properties are generally lower than commercial real
estate and construction loans and include general economic
risks, such as the strength of the job market, employment
stability and the strength of the housing market. Since most
loans are secured by a primary or secondary residence, the
borrower's continued employment is the greatest risk to
repayment.
COMMERCIAL BUSINESS LOANS. We make loans for commercial purposes in various
lines of businesses, including the manufacturing, service industry, and
professional service areas. At September 30, 2004, our individual commercial
business loans ranged in size from approximately $1 thousand to $1.7 million,
with an average loan size of approximately $69 thousand. Commercial loans are
generally considered to have greater risk than first or second mortgages on real
estate because commercial loans may be unsecured, or if they are secured, the
value of the collateral may be difficult to assess and more likely to decrease
than real estate. At September 30, 2004, commercial business loans amounted to
$14.1 million, or 9.5% of our loan portfolio. Historically, commercial loans
provide greater yields and reprice more frequently than other types of loans,
such as real estate loans. More frequent repricing means that the yields on our
commercial loans adjust with interest rate changes.
FARM LOANS. We purchase the secured portion of guaranteed farm loans from the
USDA and SBA. As of September 30, 2004 the guaranteed portion of USDA/SBA
guaranteed farm loans which we retained amounted to $9.3 million, or 6.2% of our
loan portfolio. At September 30, 2004, our individual farm loans ranged in size
from $30 thousand to $540 thousand with an average loan size of approximately
$211 thousand. As the portion of these loans we purchase is guaranteed by the
USDA and the SBA, the risks involved with these instruments are minimal.
CONSUMER LOANS. We make a variety of loans to individuals for personal and
household purposes, including secured and unsecured installment loans and
revolving lines of credit. Consumer loans are underwritten based on the
borrower's income, current debt level, past credit history, and the availability
and value of collateral. Consumer rates are both fixed and variable, with terms
negotiable. At September 30, 2004, our individual consumer loans ranged in size
from $1 thousand to $22 thousand, with an average loan size of approximately $6
thousand. Our installment loans typically amortize over periods up to 60 months.
We will offer consumer loans with a single maturity date when a specific source
of repayment is available. We typically require monthly payments of interest and
a portion of the principal on our revolving loan products. Consumer loans are
generally considered to have greater risk than first or second mortgages on real
estate because they may be unsecured, or, if they are secured, the value of the
collateral may be difficult to assess and more likely to decrease in value than
real estate. At September 30, 2004, consumer loans amounted to $1.5 million, or
1.0% of our loan portfolio.
MORTGAGE BANKING. The bank's residential mortgage banking division, through the
bank's branches and our loan production offices in Pennsylvania and New York,
brokers residential one to four family loans for funding by third party
investors without recourse to the bank. Servicing is released to the third party
investors.
41
We believe establishment of the residential lending division provides us with a
cost effective source of fee income, without exposing the bank to credit or
interest rate risk. In order to launch our residential mortgage banking
division, we have retained Samuel L. Chaznow and four full-time and two
part-time additional employees.
Although the majority of loans brokered by our mortgage banking division are
conforming loans for prime borrowers, the mortgage banking division, through a
third party investor, does broker loans for borrowers who either have difficulty
documenting their income or who otherwise do not meet prime credit standards.
These loans are also funded by the third party investor, without recourse to the
bank and servicing is released. Our mortgage banking division does not originate
loans for our portfolio, and as the loans are funded by third parties, we
receive fee income but do not take title to the loans, and so the loans never
appear on our balance sheet. The impact of our mortgage banking operations is
seen on our income statement, as the fee income is reported under non-interest
income.
On a typical transaction, our mortgage banking division will solicit a borrower,
take an initial application, qualify the application with a third party investor
and perform other settlement services in exchange for an originator fee.
Although our residential mortgage banking business is greatly impacted by trends
in, and absolute levels of, interest rates, we believe we have an opportunity to
continue to grow our residential mortgage banking business through continued
emphasis on financing new home purchases and growing our presence in New York
and Pennsylvania.
LOAN APPROVAL. Certain credit risks are inherent in making loans. These include
prepayment risks, risks resulting from uncertainties in the future value of
collateral, risks resulting from changes in economic and industry conditions,
and risks inherent in dealing with individual borrowers. We attempt to mitigate
repayment risks by adhering to internal credit policies and procedures. These
policies and procedures include officer and client lending limits, a
multi-layered approval process for larger loans, documentation examination, and
follow-up procedures for any exceptions to credit policies. Our loan approval
policies provide for various levels of officer lending authority. When the
amount of aggregate loans to a single borrower exceeds an individual officer's
lending authority, the loan request will be considered by an officer with a
higher lending limit or by the officers' loan committee, directors loan
committee or full board of directors. The officers loan committee and the
directors loan committee have a set lending authority and any loans in excess of
these limits must be submitted to the full board for approval. We do not make
any loans to any director, officer, or employee of the bank unless the loan is
approved by the board of directors of the bank and is on terms not more
favorable to such person than would be available to a person not affiliated with
the bank.
CREDIT ADMINISTRATION AND LOAN REVIEW. We maintain a continuous loan review
system. We also apply a credit grading system to each loan, and we use an
independent consultant to review the loan files on a quarterly basis to confirm
the grading of each loan. Each loan officer is responsible for each loan he or
she makes, regardless of whether other individuals or committees joined in the
approval. This responsibility continues until the loan is repaid or until the
loan is officially assigned to another officer.
LENDING LIMITS. Our lending activities are subject to a variety of lending
limits imposed by federal law. In general, the bank is subject to a legal limit
on loans to a single borrower equal to 15% of the bank's capital and unimpaired
surplus. This limit will increase or decrease as the bank's capital increases or
decreases. Based upon the bank's capital and unimpaired surplus at September 30,
2004, the board has imposed a loan limit of $3.0 million per borrower, which
represented approximately 100% of our legal lending limit at September 30, 2004.
These limits will increase or decrease in response to increases or decreases in
the bank's level of capital. We are able to sell participations in our larger
commercial loans to other financial institutions, which allows us to manage the
risk involved in these loans and to meet the lending needs of our clients
requiring extensions of credit in excess of these limits. Loans that are sold as
participations to other banks are sold without recourse to the bank.
DEPOSIT SERVICES
Our principal source of funds is core deposits. We offer a full range of deposit
services, including checking accounts, commercial accounts, savings accounts,
and other time deposits of various types, ranging from daily money market
accounts to long-term certificates of deposit. Deposit rates are reviewed
regularly by senior
42
management of the bank. We believe that the rates we offer are competitive with
those offered by other financial institutions in our area.
Over the past three years, we have adopted a strategy of focusing on the
origination and retention of transaction accounts and the reduction of our
dependence on higher cost time deposits as a funding source. We have implemented
a suite of interest bearing checking account products, called High Performance
Checking, with interest rates and other features tired to differing levels of
minimum balances. Since 2002, time deposits have declined from 30.9% of our
deposit portfolio, with an average rate of 3.06% to 26.7% of our deposit
portfolio, with an average rate of 2.09% for the nine months ended September 30,
2004. Our NOW accounts, which include our High Performance Checking and
commercial checking accounts, have increased from 18.8% of our average deposit
portfolio for the year end of December 31, 2002 to 21.4% for the nine months
ended September 30, 2004. In addition to lowering our cost of funds, we believe
increasing our core deposits presents greater cross selling opportunities then
are available with customers holding time deposits.
To attract additional public deposits we have also developed a public fund money
market account. The account allows municipal depositors to automatically
transfer balances from non-interest bearing transaction accounts into a variable
rate interest bearing money market account. We believe this product will provide
an alternative to higher rate time deposit accounts traditionally used by public
depositors.
OTHER BANKING SERVICES
We offer other bank services including safe deposit boxes, traveler's checks,
direct deposit, United States Savings Bonds, and banking by mail. We earn fees
for most of these services, including debit and credit card transactions, sales
of checks, and wire transfers. We also receive ATM transaction fees from
transactions performed by our clients. We are associated with the NYCE, CIRRUS,
PLUS and QUEST ATM networks, which are available to our clients throughout the
country. We also offer Internet banking services, bill payment services, cash
management services, trust services and full service securities brokerages.
INSURANCE AGENCY SERVICES
Tri-State Insurance Agency, Inc. is a full service insurance agency. The Agency
is primarily a property and casualty agency, with property and casualty coverage
accounting for 95% of the agency's commission income. Life and health insurance
accounts for 5% of commission income. Approximately 65% of the agency's premium
volume is from commercial lines of insurance, with the remaining 35% from
personal lines. The agency places insurance with over 15 companies. The agency
is licensed to conduct business in 15 states, but 90% of its business is within
the State of New Jersey. Customers primarily come from personal contacts of the
senior management of the agency and the agency's producers, as well as through
cross selling efforts with the bank.
DESCRIPTION OF PROPERTY
Certain information regarding the company's properties as of December 31, 2003
is set forth in the following table. All properties are adequately covered by
insurance.
DATE OF
LOCATION LEASED OR OWNED LEASE EXPIRATION
-------- --------------- ----------------
399 Route 23 Owned N/A
Franklin, New Jersey
7 Church Street Owned N/A
Vernon, New Jersey
266 Clove Road Leased March, 2007
Montague, New Jersey
43
DATE OF
LOCATION LEASED OR OWNED LEASE EXPIRATION
-------- --------------- ----------------
96 Route 206
Augusta, New Jersey Leased August, 2006
455 Route 23 Owned(1) N/A
Wantage, New Jersey
15 Trinity Street Owned N/A
Newton, New Jersey
165 Route 206 Owned N/A
Andover, New Jersey
100 Route 206 Owned N/A
Augusta, New Jersey
33 Main Street Owned N/A
Sparta, New Jersey
200 Munsonhurst Road Leased December, 2008
Franklin, New Jersey
(1) We own the building housing our Wantage branch. The land on which the
building is located is leased pursuant to a ground lease which runs until
December 31, 2020, and contains an option for us to extend the lease for an
additional 25 year term.
LEGAL PROCEEDINGS
We are periodically parties to or otherwise involved in legal proceedings
arising in the normal course of business, such as claims to enforce liens,
claims involving the making and servicing of real property loans, and other
issues incident to the business of the company and the bank. Management does not
believe that there is any pending or threatened proceeding against the company
or the bank, which if determined adversely, would have a material effect on the
business or financial position of the company.
EMPLOYEES
As of December 31, 2003, the company employed 101 full-time employees and 28
part-time employees. None of these employees is covered by a collective
bargaining agreement and we believe that our employee relations are good.
44
MANAGEMENT
The direction and control of the company is vested in the board of directors.
The term of each director is three years. Directors are divided into three
classes and elections are staggered so that the term for one class of directors
expires each year. The following table sets forth information with respect to
the directors and certain executive officers, including their ages, a brief
description of their recent business experience, certain directorships held by
each, the year in which each became a director of the company and the year in
which their terms as director of the company expire.
NAME AND POSITION AGE PRINCIPAL OCCUPATION FOR THE PAST DIRECTOR SINCE TERM EXPIRES
----------------- --- --------------------------------- -------------- ------------
FIVE YEARS
----------
DIRECTORS
---------
Donald L. Kovach, 69 Chairman of the Board, CEO and 1976 2006
Chairman of the Board, CEO President of the company
and President
Irvin Ackerson, 82 Excavating Contractor, 1976 2007
Director Ackerson Contracting Co.,
Oak Ridge, New Jersey
Terry H. Thompson, 57 President and Chief Operating 2001 2007
Director, Secretary and Officer of the bank
President of the Bank
Mark J. Hontz, 37 Partner, 1998 2006
Director Hollander Hontz Hinkes & Pasculli,
L.L.C.,
Newton, New Jersey
Joel D. Marvil, 70 Chairman of Manufacturing Co., 1989 2006
Vice Chairman Ames Rubber Corporation,
Hamburg, New Jersey
Edward J. Leppert, 44 Owner, 2002 2005
Director E.J. Leppert & Co., C.P.A.;
Former Partner,
Murphy, Perry & Leppert
Richard Scott, 68 Dentist, 1976 2005
Director Richard Scott, DDS,
Franklin, New Jersey
Joseph Zitone, 72 General Contractor, 1984 2005
Director Zitone Construction,
Montague, New Jersey
EXECUTIVE OFFICERS WHO ARE
--------------------------
NOT DIRECTORS
-------------
Tammy Case 46 Executive Vice President, Loan 2004 N/A
Administration; Formerly Senior
Lending Officer, Newton Trust
Company
Samuel L. Chaznow 46 Vice President; Formerly Area 2003 N/A
Sales Manager and Assistant Vice
President First Horizon Home Loan
George B. Harper 50 President Tri-State Insurance 2001 N/A
Agency, Inc.
Candace Leatham 50 Executive Vice President and 1984 N/A
Treasurer of the bank
George Lista 45 Chief Operating Officer, Tri-State 2001 N/A
Insurance Agency
45
EXECUTIVE OFFICERS
Set forth below is certain information regarding our executive officers.
DONALD L. KOVACH. Mr. Kovach is Chairman of the Board and Chief Executive
Officer of the company. He is a life-long resident of Sussex County, and has
been the Chairman of the bank since it was formed. Prior to becoming the
company's Chief Executive Officer, Mr. Kovach was an attorney in private
practice, and served as Sussex County Counsel, as municipal counsel to the
Sussex County towns of Hamburg, Hopatcong and Vernon, and as counsel to the
Sussex County Community College. Mr. Kovach is active in many community
organizations, and is a director of Independent Community Bankers Financial
Services.
TERRY H. THOMPSON. Mr. Thompson is President and Chief Operating Officer of the
bank. He has been our Chief Operating Officer since 1994, and was named
President in 2003. Mr. Thompson began his banking career in 1970, and held a
number of increasingly senior positions with Summit Bancorp, a New Jersey bank
holding company with operations throughout the state. Mr. Thompson is also the
New Jersey state director for the Independent Community Bankers Association, a
national trade group for community banks.
CANDACE LEATHAM. Ms. Leatham is the Executive Vice President and Treasurer of
the bank. She has over 30 years of financial services industry experience, and
has been an employee of the company and the bank for almost 25 years. She is
active in her local community, serving as a member of the Hardyston Township
Zoning Board of Adjustment and the Hardyston Township Municipal Utilities
Authority,
GEORGE B. HARPER. Mr. Harper is President of Tri-State Insurance Agency, a
subsidiary of the bank, where has been President since 1976. He is active in
many community organizations, including serving as a Director of Sussex Area
Charities, and has served as the Mayor and a Council Member of Sandyston
Township since 1986.
GEORGE LISTA. Mr. Lista is Chief Operating Officer of Tri-State Insurance
Agency, a subsidiary of the bank. He has served as an executive officer of
Tri-State and a predecessor agency since 1982.
TAMMY CASE. Ms. Case is Executive Vice President - Loan Administration of the
bank. She has over 27 years of experience in the banking industry, 23 of which
has been spent in Sussex County. Prior to joining the company, Ms. Case was the
Senior Vice President of Business Banking Services and the Senior Loan Officer
of Newton Trust Company, another Sussex County based community bank. She is also
an honors graduate of the Stonier Graduate School of Banking.
SAMUEL CHAZANOW. Mr. Chazanow is the Vice President and head of residential
mortgage banking operations for the Bank. Mr. Chazanow has been a mortgage
banking professional since 1989, most recently as the area sales manager for the
Northeast Region for First Horizon Home Loans, a large national lending company.
Mr. Chazanow has been based in the northeast Pennsylvania marketplace for his
entire mortgage banking career.
COMMITTEES OF THE BOARD
The board of directors maintains an Audit Committee and a Compensation
Committee. The board of directors also plans to establish a Nominating Committee
that meets the requirements of the American Stock Exchange ("AMEX") listing
standards beginning with the 2005 Annual Meeting. For the 2004 Annual Meeting,
the full board acted as a Nominating Committee. It is expected that the
Nominating Committee will consider qualified nominations for directors that are
submitted by shareholders. All shareholder recommendations will be evaluated on
the same basis as any recommendation from members of the Board of management of
the company.
AUDIT COMMITTEE. The company's Audit Committee assists the board of directors
with its oversight of our accounting and financial reporting processes,
including internal audit functions, and the audits of our financial statements.
In connection with its oversight responsibilities, the Audit Committee is
responsible for the appointment, compensation, evaluation, retention and
termination of our independent auditors. The Audit Committee has sole
responsibility for oversight over the independent auditor, including resolution
of disagreements between company management and the independent auditor
regarding financial reporting. In connection with its oversight role, the Audit
Committee reviews the independent auditor's reports regarding critical
accounting policies, alternative treatments within generally accepted accounting
principles, and other written communications between
46
the independent auditor and management. The Audit Committee is also responsible
for receiving and responding to complaints and concerns relating to accounting
and auditing matters and the pre-approval of all non-audit service provided by
its independent auditor. Furthermore, the Audit Committee is also responsible
for, among other things, reporting to the board of directors on the results of
the annual audit, and reviewing the financial statements and related financial
and non-financial disclosures included in our earnings releases and Annual
Reports on Form 10-KSB. The Audit Committee has adopted a written charter
outlining its practices and responsibilities.
During the year ended December 31, 2003, the Audit Committee met five times. At
each meeting, the Audit Committee reviewed the results of reviews performed in
the areas of internal audit and compliance. The Audit Committee was apprised of
the status of all audit findings and the resolutions instituted by management.
The company's Audit Committee consists of directors Edward J. Leppert
(Chairman), Joel D. Marvil and Richard W. Scott. All directors who serve on the
Audit Committee are "independent" for purposes of the AMEX listing standards
and, as required under the Sarbanes-Oxley Act, no member of the Audit Committee
receives any form of compensation from the company outside from compensation for
board and committee services. The board has determined that Mr. Leppert
qualified as an "audit committee financial expert" as that term is defined in
Item 401(e) of SEC Regulation S-B.
The Audit Committee acts only in an oversight capacity, and in doing so relies
on the work and assurances of our management and its independent auditors.
COMPENSATION COMMITTEE. The Compensation Committee sets the compensation for the
executive officers of the company. The Compensation Committee consists of
directors Joel D. Marvil (Chairman), Irvin Ackerson, Edward J. Leppert and Mark
J. Hontz, all of whom are "independent" for purposes of the AMEX listing
standards.
DIRECTORS' COMPENSATION
During 2003, directors of the bank who were not full-time employees of the bank
received a fee of $500 for each regular monthly bank board meeting or special
bank board meeting attended, and $100 for each committee meeting attended. Each
member of the bank's loan committee will receive $500 per meeting in 2004.
During 2003, directors of the company received an annual retainer of $5,000
each. In addition, members of the Audit Committee will receive in 2004 an
additional fee of $1,000 per Audit Committee meeting, and the Chairman will
receive $1,500 per meeting.
The company maintains the 1995 Stock Option Plan for Non-Employee Directors (the
"Non-Employee Plan"), the purpose of which is to assist the company in
attracting and retaining qualified persons to serve as members of the board of
directors. Under the Non-Employee Plan, options may be granted at exercise
prices which may not be less than the fair market value of the common stock on
the date of grant. Under the Non-Employee Plan, each non-employee director
elected at the 1995 Annual Meeting was granted an option to purchase 3,000
shares at $11.25 per share (or 6,950 shares at $4.84 as adjusted for stock
dividends). In addition, each non-employee director who is elected or re-elected
to serve on the board of directors at succeeding annual meetings will be granted
an option to purchase 500 shares of common stock at the time of such
re-election. As of December 31, 2003, 44,732 options were outstanding under this
plan and 2,344 authorized shares were available for grant.
In addition, members of the board of directors are eligible to participate in
the 2001 Stock Option Plan, which was approved by the shareholders in 2000.
Under the 2001 Stock Option Plan, options to purchase up to a total of 165,000
shares of common stock may be granted. Pursuant to the terms of the 2001 Stock
Option Plan, options which qualify as incentive stock options under the Internal
Revenue Code of 1986 must be granted at an exercise price of no less than 100%
of the then current fair market value of the common stock, and options which are
non-statutory options may be granted at an exercise price no less than 85% of
the then current fair market value of the common stock.
DIRECTOR RELATIONSHIPS
No director of the company is also a director of any company with a class of
securities registered pursuant to Section 12 of the Securities Exchange Act of
1934 or subject to the requirements of Section 15(d) thereof, or any company
registered as an investment company under the Investment Company Act of 1940.
47
SECURITY OWNERSHIP OF MANAGEMENT
The table sets forth certain information as of August 31, 2004 with respect to
(i) each of the directors and executive officers of the company and (ii) the
directors and executive officers as a group:
COMMON STOCK BENEFICIALLY
PERCENTAGE OF
NAME OF BENEFICIAL OWNER NUMBER OF SHARES1 SHARES OUTSTANDING
------------------------ ----------------- ------------------
Irvin Ackerson 35,273(2) 1.90%
George Harper 40,322(3) 2.18%
Mark J. Hontz 3,817(4) 0.21%
Donald L. Kovach 137,931(5) 7.42%
Candace Leatham 49,411(6) 2.67%
Edward J. Leppert 13,378(7) 0.72%
George Lista 16,958(8) 0.91%
Joel D. Marvil 49,761(9) 2.68%
Richard Scott 56,319(10) 3.04%
Terry H. Thompson 27,610(11) 1.49%
________________________
1 Beneficially-owned shares include shares over which the named person
exercises either sole or shared voting power or sole or shared investment power.
It also includes shares owned (i) by a spouse, minor children or by relatives
sharing the same home, (ii) by entities owned or controlled by the named person
and (iii) by other persons if the named person has the right to acquire such
shares within sixty (60) days by the exercise of any right or option. Unless
otherwise noted, all shares are owned of record and beneficially by the named
person, either directly or through the dividend reinvestment plan.
2 Includes (i) 11,418 shares owned by Mr. Ackerson's wife and (ii) 11,360
shares pursuant to immediately exercisable stock options.
3 Includes 4,794 shares pursuant to immediately exercisable stock options.
4 Includes 1,000 shares pursuant to immediately exercisable stock options.
5 Includes (i) 17,448 shares owned by Mr. Kovach's wife, (ii) 9,977 shares held
by IRAs for the benefit of Mr. Kovach and his wife, (iii) 1,433 shares held in
the name of ICBA Financial Services f/b/o Donald L. Kovach, (iv) 1,323 shares
held in the name of ICBA Financial Services f/b/o Betty J. Kovach, (v) 16,764
shares pursuant to immediately exercisable stock options and (vi) 42,098 shares
over which Mr. Kovach has voting authority as administrator for Sussex Bank
Employee Stock Ownership Plan.
6 Includes (i) 6,477 shares pursuant to immediately exercisable stock options
and (ii) 42,098 shares over which Ms. Leatham has voting authority as
administrator of Sussex Bank Employee Stock Ownership Plan.
7 Includes (i) 992 shares held in the name of Sun America f/b/o Cynthia
Leppert, IRA, (ii) 3,396 shares held in the name of Salomon Smith Barney f/b/o
Edward J. Leppert, IRA and (iii) 3,150 shares pursuant to immediately
exercisable stock options.
8 Includes 3,744 shares pursuant to immediately exercisable stock options.
9 Includes 14,429 shares pursuant to immediately exercisable stock options.
10 Includes 12,307 shares pursuant to immediately exercisable stock options.
11 Includes (i) 13,425 shares held in the name of American Express Trust Co.
f/b/o Terry H. Thompson, IRA, and (ii) 9,546 shares pursuant to immediately
exercisable stock options.
48
COMMON STOCK BENEFICIALLY
PERCENTAGE OF
NAME OF BENEFICIAL OWNER NUMBER OF SHARES SHARES OUTSTANDING
------------------------ ---------------- ------------------
Joseph Zitone 94,313(12) 5.11%
Directors and Executive Officers as a Group (11 persons) 500,446 25.82%
It is expected that upon consummation of this offering, our Directors and
Executive Officers are expected to own approximately 17.7% of outstanding common
stock.
SUMMARY OF CASH AND CERTAIN OTHER COMPENSATION
The following table sets forth a summary of cash and non-cash compensation for
the three fiscal years ended December 31, 2003 awarded to, earned by, or paid
to, the Chief Executive Officer of the company and each other executive officer
whose remuneration exceeded $100,000 for the most recently completed fiscal
year.
SUMMARY COMPENSATION TABLE
CASH AND CASH EQUIVALENT FORMS OF REMUNERATION
----------------------------------------------
ANNUAL COMPENSATION AWARD PAYOUTS
SECURITIES
OTHER ANNUAL UNDERLYING LTIP ALL OTHER
NAME YEAR SALARY ($) BONUS ($) COMPENSATION OPTIONS/SARS PAYOUTS ($) COMPENSATION
---- ---- ---------- --------- ------------ ------------- ------------ ------------
($) (#) ($)
--- --- ---
Donald L. 2003 $202,087 - N/A13 9,975 None $143,049(14)
Kovach
2002 $188,143 - N/A13 3,150 None $117,869(14)
2001 $177,234 - N/A13 1,134 None $ 94,156(14)
George B. 2003 $ 50,000 $21,515(15) $76,264(16) 4,988 None -
Harper
2002 $ 50,000 $ 5,660(15) $67,022(16) -- None -
2001 $ 12,500(17) - $11,300(16) -- None -
________________________
12 Includes (i) 12,467 shares held in the name of Zitone Construction & Supply
Co., Inc. Profit Sharing Plan Trust, (ii) 22,509 shares held in the name of
Zitone Family Limited Partnership, (iii) 17,198 shares held in the name of Smith
Barney f/b/o Joseph Zitone and (iv) 3,701 shares pursuant to immediately
exercisable stock options.
13 The company provided additional life insurance and an automobile and matched
the contributions by Messrs. Kovach and Thompson to their respective 401(k)
plans. The use made thereof for personal purposes did not exceed 10% of the
total cash compensation to such person's respective base salary and bonus and
there is not included in the above table.
14 Represents the amount charged by the company to expense in connection with
the Supplemental Executive Retirement Plan ("SERP") implemented for the benefit
of Mr. Kovach in 2000.
15 For purposes of this chart, bonus represents the fair market value of 1,516
shares in 2003 and 535 shares in 2002 of the company's common stock.
16 Represents commissions earned on the sale of insurance products.
17 Pursuant to the company's acquisition of Tri-State Insurance Agency, Inc. on
October 1, 2001, Messrs. Harper and Lista became executive officers of the
company at annual salaries of $50,000 and $120,000, respectively.
49
ANNUAL COMPENSATION AWARD PAYOUTS
SECURITIES
OTHER ANNUAL UNDERLYING LTIP ALL OTHER
NAME YEAR SALARY ($) BONUS ($) COMPENSATION OPTIONS/SARS PAYOUTS ($) COMPENSATION
---- ---- ---------- --------- ------------ ------------- ------------ ------------
($) (#) ($)
--- --- ---
George Lista 2003 $120,000 $21,515(15) $95,822(16) 4,988 None -
2002 $120,000 $ 5,660(15) $61,796(16) -- None -
2001 $ 30,000(17) - $16,740(16) -- None -
Terry H. 2003 $109,650 - $ 1,051(18)(13) 7,481 None -
Thompson
2002 $ 98,280 - N/A13 3,780 None -
2001 $ 93,880 - N/A13 735 None -
EMPLOYMENT AGREEMENTS
The company and the bank are parties to an Amended Employment Agreement with Mr.
Donald L. Kovach pursuant to which he serves as President and Chief Executive
Officer of the company and Chief Executive Officer of the bank (the "Employment
Agreement"). The Employment Agreement, as amended, provides for a term ending on
August 31, 2007, although it will be automatically extended on each anniversary
date for up to two additional one-year periods unless either party provides
notice of their intention not to extend the contract. The Employment Agreement
provides that Mr. Kovach will receive a base salary of $223,300, subject to
increase or decrease, and he may be granted a discretionary bonus, in cash or
equity, as determined by the board of directors. The Employment Agreement
permits the company to terminate Mr. Kovach's employment for cause at any time.
The Employment Agreement defines cause to mean personal dishonesty, willful
misconduct, breach of fiduciary duty involving personal profit, intentional
failure to perform stated duties, willful violation of law, rule or regulation,
other than traffic violations or similar offenses, or violation of a final cease
and desist order, or a material breach of any provision of the Employment
Agreement. In the event Mr. Kovach is terminated for any reason other than
cause, or in the event Mr. Kovach resigns his employment because he is
reassigned to a position of lesser rank or status than President and Chief
Executive Officer, his place of employment is relocated by more than 30 miles
from its location on the date of the Employment Agreement, or his compensation
or other benefits are reduced, Mr. Kovach, or in the event of his death, his
beneficiary, will be entitled to receive his base salary at the time of such
termination or resignation for the remaining term of the Employment Agreement.
In addition, the company will continue to provide Mr. Kovach with certain
insurance and other benefits through the end of the term of the Employment
Agreement. Mr. Kovach's Employment Agreement further provides that upon the
occurrence of a change in control of the company, as defined in the Employment
Agreement, and in the event Mr. Kovach is terminated for reasons other than
cause or in the event Mr. Kovach, within 18 months of the change in control,
resigns his employment for the reasons discussed above, he shall be entitled to
receive a severance payment based upon his then current base salary. Under the
Agreement, in the event the change in control occurs, Mr. Kovach is entitled to
a severance payment equal to 2.99 times his then current base salary. The
Employment Agreement also prohibits Mr. Kovach from competing with the bank and
the company for a period of one year following termination of his employment.
The company and the bank are parties to an employment agreement with Terry
Thompson. Mr. Thompson's agreement has substantially the same terms as those
contained in Mr. Kovach's agreement, except that the term of Mr. Thompson's
agreement expires on January 23, 2006. Mr. Thompson's agreement also provides
that its terms will automatically be extended for one additional year, until
January 23, 2007, unless the company provides notice three (3) months prior to
the termination of the original term of the agreement Mr. Thompson's base salary
is set at $110,000.
________________________
18 Includes the implied value realized upon the exercise of options to purchase
189 shares representing the difference between the exercise price and the fair
market value on the date of exercise. Because Mr. Thompson did not sell the
underlying shares, he did not recognize this implied value.
50
In connection with the company's acquisition of Tri-State Insurance Agency, Inc.
effective October 1, 2001, the company entered into employment agreements with
each of Messrs George B. Harper and George Lista. Under these agreements, each
of Messrs. Harper and Lista is to be paid a base salary ($50,000 for Mr. Harper
and $120,000 for Mr. Lista) and commissions for insurance products actually
placed. In addition, each of Messrs Harper and Lista is entitled to receive
bonuses based upon the net before tax income of Tri-State for each twelve-month
period commencing on the effective date of the acquisition. To the extent
Tri-State's net before tax income exceeds certain designated targets contained
in each employment agreement, each of Messrs. Harper and Lista will be entitled
to receive a bonus equal to 25% of the amount by which the net before tax income
of Tri State exceeds the target. The bonus is to be paid in shares of the
company's common stock. The amount of stock to be issued will be determined by
dividing the amount of the bonus by the fair market value of the company's
common stock, determined by taking the average closing price of the common stock
for the fifteen trading days prior to issuance. For the twelve-month period
ended September 30, 2003, Tri-State exceeded its targeted net before tax income,
and each of Messrs. Harper and Lista received a bonus of 1,516 shares of the
company's common stock. The employment agreements with Messrs. Harper and Lista
expire on September 30, 2006.
On July 31, 2004, the bank entered into an employment agreement with Tammy Case
under which she will serve as the Executive Vice-President - Loan Administration
of the bank. The agreement has term of 3 years and will automatically renew for
each additional year on the third anniversary of the agreement unless either
party has provided notice of its intention not to renew at least 3 months before
the end of the term. Under the Agreement, Ms. Case is to receive a base salary
of $97,000, will be eligible to receive a production bonus in shares of the
company's common stock, based upon growth in the company's loan portfolio, and
will also be eligible to participate in any other cash bonus programs
established by the company for its executive officers. Ms. Case may be
terminated for "cause" as defined in the Agreement. In the event she is
terminated without "cause" she will be entitled to receive her then current base
salary for the remaining term of the Agreement, but in no event for less than 6
months, and the company will be obligated to continue her health benefits for
such period. Ms. Case's agreement contains a change of control provision
substantially similar to the one contained in Mr. Kovach's agreement described
above, except that her payment will equal two times her then current base
salary. Ms. Case's agreement also contains a covenant not to compete, whereby
she is prohibited for a period of 1 year after her termination from affiliating
with any enterprise that competes with the company within Sussex County, New
Jersey.
RETIREMENT PLANS
The bank maintains a salary continuation plan for Mr. Kovach. Under this plan,
as recently amended, Mr. Kovach will receive a retirement benefit equal to 35%
of his average final compensation determined by his last five years of
employment, provided that to the extent Mr. Kovach continues to work past age
70, his final compensation will be increased 4% per year for each year he works
past age 70 until his retirement. Mr. Kovach will receive this benefit in the
event that he works until retirement, or he is involuntarily discharged prior to
his retirement for any reason other than "cause". For purposes of the Salary
Continuation Agreement, cause is defined in the same manner as under Mr.
Kovach's Employment Agreement. Annual retirement payments are to be made for
fifteen years under the Salary Continuation Agreement to Mr. Kovach or, in the
event of his death, to his spouse.
The bank has also instituted a salary continuation plan for Mr. Thompson. Under
this plan, Mr. Thompson will receive a retirement benefit equal to 35% of his
average final compensation determined by his last five years of employment. Mr.
Thompson's benefits under the salary continuation plan will not vest unless Mr.
Thompson remains employed with the company and the bank until January, 2006.
1995 INCENTIVE STOCK OPTION PLAN AND 2001 STOCK OPTION PLAN
The company maintains the 1995 Incentive Stock Option Plan that provides for
options to purchase shares of common stock to be issued to key employees of the
company, the bank and any other subsidiaries that the company may acquire or
incorporate in the future. The company also maintains the 2001 Stock Option
Plan, under which options to purchase shares of common stock may be issued to
employees, officers and directors of the company, the bank and any other
subsidiaries which the company may acquire or incorporate in the future.
Recipients of options granted under the Plans are selected by the Stock Option
Committee of the board of directors. The Stock Option Committee has the
authority to determine the terms and conditions of options granted under the
Plans and the exercise price therefore. The exercise price for options granted
under the 1995 Incentive Stock Option Plan, and for
51
Incentive Stock Options under the 2001 Stock Option Plan may be no less than the
fair market value of the common stock. The exercise price for non-statutory
options granted under the 2001 Stock Option Plan may be no less than 85% of the
fair market value of the common stock.
The following table sets forth information with regard to stock options granted
under the company's 1995 Incentive Stock Option Plan and 2001 Stock Option Plan.
The following table furnishes information regarding stock options granted to the
individuals named in the table above:
INDIVIDUAL GRANTS
-----------------
NUMBER OF PERCENTAGE OF
SECURITIES TOTAL OPTIONS/SARS
UNDERLYING GRANTED TO PRESENT VALUE OF
OPTIONS/SARS EMPLOYEES IN FISCAL EXERCISE OR STOCK OPTION ON EXPIRATION
NAME GRANTED YEAR BASE PRICE ($/SH) DATE OF GRANT(19) DATE
---- ------- ---- ----------------- ----------------- ----
Donald L. Kovach 9,975(20) 16.3% $9.90 $1.16 01/22/13
Terry H. Thompson 7,481(21) 12.2% $9.90 $1.16 01/22/13
George B. Harper 4,988(22) 8.2% $10.05 $1.15 04/23/13
George Lista 4,988(23) 8.2% $10.05 $1.15 04/23/13
The following table sets forth information concerning the fiscal year-end value
of unexercised stock options held by the executive officers named in the table
above.
AGGREGATED OPTION/SAR EXERCISES IN LAST FISCAL YEAR AND
FISCAL YEAR-END OPTION/SAR VALUES
---------------------------------
NUMBER OF UNEXERCISED VALUE OF UNEXERCISED
OPTIONS/SARS IN-THE-MONEY OPTIONS/SARS
NUMBER OF AT FISCAL YEAR-END AT FISCAL YEAR-END
SHARES ------------------ ------------------
ACQUIRED ON VALUE
NAME EXERCISE REALIZED ($) EXERCISABLE UNEXERCISABLE EXERCISABLE UNEXERCISABLE
---- -------- ------------ ----------- ------------- ----------- -------------
Donald L. Kovach - - 10,619 9,705 $75,275 $96,107
Terry H. Thompson 189 $1,605 4,128 7,967 $41,012 $78,857
George H. Harper - - 2,297 3,741 $22,778 $37,590
George Lista - - 1,247 3,741 $12,530 $37,590
________________________
19 The present value of each option grant is estimated on the date of grant
using the Black-Scholes option pricing model with the following weighted-average
assumptions: dividend yield of 2.41%, expected volatility of 13.24%, risk-free
interest rate of 3.05% for Mr. Kovach and Mr. Thompson and 2.93% for Mr. Harper
and Mr. Lista and an expected life of five (5) years.
20 As of December 31, 2003, 2,494 of these options were immediately exercisable.
21 As of December 31, 2003, 1,870 of these options were immediately exercisable.
22 As of December 31, 2003, 1,247 of these options were immediately exercisable.
23 As of December 31, 2003, 1,247 of these options were immediately exercisable.
52
TRANSACTIONS WITH MANAGEMENT
The bank has made in the past and, assuming continued satisfaction of generally
applicable credit standards, expects to continue to make loans to directors,
executive officers and their associates (i.e. corporations or organizations for
which they serve as officers or directors or in which they have beneficial
ownership interests of ten percent or more). All of these loans have been made
in the ordinary course of the bank's business on substantially the same terms,
including interest rates and collateral, as those prevailing at the time for
comparable transactions with other persons and do not involve more than the
normal risk of default or present other unfavorable features.
The bank also had the following transactions with directors, executive officer
and their associates at terms at least as favorable to the bank as could be
obtained from an independent third party.
The bank paid $15,770 to Irvin Ackerson for real estate appraisal services
rendered to the bank for loan originations during fiscal 2003. Mr. Ackerson
continues to render real estate appraisal services to the bank. The bank also
paid $10,716 to related parties during 2003 for legal, tax accounting and
construction services.
The bank leases its Montague branch office from Montague Mini Mall, Inc.
pursuant to a lease covering 1,200 square feet. The lease agreement was renewed
as of April 1, 2002. As renewed, the lease will terminate on March 31, 2007 and
provides for a monthly rent of $1,850 or $22,200 per year. Mr. Joseph Zitone, a
director of the company, is the majority shareholder or Montague Mini Mall, Inc.
The company considers the lease terms to be comparable to those which exist with
unaffiliated third parties.
53
DESCRIPTION OF THE COMPANY'S SECURITIES
GENERAL
Sussex Bancorp is incorporated under the laws of the State of New Jersey. The
rights of the holders of our stock will be governed by the New Jersey Business
Corporation Act and the certificate of incorporation. The company's certificate
of incorporation provides for an authorized capitalization consisting of
5,000,000 shares of common stock, without par value.
As of September 30, 2004, 1,842,188 shares of the company's common stock were
outstanding, leaving 3,157,812 shares of authorized common stock available to be
issued. Under New Jersey law, the board of directors is generally empowered to
issue authorized common stock without shareholder approval.
Upon completing of the offering, assuming the exercise of the over-allotment
options granted to the underwriter, there will be 2,973,338 shares of common
stock outstanding. Up to an additional 268,570 shares of common stock will be
issuable upon exercise of the outstanding options granted under the company's
1995 and 2001 stock option plans.
DIVIDEND RIGHTS
The holders of the company's common stock are entitled to dividends, when, as,
and if declared by the board of directors, subject to the restrictions imposed
by New Jersey law. The only statutory limitation applicable to the company is
that dividends may not be paid if the company is insolvent. However, as a
practical matter, unless the company expands its activities, its only source of
income will be the earnings of the bank. Under the Banking Act, dividends may be
paid only if, after the payment of the dividend, the capital stock of the bank
will be unimpaired and either the bank will have a surplus of not less than 50%
of its capital stock or the payment of the dividend will not reduce the bank's
surplus.
VOTING RIGHTS
Each share of the common stock is entitled to one vote per share. Cumulative
voting is not permitted. Under New Jersey corporate law, the affirmative vote of
a majority of the votes cast is required to approve any merger, consolidation or
disposition of substantially all of the company's assets.
PREEMPTIVE RIGHTS
Under New Jersey law, shareholders may have preemptive rights if these rights
are provided in the certificate of incorporation. The company's certificate of
incorporation does not provide for preemptive rights.
APPRAISAL RIGHTS
Under New Jersey law, dissenting shareholders will have appraisal rights
(subject to the broad exception set forth in the next sentence) upon certain
mergers or consolidations. Appraisal rights are not available in any such
transaction if shares of the corporation are listed for trading on a national
securities exchange or held of record by more than 1,000 holders. In addition,
appraisal rights are not available to shareholders of an acquired corporation
if, as a result of the transaction, shares of the acquired corporation are
exchanged for any of the following: (i) cash; (ii) any securities listed on a
national securities exchange or held of record by more than 1,000 holders; or
(iii) any combination of the above. New Jersey law also provides that a
corporation may grant appraisal rights in other types of transactions or
regardless of the consideration received by providing for such rights in its
certificate of incorporation. The company's certificate of incorporation does
not provide appraisal rights beyond those called for under New Jersey law.
54
DIRECTORS
Under New Jersey law and the company's certificate of incorporation, the company
is to have a minimum of three (3) directors and a maximum of twenty-five (25),
with the number of directors at any given time to be fixed by the board of
directors. The company currently has eight (8) directors.
INDEMNIFICATION
The company's certificate of incorporation provides that the company will
indemnify any person who was or is a party to any threatened, pending or
completed action, whether civil or criminal, administrative or investigative by
reason of the fact that such person is or was a director or officer of the
company, or is or was serving as a director or officer of any other entity at
the company's request against expenses, judgments, fines and amounts paid in
settlement incurred by such person in connection with such action, provided that
the director or officer acted in good faith in a manner he reasonably believed
to be in or not opposed to the best interest of the company and, with respect to
any criminal action or proceeding, had no reasonable cause to believe his
conduct was unlawful. In addition, in the event that such action is in the name
of the company, a director or officer may not be indemnified if he is found
liable to the company unless a court determines that, despite the finding of
liability, the officer or director is fairly and reasonably entitled to
indemnification.
LIMITATION OF LIABILITY
The company's certificate of incorporation contains provisions that may limit
the liability of any of its directors or officers to the company or its
shareholders for damages for an alleged breach of any duty owed to the company
or its shareholders. This limitation will not relieve an officer or director
from liability based on any act or omission (i) which was in breach of such
person's duty of loyalty to the company or its shareholders; (ii) which was not
in good faith or involved a knowing violation of law; or (iii) which resulted in
receipt by such officer or director of an improper personal benefit. These
provisions are permissible under New Jersey law.
ANTI-TAKEOVER PROVISIONS
BANK REGULATORY REQUIREMENTS
Under the Federal Change in Bank Control Act (the "Control Act"), a 60 day prior
written notice must be submitted to the Federal Reserve Bank ("FRB") if any
person, or any group acting in concert, seeks to acquire 10% or more of any
class of outstanding voting securities of a bank holding company, unless the FRB
determines that the acquisition will not result in a change of control. Under
the Control Act, the FRB has 60 days within which to act on such notice taking
into consideration certain factors, including the financial and managerial
resources of the acquirer, the convenience and needs of the community served by
the bank holding company and its subsidiary banks and the antitrust effects of
the acquisition. Under the Bank Holding Company Act of 1956, as amended
("BHCA"), a company is generally required to obtain prior approval of the FRB
before it may obtain control of a bank holding company. Under the BHCA, control
is generally described to mean the beneficial ownership of 25% or more of the
outstanding voting securities of a company, although a presumption of control
may exist if a party beneficially owns 10% or more of the outstanding voting
securities of a company and certain other circumstances are present.
CLASSIFIED BOARD OF DIRECTORS
Pursuant to the company's certificate of incorporation, the board of directors
is divided into three classes, each of which contains approximately one-third of
the whole number of the members of the board. Each class serves a staggered
term, with approximately one-third of the total number of directors being
elected each year. The certificate of incorporation and bylaws provide that the
size of the board shall be determined by a majority of the directors. The
certificate of incorporation and the bylaws provide that any vacancy occurring
in the board, including a vacancy created by an increase in the number of
directors or resulting from death, resignation, retirement, disqualification,
removal from office or other cause, shall be filled for the remainder of the
unexpired term exclusively by a majority vote of the directors then in office.
The classified board is intended to provide for continuity of the board of
directors and to make it more difficult and time consuming for a stockholder
group to use
55
its voting power to gain control of the board of directors without the consent
of the incumbent board of directors of the company.
STOCKHOLDER VOTE REQUIRED TO APPROVE BUSINESS COMBINATIONS
Under New Jersey law, business combinations, including mergers, consolidations
and sales of all or substantially all of the assets of a corporation must,
subject to certain exceptions, be approved by the vote of the holders of a
majority of the outstanding shares of common stock of the company and any other
affected class of stock, unless a higher vote is required under a company's
certificate of incorporation. The company's certificate of incorporation does
not contain any higher voting requirements.
AMENDMENT OF CERTIFICATE OF INCORPORATION AND BYLAWS
Amendments to the certificate of incorporation must be approved by a majority
vote of the company's board of directors and also by a majority of the
outstanding shares of its voting stock.
NEW JERSEY SHAREHOLDERS PROTECTION ACT
A provision of New Jersey law, the New Jersey Shareholders Protection Act,
prohibits certain transactions involving an "interested stockholder' and a
corporation. An "interested stockholder" is generally defined as one who is the
beneficial owner, directly or indirectly, of 10% or more of the voting power of
the outstanding stock of the corporation. The Shareholders Act prohibits certain
business combinations between an interested stockholder and a New Jersey
corporation subject to the Shareholders Act for a period of five years after the
date the interested stockholder acquired his stock, unless the transaction was
approved by the corporation's board of directors prior to the time the
interested stockholder acquired his stock. After the five-year period expires,
the prohibition on business combinations with an interested stockholder
continues unless certain conditions are met. The conditions include (i) that the
business combination is approved by the board of directors of the target
corporation; (ii) that the business combination is approved by a vote of
two-thirds of the voting stock not owned by the interested stockholder; and
(iii) that the stockholders of the corporation receive a price in accordance
with the Shareholders Act.
SUPERVISION AND REGULATION
Bank holding companies and banks are extensively regulated under both federal
and state law. These laws and regulations are intended to protect depositors,
not shareholders. To the extent that the following information describes
statutory and regulatory provisions, it is qualified in its entirety by
reference to the particular statutory and regulatory provisions. Any change in
the applicable law or regulation may have a material effect on the business and
prospects of the company and the bank.
BANK HOLDING COMPANY REGULATION
As a bank holding company registered under the Bank Holding Company Act, the
company is subject to the regulation and supervision applicable to bank holding
companies by the Board of Governors of the Federal Reserve System. The company
is required to file with the Federal Reserve annual reports and other
information regarding its business operations and those of its subsidiaries.
The Bank Holding Company Act requires, among other things, the prior approval of
the Federal Reserve in any case where a bank holding company proposes to (i)
acquire all or substantially all of the assets of any other bank, (ii) acquire
direct or indirect ownership or control of more than 5% of the outstanding
voting stock of any bank (unless it owns a majority of such company's voting
shares) or (iii) merge or consolidate with any other bank holding company. The
Federal Reserve will not approve any acquisition, merger, or consolidation that
would have a substantially anti-competitive effect, unless the anti-competitive
impact of the proposed transaction is clearly outweighed by a greater public
interest in meeting the convenience and needs of the community to be served. The
Federal Reserve also considers capital adequacy and other financial and
managerial resources and future prospects of the companies and the banks
concerned, together with the convenience and needs of the community to be
served, when reviewing acquisitions or mergers.
56
The Bank Holding Company Act generally prohibits a bank holding company, with
certain limited exceptions, from (i) acquiring or retaining direct or indirect
ownership or control of more than 5% of the outstanding voting stock of any
company which is not a bank or bank holding company, or (ii) engaging directly
or indirectly in activities other than those of banking, managing or controlling
banks, or performing services for its subsidiaries, unless such non-banking
business is determined by the Federal Reserve to be so closely related to
banking or managing or controlling banks as to be properly incident thereto.
The Bank Holding Company Act was substantially amended through the Modernization
Act. The Modernization Act permits bank holding companies and banks that meet
certain capital, management and Community Reinvestment Act standards to engage
in a broader range of non-banking activities. In addition, bank holding
companies which elect to become financial holding companies may engage in
certain banking and non-banking activities without prior Federal Reserve
approval. Finally, the Modernization Act imposes certain new privacy
requirements on all financial institutions and their treatment of consumer
information. At this time, the company has elected not to become a financial
holding company, as it does not engage in any activities which are not
permissible for banks.
There are a number of obligations and restrictions imposed on bank holding
companies and their depository institution subsidiaries by law and regulatory
policy that are designed to minimize potential loss to the depositors of such
depository institutions and the FDIC insurance funds in the event the depository
institution becomes in danger of default. Under a policy of the Federal Reserve
with respect to bank holding company operations, a bank holding company is
required to serve as a source of financial strength to its subsidiary depository
institutions and to commit resources to support such institutions in
circumstances where it might not do so absent such policy. The Federal Reserve
also has the authority under the Bank Holding Company Act to require a bank
holding company to terminate any activity or to relinquish control of a non-bank
subsidiary upon the Federal Reserve's determination that such activity or
control constitutes a serious risk to the financial soundness and stability of
any bank subsidiary of the bank holding company.
CAPITAL ADEQUACY GUIDELINES FOR BANK HOLDING COMPANIES
The Federal Reserve has adopted risk-based capital guidelines for bank holding
companies. The risk-based capital guidelines are designed to make regulatory
capital requirements more sensitive to differences in risk profile among banks
and bank holding companies, to account for off-balance sheet exposure, and to
minimize disincentives for holding liquid assets. Under these guidelines, assets
and off-balance sheet items are assigned to broad risk categories each with
appropriate weights. The resulting capital ratios represent capital as a
percentage of total risk-weighted assets and off-balance sheet items.
The minimum ratio of total capital to risk-weighted assets (including certain
off-balance sheet activities, such as standby letters of credit) is 8%. At least
4% of the total capital is required to be "Tier I Capital," consisting of common
shareholders' equity and qualifying preferred stock, less certain goodwill items
and other intangible assets. The remainder ("Tier II Capital") may consist of
(a) the allowance for loan losses of up to 1.25% of risk-weighted assets, (b)
non-qualifying preferred stock, (c) hybrid capital instruments, (d) perpetual
debt, (e) mandatory convertible securities, and (f) qualifying subordinated debt
and intermediate-term preferred stock up to 50% of Tier I capital. Total capital
is the sum of Tier I and Tier II capital less reciprocal holdings of other
banking organizations' capital instruments, investments in unconsolidated
subsidiaries and any other deductions as determined by the Federal Reserve
(determined on a case by case basis or as a matter of policy after formal
rule-making).
Bank holding company assets are given risk-weights of 0%, 20%, 50% and 100%. In
addition, certain off-balance sheet items are given similar credit conversion
factors to convert them to asset equivalent amounts to which an appropriate
risk-weight will apply. These computations result in the total risk-weighted
assets. Most loans are assigned to the 100% risk category, except for performing
first mortgage loans fully secured by residential property which carry a 50%
risk-weighting and loans secured by deposits in the bank which carry a 20% risk
weighting. Most investment securities (including, primarily, general obligation
claims of states or other political subdivisions of the United States) are
assigned to the 20% category, except for municipal or state revenue bonds, which
have a 50% risk-weight, and direct obligations of the U.S. Treasury or
obligations backed by the full faith and credit of the U.S. Government, which
have a 0% risk-weight. In converting off-balance sheet items, direct credit
substitutes including general guarantees and standby letters of credit backing
financial obligations are given a 100% risk weighting. Transaction related
contingencies such as bid bonds, standby letters of credit backing nonfinancial
obligations, and
57
undrawn commitments (including commercial credit lines with an initial maturity
of more than one year) have a 50% risk weighting. Short-term commercial letters
of credit have a 20% risk weighting and certain short-term unconditionally
cancelable commitments have a 0% risk weighting.
In addition to the risk-based capital guidelines, the Federal Reserve has
adopted a minimum Tier I capital (leverage) ratio, under which a bank holding
company must maintain a minimum level of Tier I capital to average total
consolidated assets of at least 3% in the case of a bank holding company that
has the highest regulatory examination rating and is not contemplating
significant growth or expansion. All other bank holding companies are expected
to maintain a leverage ratio of at least 100 to 200 basis points above the
stated minimum.
BANK REGULATION
As a New Jersey-chartered commercial bank, the bank is subject to the
regulation, supervision, and control of the New Jersey Department of Banking and
Insurance. As an FDIC-insured institution, the bank is subject to regulation,
supervision and control of the FDIC, an agency of the federal government. The
regulations of the FDIC and the New Jersey Department of Banking and Insurance
impact virtually all of the bank's activities, including the minimum level of
capital we must maintain, our ability to pay dividends, our ability to expand
through new branches or acquisitions and various other matters.
INSURANCE DEPOSITS. Our deposits are insured up to a maximum of $100,000 per
depositor under the Bank Insurance Fund of the FDIC. The FDIC has established a
risk-based assessment system for all insured depository institutions. Under the
risk-based assessment system, deposit insurance premium rates range from 0-27
basis points of assessed deposits. For the year ended December 31, 2003 we paid
$ 30,202 in deposit insurance premiums.
CAPITAL ADEQUACY GUIDELINES. The FDIC has promulgated risk-based capital
guidelines that are designed to make regulatory capital requirements more
sensitive to differences in risk profile among banks, to account for off-balance
sheet exposure, and to minimize disincentives for holding liquid assets. Under
these guidelines, assets and off-balance sheet items are assigned to broad risk
categories, each with appropriate weights. The resulting capital ratios
represent capital as a percentage of total risk-weighted assets and off-balance
sheet items. These guidelines are substantially similar to the Federal Reserve
Board guidelines discussed above.
In addition to the risk-based capital guidelines, the FDIC has adopted a minimum
Tier 1 capital (leverage) ratio. This measurement is substantially similar to
the Federal Reserve leverage capital measurement discussed above. At September
30, 2004, the company's and the bank's ratios of total capital to risk-weighted
assets were 12.02% and 11.72% respectively.
DIVIDENDS. The bank may pay dividends as declared from time to time by the board
of directors out of funds legally available, subject to certain restrictions.
Under the New Jersey Banking Act of 1948, the bank may not pay a cash dividend
unless, following the payment, the bank's capital stock will be unimpaired and
the bank will have a surplus of no less than 50% of the bank capital stock or,
if not, the payment of the dividend will reduce the surplus. In addition, the
bank cannot pay dividends in such amounts as would reduce the bank's capital
below regulatory imposed minimums.
SARBANES-OXLEY ACT
On July 30, 2002, the Sarbanes-Oxley Act, or "SOX," was enacted. SOX is not a
banking law, but applies to all public companies, including Sussex. The stated
goals of SOX are to increase corporate responsibility, to provide for enhanced
penalties for accounting and auditing improprieties at publicly traded companies
and to protect investors by improving the accuracy and reliability of corporate
disclosures pursuant to the securities laws. SOX is the most far reaching U.S.
securities legislation enacted in some time. SOX generally applies to all
companies, both U.S. and non-U.S., that file or are required to file periodic
reports with the Securities and Exchange Commission (the "SEC") under the
Securities Exchange Act of 1934, as amended (the "Exchange Act").
SOX includes very specific additional disclosure requirements and new corporate
government rules, requires the SEC and securities exchanges to adopt extensive
additional disclosure, corporate governance and other related rules and mandates
further studies of specific issues by the SEC. SOX represents significant
federal involvement in matters traditionally left to state regulatory systems,
such as the regulation of the accounting profession, and to state
58
corporate law, such as the relationship between a board of directors and
management and between a board of directors and its committees. SOX addresses,
among other matters:
o audit committees;
o certification of financial statements by the chief executive
officer and the chief financial officer;
o the forfeiture of bonuses or other incentive-based competition
and profits from the sale of an issuer's securities by directors
and senior officers in the twelve month period following initial
publication of any financial statements that later require
restatement;
o a prohibition on insider trading during pension plan black out
periods;
o disclosure of off-balance sheet transactions;
o a prohibition on personal loans to officers and directors,
unless subject to Federal Reserve Regulation O;
o expedited filing requirements for Form 4 statements of changes
of beneficial ownership of securities required to be filed by
officers, directors and 10% shareholders;
o disclosure of whether or not a company has adopted a code of
ethics;
o "real time" filing of periodic reports;
o auditor independence; and
o various increased criminal penalties for violations of
securities laws.
Complying with the requirements of SOX as implemented by the SEC will increase
our compliance costs and could make it more difficult to attract and retain
board members.
USA PATRIOT ACT
In October 2001, President Bush signed into law the USA PATRIOT Act. This Act
was in direct response to the terrorist attacks on September 11, 2001, and
strengthens the anti-money laundering provisions of the Bank Secrecy Act. Most
of the new provisions added by this Act apply to accounts at or held by foreign
banks, or accounts of or transactions with foreign entities. The bank does not
have a significant foreign business and does not expect this Act to materially
affect its operations. This Act does, however, require the banking regulators to
consider a bank's record of compliance under the Bank Secrecy Act in acting on
any application filed by a bank. As the bank is subject to the provisions of the
Bank Secrecy Act (i.e., reporting of cash transactions in excess of $10,000),
the bank's record of compliance in this area will be an additional factor in any
applications filed by it in the future. To the bank's knowledge, its record of
compliance in this area is satisfactory and its processes and procedures to
insure compliance with this Act are satisfactory.
INDEMNIFICATION OF DIRECTORS AND OFFICERS
Insofar as indemnification for liabilities arising under the 1933 Act may be
permitted to our directors, officers and controlling persons under the
provisions discussed above or otherwise, we have been advised that, in the
opinion of the SEC, such indemnification is against public policy as expressed
in the ExchangeAct and is, therefore, unenforceable.
REGISTRAR AND TRANSFER AGENT
The registrar and transfer agent for our common stock is American Stock &
Transfer Trust Company, 59 Maiden Lane, Plaza Level, New York, New York 10038.
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UNDERWRITING
We and the underwriters named below have entered into an underwriting agreement
with respect to the shares of common stock being offered. Subject to the terms
and conditions contained in the underwriting agreement, each underwriter has
agreed to purchase from us the respective number of shares of common stock set
forth opposite its name below. The underwriters' obligations are several, which
means that each underwriter is required to purchase a specific number of shares,
but it is not responsible for the commitment of any other underwriter to
purchase shares. Keefe, Bruyette & Woods, Inc. is acting as the representative
of the underwriters.
UNDERWRITERS NUMBER OF SHARS
--------------------------------------- ---------------------
Keefe, Bruyette & Woods, Inc. 983,609
---------------------
Total 983,609
=====================
The underwriters are committed to purchase and pay for all such shares of common
stock, if any are purchased, other than those covered by the over-allotment
option described below.
We have granted to the underwriters an option, exercisable no later than 30 days
after the date of this prospectus, to purchase up to 147,541 additional shares
of common stock at the public offering price less the underwriting discount set
forth on the cover page of this prospectus. The underwriters may exercise this
option only to cover over-allotments, if any, made in connection with this
offering. To the extent the option is exercised and the conditions of the
underwriting agreement are satisfied, we will be obligated to sell to the
underwriters, and the underwriters will be obligated to purchase, these
additional shares of common stock.
The underwriters propose to offer the shares of common stock directly to the
public at the offering price set forth on the cover page of this prospectus and
to certain securities dealers at the public offering price less a concession not
in excess of $.47025 per share. The underwriters may allow, and these dealers
may re-allow, a concession not in excess of $.10 per share on sales to other
dealers. After the public offering of the common stock, the underwriters may
change the offering price and other selling terms.
The following table shows the per share and total underwriting discount that we
will pay to the underwriters and the proceeds we will receive before expenses.
These amounts are shown assuming both no exercise and full exercise of the
underwriters' over-allotment option to purchase additional shares.
PER TOTAL WITHOUT TOTAL WITH
SHARE OVER-ALLOTMENT OVER-ALLOTMENT
---------------------------- ---------- -------------- --------------
Price to public $14.25000 $ 14,016,428 $ 16,118,887
Underwriting discount 0.78375 770,904 886,539
Proceeds to us, before
expenses $13.46625 13,245,524 15,232,348
We estimate that the total expenses of the offering, excluding the underwriting
discount, will be approximately $187 thousand and are payable by us.
The shares of common stock are being offered by the several underwriters,
subject to prior sale, when, as and if issued to and accepted by them, subject
to approval of certain legal matters by counsel for the underwriters and other
conditions specified in the underwriting agreement. The underwriters reserve the
right to withdraw, cancel, or modify this offer and to reject orders in whole or
in part.
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The underwriting agreement provides that the obligations of the underwriters are
conditional and may be terminated at their discretion based on their assessment
of the state of the financial markets. The obligations of the underwriters may
also be terminated upon the occurrence of the events specified in the
underwriting agreement. The underwriting agreement provides that the
underwriters are obligated to purchase all the shares of common stock in this
offering if any are purchased, other than those shares covered by the
over-allotment option described above.
LOCK-UP AGREEMENT. We, and each of our executive officers and directors, have
agreed, for a period of 180 days after the date of this prospectus, not to sell,
offer, agree to sell, contract to sell, hypothecate, pledge, grant any option to
sell, make any short sale, or otherwise dispose of or hedge, directly or
indirectly, any shares of our common stock or securities convertible into,
exchangeable, or exercisable for any shares of our common stock or warrants or
other rights to purchase shares of our common stock or other similar securities
without, in each case, the prior written consent of Keefe, Bruyette & Woods,
Inc. These restrictions are expressly agreed to preclude us, and our executive
officers and directors, from engaging in any hedging or other transaction or
arrangement that is designed to, or which reasonably could be expected to, lead
to or result in a sale, disposition or transfer, in whole or in part, of any of
the economic consequences of ownership of our common stock, whether such
transaction would be settled by delivery of common stock or other securities, in
cash, or otherwise.
INDEMNITY. We have agreed to indemnify the underwriters, and persons who control
the underwriters, against certain liabilities, including liabilities under the
Securities Act of 1933, and to contribute to payments that the underwriters may
be required to make in respect of these liabilities.
STABILIZATION. In connection with this offering, the underwriters may engage in
stabilizing transactions, over-allotment transactions, syndicate covering
transactions, and penalty bids.
o Stabilizing transactions permit bids to purchase shares of common
stock so long as the stabilizing bids do not exceed a specified maximum,
and are engaged in for the purpose of preventing or retarding a decline
in the market price of the common stock while the offering is in
progress.
o Over-allotment transactions involve sales by the underwriters of
shares of common stock in excess of the number of shares the
underwriters are obligated to purchase. This creates a syndicate short
position which may be either a covered short position or a naked short
position. In a covered short position, the number of shares of common
stock over-allotted by the underwriters is not greater than the number
of shares that they may purchase in the over-allotment option. In a
naked short position, the number of shares involved is greater than the
number of shares in the over-allotment option. The underwriters may
close out any short position by exercising their over-allotment option
and/or purchasing shares in the open market.
o Syndicate covering transactions involve purchases of common stock in
the open market after the distribution has been completed in order to
cover syndicate short positions. In determining the source of shares to
close out the short position, the underwriters will consider, among
other things, the price of shares available for purchase in the open
market as compared with the price at which they may purchase shares
through exercise of the over-allotment option. If the underwriters sell
more shares than could be covered by exercise of the over-allotment
option and, therefore, have a naked short position, the position can be
closed out only by buying shares in the open market. A naked short
position is more likely to be created if the underwriters are concerned
that after pricing there could be downward pressure on the price of the
shares in the open market that could adversely affect investors who
purchase in the offering.
o Penalty bids permit the representative to reclaim a selling concession
from a syndicate member when the common stock originally sold by that
syndicate member is purchased in stabilizing or syndicate covering
transactions to cover syndicate short positions.
These stabilizing transactions, syndicate covering transactions, and penalty
bids may have the effect of raising or maintaining the market price of our
common stock or preventing or retarding a decline in the market price of our
common stock. As a result, the price of our common stock in the open market may
be higher than it would otherwise be in the absence of these transactions.
Neither we nor the underwriters make any representation or prediction as to
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the effect that the transactions described above may have on the price of our
common stock. The underwriters may discontinue these transactions at any time.
From time to time, some of the underwriters have provided, and may continue to
provide, investment banking services to us in the ordinary course of their
respective businesses, and have received, and may continue to receive,
compensation for such services.
LEGAL MATTERS
Windels Marx Lane & Mittendorf, LLP, New Brunswick, New Jersey, will pass upon
the legality of the securities offered by this Prospectus for us. Certain legal
matters will be passed upon for the underwriter by Thacher Proffitt & Wood, LLP,
Summit, New Jersey.
EXPERTS
The consolidated financial statements of Sussex Bancorp included in this
Prospectus and in the Registration Statement have been audited by Beard Miller
Company LLP, independent registered public accounting firm, to the extent and
for the periods set forth in their report appearing elsewhere herein and in the
Registration Statement, and are included in reliance upon such report given upon
the authority of said firm as experts in auditing and accounting.
WHERE YOU CAN GET MORE INFORMATION
At your request, we will provide you, without charge, a copy of any exhibits to
our registration statement incorporated by reference in this prospectus. If you
want more information, write or call us at:
Sussex Bancorp
200 Munsonhurst Road
Route 517
Franklin, New Jersey 07416-0353
(973) 827-2914
We are subject to the informational requirements of the 1934 Act and as required
by the 1934 Act we file reports, proxy statements and other information with the
SEC. Reports, proxy statements and other information filed by us may be
inspected and copied at the public reference facilities maintained by the SEC at
Room 1024, 450 Fifth Street, N.W., Judiciary Plaza, Washington, DC 20549 and at
the SEC's regional offices located at New York, New York 10048 and Citicorp
Center, 500 West Madison Street, Suite 1400, Chicago, Illinois 60661. Our SEC
filings are also available to the public on the SEC Internet site at
HTTP://WWW.SEC.GOV and are also available on our website at
HTTP://WWW.SUSSEXBANK.COM.
We have filed with the SEC a registration statement on Form SB-2 (together with
all amendments and exhibits thereto, the "Registration Statement") with respect
to the shares of common stock offered by this prospectus. This prospectus does
not contain all of the information included in the Registration Statement. For
further information about us and the shares of common stock offered by this
prospectus, please refer to the Registration Statement and its exhibits. You may
obtain a copy of the Registration Statement through the public reference
facilities of the SEC described above. You may also access a copy of the
Registration Statement by means of the SEC's website at http://www.sec.gov.
62
SUSSEX BANCORP & SUBSIDIARIES
INDEX TO THE CONSOLIDATED FINANCIAL STATEMENTS
Page No.
--------
Consolidated Balance Sheets as of September 30, 2004 (unaudited) and December 31, 2003 F-1
Consolidated Statements of Income for the three months and the nine months ended
September 30, 2004 and 2003 (unaudited) F-2
Consolidated Statements of Stockholders' Equity for the nine months ended
September 30, 2004 and 2003 (unaudited) F-3
Consolidated Statements of Cash Flows for the nine months ended
September 30, 2004 and 2003 (unaudited) F-4
Notes to Consolidated Financial Statements (unaudited) F-6
Report of Independent Registered Public Accounting Firm F-10
Consolidated Balance Sheets as of December 31, 2003 and 2002 F-11
Consolidated Statements of Income for the years ended
December 31, 2003 and 2002 F-12
Consolidated Statements of Stockholders' Equity for the years ended
December 31, 2003 and 2002 F-13
Consolidated Statements of Cash Flows for the years ended
December 31, 2003 and 2002 F-14
Notes to Consolidated Financial Statements F-15
63
[This Page Intentionally Left Blank]
PART I - FINANCIAL INFORMATION
ITEM 1 - FINANCIAL STATEMENTS
SUSSEX BANCORP
CONSOLIDATED BALANCE SHEETS
(DOLLARS IN THOUSANDS)
(UNAUDITED)
ASSETS SEPTEMBER 30, 2004 DECEMBER 31, 2003
------ ------------------------------------------
Cash and due from banks $13,090 $11,301
Federal funds sold - 4,195
-------------------- ------------------
Cash and cash equivalents 13,090 15,496
Interest bearing time deposits with other banks 10,900 3,500
Securities available for sale 72,612 76,545
Federal Home Loan Bank Stock, at cost 690 760
Loans receivable, net of unearned income 149,042 134,374
Less: allowance for loan losses 2,078 1,734
-------------------- ------------------
Net loans receivable 146,964 132,640
Premises and equipment, net 5,667 4,650
Accrued interest receivable 1,265 1,241
Goodwill 2,124 2,124
Other assets 6,389 3,661
-------------------- ------------------
TOTAL ASSETS $259,701 $240,617
==================== ==================
LIABILITIES AND STOCKHOLDERS' EQUITY
------------------------------------
Liabilities:
Deposits:
Non-interest bearing $36,868 $31,715
Interest bearing demand 186,862 175,942
-------------------- ------------------
Total Deposits 223,730 207,657
Federal Funds Purchased 2,385 -
Borrowings 10,000 11,000
Accrued interest payable and other liabilities 2,245 2,056
Junior subordinated debentures 5,155 -
Mandatory redeemable capital debentures - 5,000
-------------------- ------------------
TOTAL LIABILITIES 243,515 225,713
Stockholders' Equity:
Common stock, no par value, authorized 5,000,000
shares;
issued and outstanding 1,842,188 in 2004 and
1,811,460 in 2003 9,987 9,616
Retained earnings 5,821 5,040
Accumulated other comprehensive income 378 248
-------------------- ------------------
TOTAL STOCKHOLDERS' EQUITY 16,186 14,904
-------------------- ------------------
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $259,701 $240,617
==================== ==================
See Notes to Consolidated Financial Statements
F-1
SUSSEX BANCORP
CONSOLIDATED STATEMENTS OF INCOME
(IN THOUSANDS EXCEPT SHARE DATA)
(UNAUDITED)
Three Months Ended Nine Months Ended
September 30, September 30,
----------------------------- ----------------------------
2004 2003 2004 2003
------------ ------------- ------------ ------------
INTEREST INCOME
Loans receivable, including fees $2,260 $2,036 $6,522 $6,008
Securities:
Taxable 483 360 1,368 1,328
Tax-exempt 221 198 634 532
Federal funds sold 10 14 41 95
Interest bearing deposits 13 11 30 36
------------ ------------- ------------ ------------
TOTAL INTEREST INCOME 2,987 2,619 8,595 7,999
------------ ------------- ------------ ------------
INTEREST EXPENSE
Deposits 493 479 1,460 1,574
Borrowings 130 142 395 437
Junior subordinated debentures 66 60 187 186
------------ ------------- ------------ ------------
TOTAL INTEREST EXPENSE 689 681 2,042 2,197
------------ ------------- ------------ ------------
NET INTEREST INCOME 2,298 1,938 6,553 5,802
Provision for Loan Losses 120 70 373 315
------------ ------------- ------------ ------------
NET INTEREST INCOME AFTER PROVISION FOR LOAN LOSSES 2,178 1,868 6,180 5,487
------------ ------------- ------------ ------------
OTHER INCOME
Service fees on deposit accounts 175 197 557 569
ATM fees 87 87 237 251
Insurance commissions and fees 526 512 1,696 1,599
Mortgage broker fees 130 5 456 49
Investment brokerage fees 96 54 217 192
Net gain on sale of loans held for sale - - - 24
Net gain on sale of securities available for sale 11 - 11 -
Net gain on sale of foreclosed real estate - - - 63
Other 84 59 252 184
------------ ------------- ------------ ------------
TOTAL OTHER INCOME 1,109 914 3,426 2,931
OTHER EXPENSE
Salaries and employee benefits 1,564 1,371 4,654 3,998
Occupancy, net 225 154 639 478
Furniture and equipment 247 199 659 600
Stationary and supplies 43 43 126 140
Professional Fees 81 47 238 263
Advertising and promotion 96 111 279 286
Postage and freight 39 44 130 130
Amortization of intangible assets 51 42 145 119
Other 395 364 1,141 1,080
------------ ------------- ------------ ------------
TOTAL OTHER EXPENSE 2,741 2,375 8,011 7,098
------------ ------------- ------------ ------------
INCOME BEFORE INCOME TAXES 546 407 1,595 1,320
Provision for Income Taxes 143 91 430 331
------------ ------------- ------------ ------------
NET INCOME $403 $316 $1,165 $989
============ ============= ============ ============
EARNINGS PER SHARE
------------ ------------- ------------ ------------
Basic $0.22 $0.18 $0.64 $0.55
============ ============= ============ ============
Diluted $0.21 $0.17 $0.61 $0.54
============ ============= ============ ============
See Notes to Consolidated Financial Statements
F-2
SUSSEX BANCORP
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
NINE MONTHS ENDED SEPTEMBER 30, 2004 AND 2003
(UNAUDITED)
ACCUMULATED
NUMBER OF OTHER TOTAL
SHARES COMMON RETAINED COMPREHENSIVE TREASURY STOCKHOLDERS
OUTSTANDING STOCK EARNINGS INCOME (LOSS) STOCK EQUITY
----------- ----- -------- ------------- ----- ------
(DOLLARS IN THOUSANDS, EXCEPT SHARE AMOUNTS)
--------------------------------------------
BALANCE DECEMBER 31, 2002 1,688,130 $7,869 $5,249 $562 $ - $13,680
Comprehensive income:
Net income - - 989 - - 989
Change in unrealized gains on securities available
for sale, net of tax - - - (431) - (431)
-------
TOTAL COMPREHENSIVE INCOME 558
Treasury shares purchased (2,400) - - - (25) (25)
Treasury shares retired - (25) - - 25 -
Issuance of common stock and exercise of stock
options 7,037 52 - - - 52
Shares issued through dividend reinvestment plan 11,478 128 - - - 128
Dividends on common stock ($.20 per share) - - (356) - - (356)
5% Stock Dividend 85,212 1,278 (1,278) - - -
-------------------------------------------------------------------------
BALANCE SEPTEMBER 30, 2003 1,789,457 $9,302 $4,604 $131 $ - $14,037
=========================================================================
BALANCE DECEMBER 31, 2003 1,811,460 $9,616 $5,040 $248 $ - $14,904
Comprehensive income:
Net income - - 1,165 - - 1,165
Change in unrealized gains on securities available
for sale, net of tax - - - 130 - 130
-------
TOTAL COMPREHENSIVE INCOME 1,295
Treasury shares purchased (1,346) - - - (23) (23)
Treasury shares retired - (23) - - 23 -
Issuance of common stock and exercise of stock
options 23,807 205 - - - 205
Income tax benefit of stock options exercised - 52 - - - 52
Shares issued through dividend reinvestment plan 8,267 137 - - - 137
Dividends on common stock ($.21 per share) - - (384) - - (384)
-------------------------------------------------------------------------
BALANCE SEPTEMBER 30, 2004 1,842,188 $9,987 $5,821 $378 $ - $16,186
==========================================================================
See Notes to Consolidated Financial Statements
F-3
SUSSEX BANCORP
CONSOLIDATED STATEMENTS OF CASH FLOWS
(IN THOUSANDS)
(UNAUDITED)
NINE MONTHS ENDED SEPTEMBER 30,
-------------------------------------
2004 2003
------------------ -----------------
CASH FLOWS FROM OPERATING ACTIVITIES
Net income $1,165 $989
Adjustments to reconcile net income to net cash provided by operating
activities:
Provision for loan losses 373 315
Provision for depreciation and amortization 422 386
Net amortization of securities premiums and discounts 456 892
Net realized gain on sale of securities (11) -
Net realized gain on sale of foreclosed real estate - (63)
Income tax benefit of stock options exercised 52 -
Proceeds from the sale of loans - 668
Net gains on sale of loans - (24)
Loans originated for sale - (644)
Earnings on investment in life insurance (81) (37)
(Increase) decrease in assets:
Accrued interest receivable (24) (104)
Other assets (788) (360)
Increase in accrued interest payable and other liabilities 189 (148)
------------------ -----------------
NET CASH PROVIDED BY OPERATING ACTIVITIES 1,753 1,870
------------------ -----------------
CASH FLOWS FROM INVESTING ACTIVITIES
Securities available for sale:
Purchases (24,154) (42,634)
Proceeds from sale of securities 7,291 -
Maturities, calls and principal repayments 20,568 38,014
Net increase in loans (14,988) (16,584)
Purchases of bank premises and equipment (1,439) (86)
Decrease (increase) in FHLB stock 70 (10)
Proceeds from sale of foreclosed real estate - 250
Decrease in interest bearing time deposits with other banks (7,400) 100
Purchase of investment in life insurance (1,500) -
------------------ -----------------
NET CASH USED IN INVESTING ACTIVITIES (21,552) (20,950)
------------------ -----------------
CASH FLOWS FROM FINANCING ACTIVITIES
Net increase in deposits 16,073 11,948
Increase in fed funds purchased 2,385 -
Decrease of borrowings (1,000) (3,000)
Proceeds from the exercise of stock options 205 52
Purchase of treasury stock (23) (25)
Dividends paid, net of reinvestments (247) (228)
------------------ -----------------
NET CASH PROVIDED BY FINANCING ACTIVITIES 17,393 8,747
------------------ -----------------
NET (DECREASE) INCREASE IN CASH AND CASH EQUIVALENTS (2,406) (10,333)
F-4
CASH AND CASH EQUIVALENTS - BEGINNING 15,496 26,096
------------------ -----------------
CASH AND CASH EQUIVALENTS - ENDING $13,090 $15,763
================== =================
SUPPLEMENTARY CASH FLOWS INFORMATION
Interest paid $2,041 $2,254
================== =================
Income taxes paid $597 $623
================== =================
SUPPLEMENTARY SCHEDULE OF NONCASH INVESTING AND FINANCING ACTIVITIES
Foreclosed real estate acquired in settlement of loans $291 $223
================== =================
See Notes to Consolidated Financial Statements
F-5
SUSSEX BANCORP
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
1. Basis of Presentation
The consolidated financial statements include the accounts of Sussex
Bancorp (the "Company") and its wholly-owned subsidiary Sussex Bank (the
"Bank"). The Bank's wholly-owned subsidiaries are Sussex Bancorp Mortgage
Company, Inc., SCB Investment Company, Inc., and Tri-State Insurance Agency,
Inc., ("Tri-State") a full service insurance agency located in Sussex County,
New Jersey. All inter-company transactions and balances have been eliminated in
consolidation. Sussex Bank is also a 49% limited partner of Sussex Settlement
Services, L.P, a title insurance agency whose registered office is located in
King of Prussia, Pennsylvania. The Bank operates eight banking offices all
located in Sussex County, New Jersey. The Company is subject to the supervision
and regulation of the Board of Governors of the Federal Reserve System (the
"FRB"). The Bank's deposits are insured by the Bank Insurance Fund ("BIF") of
the Federal Deposit Insurance Corporation ("FDIC") up to applicable limits. The
operations of the Company and the Bank are subject to the supervision and
regulation of the FRB, FDIC and the New Jersey Department of Banking and
Insurance (the "Department") and the operations of Tri-State are subject to the
supervision and regulation by the Department.
The accompanying unaudited consolidated financial statements have been
prepared in accordance with generally accepted accounting principles for interim
financial information. Accordingly, they do not include all of the information
and footnotes required by generally accepted accounting principles for full year
financial statements. In the opinion of management, all adjustments considered
necessary for a fair presentation have been included and are of a normal,
recurring nature. Operating results for the nine-month period ended September
30, 2004, are not necessarily indicative of the results that may be expected for
the year ended December 31, 2004. These consolidated financial statements should
be read in conjunction with the consolidated financial statements and the notes
thereto that are included in the Company's Annual Report on Form 10-KSB for the
fiscal period ended December 31, 2003.
2. Earnings Per Share
Basic earnings per share is calculated by dividing net income by the
weighted average number of shares of common stock outstanding during the period.
Diluted earnings per share reflects additional common shares that would have
been outstanding if dilutive potential common shares had been issued, as well as
any adjustment to income that would result from the assumed issuance of
potential common shares that may be issued by the Company relating to
outstanding stock options and guaranteed and contingently issuable shares from
the acquisition of Tri-State. Potential common shares related to stock options
are determined using the treasury stock method.
The following table sets forth the computations of basic and diluted
earnings per share as retroactively adjusted for the 5% stock dividend declared
October 15, 2003 (dollars in thousands, except per share data):
Three Months Ended September 30, 2004 Three Months Ended September 30, 2003
-------------------------------------- --------------------------------------
Per Per
Income Shares Share Income Shares Share
(Numerator) (Denominator) Amount (Numerator) (Denominator) Amount
-------------------------------------- --------------------------------------
Basic earnings per share:
Net income applicable to common
stockholders $403 1,839 $0.22 $316 1,788 $0.18
========= =========
Effect of dilutive securities:
Stock options - 55 - 50
Deferred common stock payments
for purchase of insurance agency - 17 1 34
--------------------------- ---------------------------
Diluted earnings per share:
Net income applicable to common
stockholders and assumed
conversions $403 1,911 $0.21 $317 1,872 $0.17
====================================== ======================================
F-6
Nine Months Ended September 30, 2004 Nine Months Ended September 30, 2003
-------------------------------------- --------------------------------------
Per Per
Income Shares Share Income Shares Share
(Numerator) (Denominator) Amount (Numerator) (Denominator) Amount
-------------------------------------- --------------------------------------
Basic earnings per share:
Net income applicable to common
stockholders $1,165 1,830 $0.64 $989 1,783 $0.55
========== ==========
Effect of dilutive securities:
Stock options - 73 - 28
Deferred common stock payments
for purchase of insurance agency 2 15 5 38
--------------------------- ---------------------------
Diluted earnings per share:
Net income applicable to common
stockholders and assumed
conversions $1,167 1,918 $0.61 $994 1,849 $0.54
====================================== ======================================
3. Comprehensive Income
The components of other comprehensive income and related tax effects for
the three and nine months ended September 30, 2004 and 2003 are as follows:
Three Months Ended Nine Months Ended
September 30, September 30,
2004 2003 2004 2003
------------ ---------- ---------- -----------
(In thousands) (In thousands)
Unrealized holding gains (losses) on available for sale
securities $1,340 ($1,053) $228 ($718)
Less: reclassification adjustments for gains included
in net income 11 - 11 -
------------ ---------- ---------- -----------
Net unrealized gains (losses) 1,329 (1,053) 217 (718)
Tax effect (532) 421 (87) 287
------------ ---------- ---------- -----------
Other comprehensive income (loss), net of tax $797 ($632) $130 ($431)
============ ========== ========== ===========
4. Segment Information
The Company's insurance agency operations are managed separately from
the traditional banking and related financial services that the Company also
offers. The insurance agency operation provides commercial, individual, and
group benefit plans and personal coverage.
Three Months Ended September 30, 2004 Three Months Ended September 30, 2003
Banking and Insurance Banking and Insurance
Financial Services Services Total Financial Services Services Total
------------------ -------- ----- ------------------ -------- -----
(In Thousands) (In Thousands)
Net interest income from external
sources $2,298 $- $2,298 $1,938 $- $1,938
Other income from external sources 583 526 1,109 402 512 914
Depreciation and amortization 136 30 166 102 20 122
Income (loss) before income taxes 567 (21) 546 339 68 407
Income tax expense (benefit) 151 (8) 143 64 27 91
Total assets 256,415 3,286 259,701 232,349 2,712 235,061
Nine Months Ended September 30, 2004 Nine Months Ended September 30, 2003
Banking and Insurance Banking and Insurance
Financial Services Services Total Financial Services Services Total
------------------ -------- ----- ------------------ -------- -----
(In Thousands) (In Thousands)
Net interest income from external
sources $6,553 $- $6,553 $5,802 $- $5,802
Other income from external sources 1,730 1,696 3,426 1,332 1,599 2,931
Depreciation and amortization 340 82 422 330 56 386
Income (loss) before income taxes 1,480 115 1,595 1,155 165 1,320
Income tax expense (benefit) 384 46 430 265 66 331
Total assets 256,415 3,286 259,701 232,349 2,712 235,061
F-7
5. Stock Option Plans
The Company accounts for stock option plans under the recognition and
measurement principles of APB Opinion No. 25. "Accounting for Stock Issued to
Employees," and related interpretations. No stock-based employee compensation
cost is reflected in net income, as all options granted under the Company's
plans had an exercise price equal to the market value of the underlying common
stock on the date of grant. The following table illustrates the effect on net
income and earnings per share if the Company had applied the fair value
recognition provisions of FASB Statement No. 123, "Accounting for Stock-Based
Compensation," to stock-based compensation for the periods presented:
Three Months Ended September Nine Months Ended
30, September 30,
2004 2003 2004 2003
------------- ------------- ------------- -----------
(In thousands) (In thousands)
Net income, as reported $403 $316 $1,165 $989
Total stock-based compensation expense determined
under fair value based method for all awards, net
of related tax effects (39) (16) (103) (32)
------------- ------------- ------------- -----------
Pro forma net income $364 $300 $1,062 $957
============= ============= ============= ===========
Basic earnings per share:
As reported $0.22 $0.18 $0.64 $0.55
Pro forma $0.20 $0.17 $0.58 $0.54
Diluted earnings per share:
As reported $0.21 $0.17 $0.61 $0.54
Pro forma $0.19 $0.16 $0.55 $0.52
6. Guarantees
The Company does not issue any guarantees that would require liability
recognition or disclosure, other than its standby letters of credit. Standby
letters of credit are conditional commitments issued by the Company to guarantee
the performance of a customer to a third party. Generally, all letters of
credit, when issued have expiration dates within one year. The credit risk
involved in issuing letters of credit is essentially the same as those that are
involved in extending loan facilities to customers. The Company, generally,
holds collateral and/or personal guarantees supporting these commitments. The
Company had $382,000 of standby letters of credit as of September 30, 2004.
Management believes that the proceeds obtained through a liquidation of
collateral and the enforcement of guarantees would be sufficient to cover the
potential amount of future payment required under the corresponding guarantees.
The current amount of the liability as of September 30, 2004 for guarantees
under standby letters of credit issued is not material.
7. New Accounting Standards
In January 2003, the Financial Accounting Standards Board issued FASB
Interpretation No. 46, "Consolidation of Variable Interest Entities, an
Interpretation of ARB No. 51" which was revised in December 2003. The
Interpretation provides guidance for the consolidation of variable interest
entities (VIEs). Sussex Capital Trust I qualifies as a variable interest entity
under FIN 46. Sussex Capital Trust issued mandatory redeemable preferred
securities (Trust Preferred Securities) to third-party investors and loaned the
proceeds to the Company. Sussex Capital Trust I holds, as its sole asset,
subordinated debentures issued by the Company.
FIN 46 required the Company to deconsolidate Sussex Capital Trust I from
the consolidated financial statements as of March 31, 2004. There has been no
restatement of prior periods. The impact of this deconsolidation was to increase
junior subordinated debentures or long-term debt by $5,155,000 and reduce the
mandatory capital debentures line item by $5,000,000 which had represented the
trust preferred securities of the trust. The Company's equity interest in the
trust subsidiary of $155,000, which had previously been eliminated in
consolidation, is now reported in "Other assets". For regulatory reporting
purposes, the Federal Reserve Board has indicated that the preferred securities
will continue to qualify as Tier I Capital subject to previously specified
limitations until further notice. If regulators make a determination that Trust
Preferred Securities can no longer be considered in regulatory capital, the
securities become callable and the Company may redeem them. The adoption of FIN
46 did not have an impact on the Company's results of operations or liquidity.
In March 2004, the SEC released Staff Accounting Bulletin (SAB) No. 105,
"Application of Accounting Principles to Loan Commitments." SAB 105 provides
guidance about the measurements of loan commitments recognized at fair value
under FASB
F-8
Statement No. 133, "Accounting Derivative Instruments and Hedging Activities."
SAB 105 also requires companies to disclose their accounting policy for those
loan commitments including methods and assumptions used to estimate fair value
and associated hedging strategies. SAB 105 is not effective for all loan
commitments accounted for as derivatives that are entered into after March 31,
2004. The adoption of SAB 105 is not expected to have a material effect on our
consolidated financial statements.
In March 2004, the FASB's Emerging Issues Task Force (EITF) reached a
consensus on EITF Issue No., 03-1, "The Meaning of Other-Than-Temporary
Impairment and Its Application to Certain Investments" (EITF 03-1). EITF 03-1
provides guidance regarding the meaning of other-than-temporary impairment and
its application to investments classified as either available-for-sale or
held-to-maturity under FASB Statement No. 115, "Accounting for Certain
Investments in Debt and Equity Securities," and to equity securities accounted
for under the cost method. Included in EITF 03-1 is guidance on how to account
for impairments that are solely due to interest rate changes, including changes
resulting from increases in sector credit spreads. This guidance was to become
effective for reporting periods beginning after June 15, 2004. However, on
September 30, 2004, the FASB issued a Staff Position that delays the effective
date for the recognition and measurement guidance of EITF 03-1 until additional
clarifying guidance is issued. We are not able to assess the impact of the
adoption of EITF 03-1 until final guidance is issued.
F-9
Report of Independent Registered Public Accounting Firm
To the Board of Directors and Stockholders
Sussex Bancorp
Franklin, New Jersey
We have audited the accompanying consolidated balance sheets of Sussex
Bancorp and its subsidiaries as of December 31, 2003 and 2002, and the related
consolidated statements of income, stockholders' equity and cash flows for the
years then ended. These consolidated financial statements are the responsibility
of the Company's management. Our responsibility is to express an opinion on
these consolidated financial statements based on our audits.
We conducted our audits in accordance with the standards of the Public
Company Accounting Oversight Board (United States). Those standards require that
we plan and perform the audit to obtain reasonable assurance about whether the
financial statements are free of material misstatement. An audit includes
examining, on a test basis, evidence supporting the amounts and disclosures in
the financial statements. An audit also includes assessing the accounting
principles used and significant estimates made by management, as well as
evaluating the overall financial statement presentation. We believe that our
audits provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above
present fairly, in all material respects, the financial position of Sussex
Bancorp and its subsidiaries as of December 31, 2003 and 2002, and the results
of their operations and their cash flows for the years then ended, in conformity
with accounting principles generally accepted in the United States of America.
/s/ Beard Miller Company LLP
Allentown, Pennsylvania
January 9, 2004
F-10
CONSOLIDATED BALANCE SHEETS
DECEMBER 31,
------------------------------------
2003 2002
---------------- ----------------
(DOLLARS IN THOUSANDS)
ASSETS
Cash and due from banks $ 11,301 $ 9,186
Federal funds sold 4,195 16,910
---------------- ----------------
Cash and cash equivalents 15,496 26,096
Interest bearing time deposits with other banks 3,500 3,600
Securities available for sale 76,545 72,720
Federal Home Loan Bank stock, at cost 760 750
Loans receivable, net of allowance for loan losses 2003 $1,734; 2002 $1,386 132,640 112,069
Bank premises and equipment, net 4,650 4,634
Accrued interest receivable 1,241 1,144
Goodwill 2,124 1,932
Other assets 3,661 2,959
---------------- ----------------
TOTAL ASSETS $240,617 $225,904
================ ================
LIABILITIES AND STOCKHOLDERS' EQUITY
Liabilities:
Deposits:
Non-interest bearing $ 31,715 $ 26,514
Interest bearing 175,942 163,344
---------------- ----------------
Total Deposits 207,657 189,858
Borrowings 11,000 15,000
Accrued interest payable and other liabilities 2,056 2,366
Mandatory redeemable capital debentures 5,000 5,000
---------------- ----------------
TOTAL LIABILITIES 225,713 212,224
---------------- ----------------
Stockholders' equity:
Common stock, no par value; authorized 5,000,000 shares; issued and
outstanding 1,811,460 shares in 2003 and 1,688,130 shares in 2002 9,616 7,869
Retained earnings 5,040 5,249
Accumulated other comprehensive income 248 562
---------------- ----------------
TOTAL STOCKHOLDERS' EQUITY 14,904 13,680
---------------- ----------------
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $240,617 $225,904
================ ================
See Notes to Consolidated Financial Statements
F-11
CONSOLIDATED STATEMENTS OF INCOME
YEARS ENDED DECEMBER 31,
------------------------------------
2003 2002
--------------- ---------------
(IN THOUSANDS, EXCEPT PER SHARE DATA)
INTEREST INCOME
Loans receivable, including fees $ 8,093 $ 7,734
Securities:
Taxable 1,783 2,127
Tax-exempt 739 494
Federal funds sold 110 395
Interest-bearing deposits 46 110
--------------- ---------------
TOTAL INTEREST INCOME 10,771 10,860
--------------- ---------------
INTEREST EXPENSE
Deposits 2,039 2,851
Borrowings 573 553
Mandatory redeemable capital debentures 248 132
--------------- ---------------
TOTAL INTEREST EXPENSE 2,860 3,536
--------------- ---------------
NET INTEREST INCOME 7,911 7,324
PROVISION FOR LOAN LOSSES 405 300
--------------- ---------------
NET INTEREST INCOME AFTER PROVISION FOR LOAN LOSSES 7,506 7,024
--------------- ---------------
OTHER INCOME
Service fees on deposit accounts 769 659
ATM and debit card fees 332 262
Insurance commissions and fees 2,063 1,689
Investment brokerage fees 244 249
Mortgage banking fees 213 14
Net realized gain on sale of securities 133 -
Net gain on sale of loans 42 24
Net gain on sale of foreclosed real estate 63 -
Other 244 395
--------------- ---------------
TOTAL OTHER INCOME 4,103 3,292
--------------- ---------------
OTHER EXPENSES
Salaries and employee benefits 5,478 4,640
Occupancy, net 642 601
Furniture, equipment and data processing 837 833
Stationery and supplies 181 194
Professional fees 376 319
Advertising and promotion 416 464
Postage and freight 174 154
Amortization of intangible assets 162 131
Other 1,397 1,298
--------------- ---------------
TOTAL OTHER EXPENSES 9,663 8,634
--------------- ---------------
INCOME BEFORE INCOME TAXES 1,946 1,682
PROVISION FOR INCOME TAXES 505 526
--------------- ---------------
NET INCOME $ 1,441 $ 1,156
=============== ===============
EARNINGS PER SHARE
Basic $ 0.80 $ 0.66
=============== ===============
Diluted $ 0.78 $ 0.64
=============== ===============
See Notes to Consolidated Financial Statements
F-12
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
YEARS ENDED DECEMBER 31, 2003 AND 2002
ACCUMULATED
NUMBER OF OTHER
SHARES COMMON RETAINED COMPREHENSIVE TREASURY
OUTSTANDING STOCK EARNINGS INCOME STOCK TOTAL
------------ ------------ ------------- ------------ ------------- ------------
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
BALANCE - DECEMBER 31, 2001 1,659,057 $7,732 $4,509 $123 $(127) $12,237
------------
Comprehensive income:
Net income - - 1,156 - - 1,156
Change in unrealized gains on
securities available for sale - - - 439 - 439
------------
TOTAL COMPREHENSIVE INCOME 1,595
------------
Treasury stock purchased (14,554) - - - (156) (156)
Treasury stock retired - (283) - - 283 -
Issuance of common stock and
exercise of stock options 31,280 302 - - - 302
Issuance of common stock through
dividend reinvestment plan 12,347 118 - - - 118
Dividends on common stock ($.24
per share) - - (416) - - (416)
------------ ------------ ------------- ------------ ------------- ------------
BALANCE - DECEMBER 31, 2002 1,688,130 7,869 5,249 562 - 13,680
------------
Comprehensive income:
Net income - - 1,441 - - 1,441
Change in unrealized gains on
securities available for sale - - - (314) - (314)
------------
TOTAL COMPREHENSIVE INCOME 1,127
------------
Treasury stock purchased (2,400) - - - (25) (25)
Treasury stock retired - (25) - - 25 -
Issuance of common stock and
exercise of stock options 28,264 354 - - - 354
Issuance of common stock through
dividend reinvestment plan 11,478 128 - - - 128
Dividends on common stock ($.20
per share) - - (356) - - (356)
5% stock dividend 85,988 1,290 (1,294) - - (4)
------------ ------------ ------------- ------------- ------------
BALANCE - DECEMBER 31, 2003 1,811,460 $9,616 $5,040 $248 $ - $14,904
============ ============ ============= ============ ============= ============
See Notes to Consolidated Financial Statements
F-13
CONSOLIDATED STATEMENTS OF CASH FLOWS
YEARS ENDED DECEMBER 31,
------------------------------------
2003 2002
--------------- ---------------
(IN THOUSANDS)
CASH FLOWS FROM OPERATING ACTIVITIES
Net income $1,441 $1,156
Adjustments to reconcile net income to net cash provided by operating activities:
Provision for loan losses 405 300
Provision for depreciation and amortization 672 695
Realized gain on sale of securities (133) -
Realized gain on sale of foreclosed real estate (63) -
Deferred income taxes (203) (170)
Net amortization of securities premiums and discounts 1,095 569
Proceeds from sale of loans 2,446 1,220
Net gains on sale of loans (42) (24)
Loans originated for sale (2,404) (1,196)
Earnings on investment in life insurance (49) (55)
Increase in assets:
Accrued interest receivable (97) (180)
Other assets (358) (53)
Decrease in accrued interest payable and other liabilities (73) (56)
--------------- ---------------
NET CASH PROVIDED BY OPERATING ACTIVITIES 2,637 2,206
--------------- ---------------
CASH FLOWS FROM INVESTING ACTIVITIES
Securities available for sale:
Purchases (56,128) (60,109)
Maturities, calls and principal repayments 45,876 30,267
Proceeds from sale of securities 4,942 -
Net increase in loans (21,199) (7,364)
Purchases of bank premises and equipment (526) (273)
Acquisition of insurance agency (131) -
Increase in FHLB stock (10) (65)
Net (increase) decrease in interest bearing time deposits with other banks 100 (500)
Proceeds from sale of foreclosed real estate 250 -
--------------- ---------------
NET CASH USED IN INVESTING ACTIVITIES (26,826) (38,044)
--------------- ---------------
CASH FLOWS FROM FINANCING ACTIVITIES
Net increase in deposits 17,799 11,304
Repayments of borrowings (4,000) -
Proceeds from borrowings - 5,000
Proceeds from the issuance of capital debentures - 5,000
Proceeds from the exercise of stock options 47 49
Purchase of treasury stock (25) (156)
Dividends paid, net of reinvestments (228) (298)
Cash paid in lieu of fractional shares (4) -
--------------- ---------------
NET CASH PROVIDED BY FINANCING ACTIVITIES 13,589 20,899
--------------- ---------------
NET DECREASE IN CASH AND CASH EQUIVALENTS (10,600) (14,939)
CASH AND CASH EQUIVALENTS - BEGINNING 26,096 41,035
--------------- ---------------
CASH AND CASH EQUIVALENTS - ENDING $15,496 $26,096
=============== ===============
SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION
Interest paid $2,935 $3,670
=============== ===============
Income taxes paid $ 798 $ 525
=============== ===============
SUPPLEMENTAL SCHEDULE OF NONCASH INVESTING AND FINANCING ACTIVITIES
Foreclosed real estate acquired in settlement of loans $ 223 $ -
=============== ===============
See Notes to Consolidated Financial Statements
F-14
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 1 - SUMMARY OF ACCOUNTING POLICIES
PRINCIPLES OF CONSOLIDATION
The consolidated financial statements include the accounts of Sussex
Bancorp (the "Company") and its wholly-owned subsidiaries, Sussex Bank
(the "Bank") and Sussex Capital Trust I. The Bank's wholly-owned
subsidiaries are Sussex Bancorp Mortgage Company, SCB Investment Company
and Tri-State Insurance Agency, Inc. All intercompany transactions and
balances have been eliminated in consolidation.
ORGANIZATION AND NATURE OF OPERATIONS
Sussex Bancorp's business is conducted principally through the Bank.
Sussex Bank is a New Jersey state chartered bank and provides full
banking services. The Bank generates commercial, mortgage and consumer
loans and receives deposits from customers at its eight branches located
in Sussex County, New Jersey. As a state bank, the Bank is subject to
regulation of the New Jersey Department of Banking and Insurance and the
Federal Deposit Insurance Corporation. Sussex Bancorp is subject to
regulation by the Federal Reserve Board. Sussex Capital Trust I is a
trust formed in 2002 for the purpose of issuing the mandatory redeemable
capital debentures on behalf of the Company. Sussex Bancorp Mortgage
Company brokers mortgage loans for the Bank and third parties. SCB
Investment Company holds investments. Tri-State Insurance Agency, Inc.
provides insurance agency services mostly through the sale of property
and casualty insurance policies.
ESTIMATES
The preparation of consolidated financial statements in conformity with
accounting principles generally accepted in the United States of America
requires management to make estimates and assumptions that affect the
reported amounts of assets and liabilities and disclosure of contingent
assets and liabilities at the date of the consolidated financial
statements and the reported amounts of revenues and expenses during the
reporting period. Actual results could differ from those estimates.
SIGNIFICANT GROUP CONCENTRATIONS OF CREDIT RISK
Most of the Company's activities are with customers located within
Sussex County, New Jersey. Note 4 discusses the types of securities that
the Company invests in. Note 5 discusses the types of lending that the
Company engages in. The Company does not have any significant
concentrations in any one industry or customer.
PRESENTATION OF CASH FLOWS
For purposes of reporting cash flows, cash and cash equivalents include
cash on hand, amounts due from banks and federal funds sold. Generally,
federal funds are purchased and sold for one-day periods.
SECURITIES
Securities classified as available for sale are those securities that
the Bank intends to hold for an indefinite period of time but not
necessarily to maturity. Securities available for sale are carried at
fair value. Fair values for securities are based on quoted market prices
or dealer prices, if available. If quoted market prices or dealer prices
are not available, fair value is estimated using quoted market prices or
dealer prices for similar securities. Any decision to sell a security
classified as available for sale would be based on various factors,
including significant movement in interest rates, changes in maturity
mix of the Bank's assets and liabilities, liquidity needs, regulatory
capital considerations and other similar factors. Unrealized gains or
losses are reported as increases or decreases in other comprehensive
income, net of the related deferred tax effect. Realized gains or
losses, determined on the basis of the cost of the specific securities
sold, are included in earnings. Premiums and discounts are recognized in
interest income using the interest method over the terms of the
securities. Equity securities are comprised of stock in various
companies and mutual funds.
Declines in the fair value of securities below their cost that are
deemed to be other than temporary are reflected in earnings as realized
losses. In estimating other-than-temporary impairment losses, management
considers (1) the length
F-15
of time and the extent to which the fair value has been less than cost,
(2) the financial condition and near-term prospects of the issuer, and
(3) the intent and ability of the company to retain its investment in
the issuer for a period of time sufficient to allow for any anticipated
recovery in fair value.
Federal law requires a member institution of the Federal Home Loan Bank
system to hold stock of its district FHLB according to a predetermined
formula. The restricted stock is recorded at cost.
LOANS RECEIVABLE
Loans receivable that management has the intent and ability to hold for
the foreseeable future until maturity or payoff are stated at their
outstanding unpaid principal balances, net of an allowance for loan
losses and any deferred fees or costs. Interest income is accrued on the
unpaid principal balance. Loan origination fees, net of certain direct
origination costs, are deferred and recognized as an adjustment of the
yield (interest income) of the related loans. The Bank is generally
amortizing these amounts over the contractual life of the loan.
The accrual of interest is discontinued when the contractual payment of
principal or interest has become 90 days past due or management has
serious doubts about further collectibility of principal or interest,
even though the loan is currently performing. A loan may remain on
accrual status if it is in the process of collection and is either
guaranteed or well secured. When a loan is placed on nonaccrual status,
unpaid interest credited to income in the current year is reversed and
unpaid interest accrued in prior years is charged against the allowance
for loan losses. Interest received on nonaccrual loans generally is
either applied against principal or reported as interest income,
according to management's judgment as to the collectibility of
principal. Generally, loans are restored to accrual status when the
obligation is brought current, has performed in accordance with the
contractual terms for a reasonable period of time and the ultimate
collectibility of the total contractual principal and interest is no
longer in doubt.
ALLOWANCE FOR LOAN LOSSES
The allowance for loan losses is established through provisions for loan
losses charged against income. Loans deemed to be uncollectible are
charged against the allowance for loan losses, and subsequent
recoveries, if any, are credited to the allowance.
Management's periodic evaluation of the adequacy of the allowance is
based on known and inherent risks in the portfolio, adverse situations
that may affect the borrower's ability to repay, the estimated value of
any underlying collateral, composition of the loan portfolio, current
economic conditions and other relevant factors. This evaluation is
inherently subjective as it requires material estimates that may be
susceptible to significant change, including the amounts and timing of
future cash flows expected to be received on impaired loans.
The allowance consists of specific and general components. The specific
component relates to loans that are classified as either doubtful,
substandard or special mention. For such loans that are also classified
as impaired, an allowance is established when the discounted cash flows
(or collateral value or observable market price) of the impaired loan is
lower than the carrying value for that loan. The general component
covers non-classified loans and is based on historical loss experience
adjusted for qualitative factors.
A loan is considered impaired when, based on current information and
events, it is probable that the Bank will be unable to collect the
scheduled payments of principal or interest when due according to the
contractual terms of the loan agreement. Factors considered by
management in determining impairment include payment status, collateral
value and the probability of collecting scheduled principal and interest
payments when due. Loans that experience insignificant payment delays
and payment shortfalls generally are not classified as impaired.
Management determines the significance of payment delays and payment
shortfalls on a case-by-case basis, taking into consideration all of the
circumstances surrounding the loan and the borrower, including the
length of the delay, the reasons for the delay, the borrower's prior
payment record and the amount of the shortfall in relation to the
principal and interest owed. Impairment is measured on a loan by loan
basis for commercial and construction loans by either the present value
of expected future cash flows discounted at the loan's effective
interest rate, the loan's obtainable market price or the fair value of
the collateral if the loan is collateral dependent.
F-16
Large groups of smaller balance homogeneous loans are collectively
evaluated for impairment. Accordingly, the Bank does not separately
identify individual consumer, residential and home equity loans for
impairment disclosures.
LOANS HELD FOR SALE
Loans held for sale are comprised of residential loans that the company
originates with the intention of selling in the future. These loans are
carried at the lower of cost or estimated fair value, calculated in the
aggregate. There were no loans held for sale at December 31, 2003 and
2002. Gain or loss on sales of loans is recognized based on the specific
identification method.
TRANSFERS OF FINANCIAL ASSETS
Transfers of financial assets, including sales of loans and loan
participations, are accounted for as sales, when control over the assets
has been surrendered. Control over transferred assets is deemed to be
surrendered when (1) the assets have been isolated from the company, (2)
the transferee obtains the right (free of conditions that constrain it
from taking advantage of that right) to pledge or exchange the
transferred assets, and (3) the company does not maintain effective
control over the transferred assets through an agreement to repurchase
them before their maturity.
FORECLOSED ASSETS
Foreclosed assets are comprised of property acquired through a
foreclosure proceeding or acceptance of a deed-in-lieu of foreclosure
and loans classified as in-substance foreclosure. A loan is classified
as in-substance foreclosure when the Bank has taken possession of the
collateral regardless of whether formal foreclosure proceedings take
place. Foreclosed assets initially are recorded at fair value, net of
estimated selling costs, at the date of foreclosure, establishing a new
cost basis. After foreclosure, valuations are periodically performed by
management and the assets are carried at the lower of cost or fair value
minus estimated costs to sell. Revenues and expenses from operations and
changes in the valuation allowance are included in other expenses.
Foreclosed assets are included in other assets on the balance sheets.
BANK PREMISES AND EQUIPMENT
Bank premises and equipment are stated at cost less accumulated
depreciation. Depreciation is computed on the straight-line method over
the following estimated useful lives of the related assets:
YEARS
-----------
Buildings and building improvements 20 - 40
Leasehold improvements 5 - 10
Furniture, fixtures and equipment 5 - 10
Computer equipment and software 3 - 5
GOODWILL AND OTHER INTANGIBLES
Goodwill represents the excess of the purchase price over the fair
market value of net assets acquired. The Company has recorded goodwill
of $2,124,000 and $1,932,000 at December 31, 2003 and 2002,
respectively, related to the acquisition of an insurance agency on
October 1, 2001 as described in Note 2. The $192,000 and $220,000
increase in goodwill in 2003 and 2002, respectively, was due to
contingent payments made to the sellers in accordance with the purchase
agreement and other acquisition costs incurred. In accordance with
current accounting standards, goodwill is not amortized, but evaluated
at least annually for impairment. Any impairment of goodwill results in
a charge to income. Goodwill was tested for impairment during 2003. The
estimated fair value of the reporting segment exceeded its book value,
therefore, no write-down of goodwill was required. The goodwill is not
deductible for tax purposes.
The Company also has amortizable intangible assets resulting from the
acquisition of both insurance agencies described in Note 2, which
include the value of executive employment contracts and the value of the
acquired book of businesses, which are being amortized on a
straight-line basis over 3 to 7 years. The total net amortizable
intangible assets were $297,000 and $245,000 net of accumulated
amortization of $137,000 and $58,000 at December 31, 2003 and 2002,
respectively.
F-17
The Company has an amortizable core deposit intangible asset related to
the premiums paid on the acquisition of deposits, which is being
amortized on a straight-line basis over 15 years. This core deposit
intangible was $284,000 and $367,000, net of accumulated amortization of
$974,000 and $891,000 as of December 31, 2003 and 2002, respectively.
Other intangible assets are included in other assets on the balance
sheets for December 31, 2003 and 2002.
Amortization expense on intangible assets was $162,000 and $131,000 for
the years ended December 31, 2003 and 2002, respectively. Amortization
expense is estimated to be $175,000 per year for the years ending
December 31 2004 and 2005; $139,000 for the year ending December 31,
2006; $67,000 for the year ending December 31, 2007 and $25,000 for the
year ending December 31, 2008.
ADVERTISING COSTS
The Bank follows the policy of charging the costs of advertising to
expense as incurred.
INCOME TAXES
Deferred income taxes are provided on the liability method whereby
deferred tax assets are recognized for deductible temporary differences
and deferred tax liabilities are recognized for taxable temporary
differences. Temporary differences are the differences between the
reported amounts of assets and liabilities and their tax basis. Deferred
tax assets are reduced by a valuation allowance when, in the opinion of
management, it is more likely than not that some portion of the deferred
tax assets will not be realized. Deferred tax assets and liabilities are
adjusted for the effects of changes in tax laws and rates on the date of
enactment. Sussex Bancorp and its subsidiaries file a consolidated
federal income tax return.
OFF-BALANCE SHEET FINANCIAL INSTRUMENTS
In the ordinary course of business, the Bank has entered into
off-balance sheet financial instruments consisting of commitments to
extend credit and letters of credit. Such financial instruments are
recorded in the balance sheet when they are funded.
STOCK-BASED COMPENSATION
The Company accounts for its stock option plans under the recognition
and measurement principles of APB Opinion No. 25, "Accounting for Stock
Issued to Employees," and related interpretations. No stock-based
employee compensation cost is reflected in net income, as all options
granted under those plans had an exercise price equal to the market
value of the underlying common stock on the date of grant. The following
table illustrates the effect on net income and earnings per share if the
Company had applied the fair value recognition provisions of FASB
Statement No. 123, "Accounting for Stock-Based Compensation," to
stock-based compensation for the years ended December 31, 2003 and 2002.
Earnings per share has been adjusted for the 5% stock dividend granted
in 2003.
2003 2002
--------------- ---------------
(IN THOUSANDS)
Net income, as reported $1,441 $1,156
Total stock-based compensation expense determined under fair
value based method for all awards, net of related tax effects (47) (23)
--------------- ---------------
Pro forma net income $1,394 $1,133
=============== ===============
Basic earnings per share:
As reported $ 0.80 $ 0.66
Pro forma $ 0.78 $ 0.65
Diluted earnings per share:
As reported $ 0.78 $ 0.64
Pro forma $ 0.75 $ 0.63
F-18
The fair value of options granted is estimated on the date of grant
using the Black-Scholes option pricing model. The following represents
the weighted average fair values and weighted average assumptions used
to determine such fair values for options granted for the years ended
December 31, 2003 and 2002:
2003 2002
---------- ----------
Grant date fair value, as adjusted for 5% stock dividend $2.05 $1.64
Expected option lives 7 YEARS 5 years
Dividend yield 2.44% 2.50%
Risk-free interest rate 3.62% 4.45%
Expected volatility rate 15.18% 14.43%
EARNINGS PER SHARE
Basic earnings per share represents net income available to common
stockholders divided by the weighted-average number of common shares
outstanding during the period. Diluted earnings per share reflects
additional common shares that would have been outstanding if dilutive
potential common shares had been issued, as well as any adjustment to
income that would result from the assumed issuance. Potential common
shares that may be issued by the Company relate to outstanding stock
options and guaranteed and contingently issuable shares from the
acquisition of Tri-State. Potential common shares related to stock
options are determined using the treasury stock method.
SEGMENT REPORTING
The Company acts as an independent community financial services
provider, and offers traditional banking and related financial services
to individual, business and government customers. Through its branch and
automated teller machine networks, the Bank offers a full array of
commercial and retail financial services, including taking of time,
savings and demand deposits; the making of commercial, consumer and
mortgage loans; and the providing of other financial services. The Bank
also performs fiduciary services through its Trust Department.
Management does not separately allocate expenses, including the cost of
funding loan demand, between the commercial, retail, trust and mortgage
banking operations of the Bank. As such, discrete financial information
is not available and segment reporting would not be meaningful. The
Company's insurance agency is managed separately from the traditional
banking and related financial services that the Company offers. The
insurance operations provides primarily property and casualty coverage.
See Note 3 for segment reporting of insurance operations.
INSURANCE AGENCY OPERATIONS
Tri-State Insurance Agency, Inc. is a retail insurance broker operating
in the State of New Jersey. The insurance agency's primary source of
revenue is commission income, which is earned by placing insurance
coverage for its customers with various insurance underwriters. The
insurance agency places basic property and casualty, life and health
coverage with about fifteen different insurance carriers. There are two
main billing processes, direct billing (currently accounts for
approximately 90% of revenues) and agency billing.
Under the direct billing arrangement, the insurance carrier bills and
collects from the customer directly and remits the brokers' commission
to the broker on a monthly basis. For direct bill policies, Tri-State
records commissions as revenue when the data necessary to reasonably
determine such amounts is obtained. On a monthly basis, Tri-State
receives notification from each insurance carrier of total premiums
written and collected during the month, and the broker's net commission
due for their share of business produced by them.
Under the agency billing arrangement, the broker bills and collects from
the customer directly, retains their commission, and remits the net
premium amount to the insurance carrier. Virtually all agency-billed
policies are billed and collected on an installment basis (the number of
payments varies by policy). Although Tri-State typically bills customers
60 days prior to the effective date of a policy, revenues for the first
installment are recorded at the policy effective date. Revenues from
subsequent installments are recorded at the installment due date.
Tri-State records its commission as a percentage of each installment
due.
F-19
TRUST OPERATIONS
Trust income is recorded on a cash basis, which approximates the accrual
basis. Securities and other property held by the Company in a fiduciary
or agency capacity for customers of the trust department are not assets
of the Company and, accordingly, are not included in the accompanying
consolidated financial statements.
RECLASSIFICATIONS
Certain amounts in the 2002 financial statements have been reclassified
to conform with the 2003 presentation format. These reclassifications
had no effect on net income.
NEW ACCOUNTING STANDARDS
In November 2002, the Financial Accounting Standards Board (FASB) issued
FASB Interpretation No. 45 (FIN 45), "Guarantor's Accounting and
Disclosure Requirements for Guarantees, Including Indirect Guarantees of
Indebtedness of Others." This Interpretation expands the disclosures to
be made by a guarantor in its financial statements about its obligations
under certain guarantees and requires the guarantor to recognize a
liability for the fair value of an obligation assumed under certain
specified guarantees. Under FIN 45, the Company does not issue any
guarantees that would require liability recognition or disclosure, other
than its standby letters of credit, as discussed in Note 18. Adoption of
FIN 45 did not have a significant impact on the Company's financial
condition or results of operations.
In January 2003, the Financial Accounting Standards Board issued FASB
Interpretation No. 46, "Consolidation of Variable Interest Entities, an
Interpretation of ARB No. 51." FIN 46 was revised in December 2003. This
Interpretation provides new guidance for the consolidation of variable
interest entities (VIEs) and requires such entities to be consolidated
by their primary beneficiaries if the entities do not effectively
disperse risk among parties involved. The Interpretation also adds
disclosure requirements for investors that are involved with
unconsolidated VIEs. The disclosure requirements apply to all financial
statements issued after December 31, 2003. The consolidation
requirements apply to companies that have interests in special purpose
entities for periods ending after December 15, 2003. Consolidation of
other types of VIEs is required in financial statements for periods
ending after December 15, 2004.
The Company has evaluated the impact of FIN 46 on Sussex Capital Trust
I, a variable interest entity, currently consolidated by the Company.
Management has determined that the provisions of FIN 46 will require
de-consolidation of the subsidiary trust, which issued mandatorily
redeemable preferred capital securities to third-party investors. Upon
adoption of FIN 46 as of March 31, 2004, the Trust will be
de-consolidated and the junior subordinated debentures of the Company
will be reported in the Consolidated Balance Sheets as "long-term debt,"
rather than the mandatory redeemable capital debentures line item that
represents the preferred shares in the Trust. The Company's equity
interest in the Trust, which is not significant, will be reported in
"Other assets." For regulatory reporting purposes, the Federal Reserve
Board has indicated that the preferred securities will continue to
qualify as Tier 1 Capital subject to previously specified limitations,
until further notice. Additional information on the Trust is summarized
in Note 10. The adoption of this Interpretation did not have and is not
expected to have a significant impact on the Company's results of
operations or liquidity.
In April 2003, the Financial Accounting Standards Board issued Statement
No. 149, "Amendment of Statement No. 133, Accounting for Derivative
Instruments and Hedging Activities." This Statement clarifies the
definition of a derivative and incorporates certain decisions made by
the Board as part of the Derivatives Implementation Group process. This
Statement is effective for contracts entered into or modified and for
hedging relationships designated after June 30, 2003 and should be
applied prospectively. The provisions of the Statement that relate to
implementation issues addressed by the Derivatives Implementation Group
that have been effective should continue to be applied in accordance
with their respective dates. Adoption of this standard did not have an
impact on the Company's financial condition or results of operations.
In May 2003, the Financial Accounting Standards Board issued Statement
No. 150, "Accounting for Certain Financial Instruments with
Characteristics of both Liabilities and Equity." This Statement requires
that an issuer classify a financial instrument that is within its scope
as a liability. Many of these instruments were previously classified as
equity. This Statement was effective for financial instruments entered
into or modified after May 31, 2003 and otherwise was
F-20
effective beginning July 1, 2003. The adoption of this standard did not
have an impact on the Company's financial condition or results of
operations.
NOTE 2 - ACQUISITIONS
On October 1, 2001, the Company, through its Sussex Bank subsidiary, acquired
100% of the stock of Tri-State Insurance Agency, Inc. for guaranteed
consideration, including transaction costs totaling $2,021,000. The purchase
price paid by the Company for Tri-State was comprised of an upfront cash payment
of $350,000 at closing, and deferred payments on the first, second and third
anniversaries of the closing. These deferred payments will be satisfied through
a combination of cash and common stock of the Company, with the number of shares
issued based, in part, upon the then-current market price of the Company's
current stock. The deferred payments have been included in other liabilities at
their net present value.
The acquisition has been accounted for using the purchase method of accounting
and, accordingly, the purchase price has been allocated to the assets acquired
and liabilities assumed based upon fair value at the date of acquisition,
including identifiable intangible assets of $243,000 and $60,000 representing
the fair value of the acquired book of business and executive employment
contracts, respectively. The excess of the purchase price over the fair value of
the identifiable net assets acquired was $1,757,000 and has been recorded as
goodwill. In October 2003 and 2002, additional contingent payments were paid to
the sellers in the amount of $192,000 and $175,000, respectively, based on
targeted profits of the insurance agency, resulting in additional goodwill.
In January 2003, the Company acquired certain assets of another insurance
agency, primarily a book of business. The guaranteed purchase price was $56,000.
The acquisition was accounted for using the purchase method of accounting. In
2003, additional contingent payments were paid to the seller in the amount of
$75,000 based on targeted goals. The total purchase price of $131,000 has been
allocated to amortizable intangible assets.
NOTE 3 - SEGMENT REPORTING
Segment information for 2003 and 2002 is as follows:
Year Ended December 31, 2003 Year Ended December 31, 2002
Banking and Insurance Banking and Insurance
Financial Services Total Financial Services Total
--------- -------- ----- --------- -------- -----
Services Services
-------- --------
(In Thousands) (In Thousands)
Net interest income from
external sources $7,911 $- $7,911 $7,324 $- $7,324
Other income from external
sources 2,040 2,063 4,103 1,603 1,689 3,292
Depreciation and amortization 593 79 672 648 47 695
Income before income taxes 1,813 133 1,946 1,602 80 1,682
Income tax expense 452 53 505 494 32 526
Total assets 237,617 3,000 240,617 223,351 2,553 225,904
F-21
NOTE 4 - SECURITIES AVAILABLE FOR SALE
The amortized cost and approximate fair value of securities available for sale
as of December 31, 2003 and 2002 are summarized as follows:
GROSS GROSS
AMORTIZED UNREALIZED UNREALIZED FAIR
COST GAINS LOSSES VALUE
(IN THOUSANDS)
DECEMBER 31, 2003:
U.S. Government agencies $14,651 $ 54 $ (47) $14,658
State and political subdivisions 21,214 506 (178) 21,542
Mortgage-backed securities 35,056 179 (263) 34,972
Corporate securities 4,311 168 - 4,479
Equity securities 899 11 (16) 894
--------------- ---------------- ---------------- ---------------
$76,131 $918 $(504) $76,545
=============== ================ ================ ===============
GROSS GROSS
AMORTIZED UNREALIZED UNREALIZED FAIR
COST GAINS LOSSES VALUE
(IN THOUSANDS)
DECEMBER 31, 2002:
U.S. Government agencies $13,397 $ 215 $ - $13,612
State and political subdivisions 15,605 215 (35) 15,785
Mortgage-backed securities 35,235 354 (35) 35,554
Corporate securities 6,648 238 - 6,886
Equity securities 898 6 (21) 883
--------------- ---------------- ---------------- ---------------
$71,783 $1,028 $(91) $72,720
=============== ================ ================ ===============
The following table shows the Company's investments' gross unrealized losses and
fair value, aggregated by investment category and length of time that individual
securities have been in a continuous unrealized loss position, at December 31,
2003.
LESS THAN 12 MONTHS 12 MONTHS OR MORE TOTAL
FAIR UNREALIZED FAIR UNREALIZED FAIR UNREALIZED
VALUE LOSSES VALUE LOSSES VALUE LOSSES
(IN THOUSANDS)
U.S. Government agencies $ 5,465 $ (47) $ - $ - $ 5,465 $ (47)
State and political
subdivisions 7,422 (178) - - 7,422 (178)
Mortgage-backed securities 16,621 (260) 235 (3) 16,856 (263)
Equity securities - - 833 (16) 833 (16)
------------ ------------- ------------ ------------ ------------ ------------
TOTAL TEMPORARILY
IMPAIRED
SECURITIES $29,508 $(485) $1,068 $(19) $30,576 $(504)
============ ============= ============ ============ ============ ============
Management evaluates securities for other-than-temporary impairment at least on
a quarterly basis, and more frequently when economic or market concerns warrant
such evaluation. Consideration is given to (1) the length of time and the extent
to which the fair value has been less than cost, (2) the financial condition and
near-term prospects of the issuer, and (3) the intent and ability of the company
to retain its investment in the issuer for a period of time sufficient to allow
for any anticipated recovery in fair value.
F-22
At December 31, 2003, the Company has 51 securities in an unrealized loss
position. Unrealized losses detailed above relate primarily to U.S. Government
agency debt and mortgage-backed securities and municipal debt securities. The
decline in fair value is due only to interest rate fluctuations. As the company
has the intent and ability to hold such investments until maturity or market
price recovery, no securities are deemed to be other-than-temporarily impaired.
None of the individual unrealized losses are significant.
The amortized cost and carrying value of securities available for sale at
December 31, 2003 are shown below by contractual maturity. Actual maturities may
differ from contractual maturities as issuers may have the right to call or
prepay obligations with or without call or prepayment penalties.
AMORTIZED FAIR
COST VALUE
------------- -------------
(IN THOUSANDS)
Due in one year or less $ 4,010 $ 4,069
Due after one year through five years 13,925 14,045
Due after five years through ten years 4,647 4,737
Due after ten years 17,594 17,828
------------- -------------
40,176 40,679
Mortgage-backed securities 35,056 34,972
Equity securities 899 894
------------- -------------
$76,131 $76,545
============= =============
Gross gains on sales of securities were $133,000 and gross losses were $-0- for
the year ended December 31, 2003. There were no sales of securities in the year
ended December 31, 2002.
Securities with a carrying value of approximately $12,432,000 and $12,458,000 at
December 31, 2003 and 2002, respectively, were pledged to secure public deposits
and for other purposes required or permitted by applicable laws and regulations.
NOTE 5 - LOANS RECEIVABLE
The composition of net loans receivable at December 31, 2003 and 2002 is as
follows:
2003 2002
------------- -------------
(IN THOUSANDS)
Loans secured by one to four family residential properties $ 46,587 $ 49,517
Loans secured by nonresidential properties 59,182 41,035
Loans secured by construction and land development 8,656 8,310
Loans secured by farmland 5,827 774
Commercial and industrial loans 12,392 10,985
Consumer 1,430 2,189
Other loans 287 561
------------- -------------
134,361 113,371
Unearned loan origination costs, net 13 84
Allowance for loan losses (1,734) (1,386)
------------- -------------
NET LOANS RECEIVABLE $132,640 $112,069
============= =============
F-23
Mortgage loans serviced for others are not included in the accompanying balance
sheets. The total amount of loans serviced for the benefit of others was
approximately $4,104,000 and $3,585,000 at December 31, 2003 and 2002,
respectively.
NOTE 6 - ALLOWANCE FOR LOAN LOSSES
The following table presents changes in the allowance for loan losses for the
years ended December 31, 2003 and 2002:
2003 2002
------------ ------------
(IN THOUSANDS)
Balance, beginning $1,386 $1,143
Provision for loan losses 405 300
Loans charged off (62) (59)
Recoveries 5 2
------------ ------------
Balance, ending $1,734 $1,386
============ ============
Loans on which the accrual of interest has been discontinued or reduced amounted
to approximately $1,177,000 and $1,258,000 at December 31, 2003 and 2002,
respectively. Loan balances past due 90 days or more and still accruing
interest, but which management expects will eventually be paid in full, amounted
to $-0- and $36,000 at December 31, 2003 and 2002, respectively.
The total recorded investment in impaired loans was $1,897,000 and $1,148,000 at
December 31, 2003 and 2002, respectively. Impaired loans not requiring an
allowance for loan losses was $969,000 and $476,000 at December 31, 2003 and
2002, respectively. Impaired loans requiring an allowance for loan losses was
$928,000 and $672,000 at December 31, 2003 and 2002, respectively. At December
31, 2003 and 2002, the related allowance for loan losses associated with those
loans was $244,000 and $211,000, respectively. For the years ended December 31,
2003 and 2002, the average recorded investment in impaired loans was $1,255,000
and $1,384,000, respectively. Interest income recognized on such loans during
the time each was impaired was $33,000 and $26,000, respectively. The Company
recognizes income on impaired loans under the cash basis when the collateral on
the loan is sufficient to cover the outstanding obligation to the Company. If
these factors do not exist, the Company will record all payments as a reduction
of principal on such loans.
NOTE 7 - BANK PREMISES AND EQUIPMENT
The components of bank premises and equipment at December 31, 2003 and 2002 are
as follows:
2003 2002
------------ ------------
(IN THOUSANDS)
Land $ 577 $ 577
Building and building improvements 4,253 4,243
Leasehold improvements 95 96
Furniture, fixtures and equipment 4,267 3,918
Assets in progress 182 42
------------ ------------
9,374 8,876
Accumulated depreciation (4,724) (4,242)
------------ ------------
$4,650 $4,634
============ ============
F-24
During the years ended December 31, 2003 and 2002, depreciation expense totaled
$510,000 and $564,000, respectively.
As of December 31, 2003, the Company has outstanding commitments of
approximately $735,000 for computer upgrades and branch construction and
renovations.
NOTE 8 - DEPOSITS
The components of deposits at December 31, 2003 and 2002 are as follows:
2003 2002
------------ ------------
(IN THOUSANDS)
Demand, non-interest bearing $ 31,715 $ 26,514
Savings, club and interest-bearing demand 119,461 110,729
Time, $100,000 and over 12,021 9,145
Time, other 44,460 43,470
------------ ------------
$207,657 $189,858
============ ============
At December 31, 2003 and 2002, time deposits included $3,177,000 and $3,102,000,
respectively, owned by local municipalities scheduled to mature within 30 days.
At December 31, 2003, the scheduled maturities of time deposits are as follows
(in thousands):
2004 $40,325
2005 10,467
2006 3,032
2007 971
2008 1,316
Thereafter 370
------------
$56,481
============
NOTE 9 - BORROWINGS
At December 31, 2003, the Bank has a line of credit commitment from the Federal
Home Loan Bank of New York for borrowings up to $22,584,000. There were no
borrowings under this line of credit at December 31, 2003.
At December 31, 2003 and 2002, the Bank had the following borrowings from the
Federal Home Loan Bank:
BALANCE AT DECEMBER 31,
INITIAL INTEREST -----------------------------------
MATURITY DATE CONVERSION DATE RATE 2003 2002
------------------------------ --------------------------- ------------------ --------------- ----------------
January 27, 2003 N/A 1.96 % $ - $ 1,000,000
April 25, 2003 N/A 2.03 % - 1,000,000
July 25, 2003 N/A 2.23 % - 1,000,000
October 27, 2003 N/A 2.43 % - 1,000,000
July 26, 2004 N/A 3.01 % 1,000,000 1,000,000
December 21, 2010 December 21, 2001 4.77 % 3,000,000 3,000,000
December 21, 2010 December 21, 2002 4.90 % 3,000,000 3,000,000
December 21, 2010 December 21, 2003 5.14 % 4,000,000 4,000,000
--------------- ----------------
$11,000,000 $15,000,000
=============== ================
F-25
The above three convertible notes contain a convertible option which allows the
Federal Home Loan Bank (FHLB), at quarterly intervals commencing after each
initial conversion date, to convert the fixed convertible advance into
replacement funding for the same or lesser principal amount based on any advance
then offered by the FHLB at their current market rates. The Bank has the option
to repay these advances, if converted, without penalty.
At December 31, 2003, the above borrowings are secured by a pledge of qualifying
one-to-four family mortgage loans and selected investment securities, having an
aggregate unpaid principal balance of approximately $18,510,000 of which the
Bank has borrowing capacity of 75%.
NOTE 10 - MANDATORY REDEEMABLE CAPITAL DEBENTURES
On July 11, 2002, Sussex Capital Trust I, a Delaware statutory business trust
and a wholly-owned subsidiary of the Company, issued $5 million of variable rate
capital trust pass-through securities to investors. The variable interest rate
reprices quarterly at the three month LIBOR plus 3.65% and was 4.80% and 5.43%
at December 31, 2003 and 2002, respectively. Sussex Capital Trust I purchased
$5.0 million of variable rate junior subordinated deferrable interest debentures
from Sussex Bancorp. The debentures are the sole asset of the Trust. The terms
of the junior subordinated debentures are the same as the terms of the capital
securities. Sussex Bancorp has also fully and unconditionally guaranteed the
obligations of the Trust under the capital securities. The capital securities
are redeemable by Sussex Bancorp on or after October 7, 2007, at par or earlier
if the deduction of related interest for federal income taxes is prohibited,
classification as Tier 1 Capital is no longer allowed, or certain other
contingencies arise. The capital securities must be redeemed upon final maturity
of the subordinated debentures on October 7, 2032. Proceeds totaling
approximately $4.8 million were contributed to paid-in capital at Sussex Bank.
Financing costs related to the Company's issuance of mandatory redeemable
capital debentures will be amortized over a five-year period and is included in
other assets.
NOTE 11 - LEASE COMMITMENTS AND TOTAL RENTAL EXPENSE
The Company has operating lease agreements expiring in various years through
2020. The Company has the option to extend the lease agreements for additional
lease terms. In December 2003, the Company entered into a five-year operating
lease agreement for administration and operations office space which will
commence January 2004. The Bank is responsible to pay all real estate taxes,
insurance, utilities and maintenance and repairs on its leased facilities.
Included in other income for the year ended December 31, 2002 is a $160,000
contract settlement related to a land lease of a branch facility.
Future minimum lease payments by year are as follows (in thousands):
2004 $236
2005 216
2006 183
2007 91
2008 86
Thereafter 132
------------
$944
============
Rent expense was $175,000 and $171,000 for the years ended December 31, 2003 and
2002, respectively.
In addition, the Company has plans to increase the leased space for the
insurance agency. If the additional space is leased, rent expense will increase
$67,000 per year for a ten year term.
F-26
NOTE 12 - EMPLOYEE BENEFIT PLANS
The Company has a 401(k) Profit Sharing Plan and Trust for its employees.
Employees may contribute up to the statutory limit or 75% of their salary to the
Plan. The Company provides a 50% match of the employee's contribution up to 6%
of the employee's annual salary. The amount charged to expense related to this
Plan for the years ended December 31, 2003 and 2002 was $89,000 and $66,000,
respectively.
The Company also has a nonqualified Supplemental Salary Continuation Plan for an
executive officer. Under the provisions of the Plan, the Company has executed
agreements providing the officer a retirement benefit. The Plan is funded by
life insurance carried on the life of the participant. For the years ended
December 31, 2003 and 2002, $143,000 and $118,000, respectively, was charged to
expense in connection with this Plan. At December 31, 2003 and 2002, the Bank
had an investment in life insurance of $1,195,000 and $1,146,000, respectively,
related to this Plan which is included in other assets. Earnings on the
investment in life insurance were $49,000 and $55,000 for the years ended
December 31, 2003 and 2002, respectively.
The Company has an Employee Stock Ownership Plan for the benefit of all
employees who meet the eligibility requirements set forth in the Plan. The
amount of employer contributions to the Plan is at the discretion of the Board
of Directors. The contributions charged to expense for both the years ended
December 31, 2003 and 2002 were $25,000. At December 31, 2003 and 2002, 40,084
and 35,072 shares, respectively, of the Company's common stock were held in the
Plan. In the event a terminated Plan participant desires to sell his or her
shares of the Company's stock, or for certain employees who elect to diversify
their account balances, the Company may be required to purchase the shares from
the participant at their fair market value.
NOTE 13 - COMPREHENSIVE INCOME
Accounting principles generally require that recognized revenue, expenses, gains
and losses be included in net income. Although certain changes in assets and
liabilities, such as unrealized gains and losses on available for sale
securities, are reported as a separate component of the equity section of the
balance sheet, such items, along with net income, are components of
comprehensive income.
The components of other comprehensive income and related tax effects for the
years ended December 31, 2003 and 2002 are as follows:
2003 2002
--------------- ---------------
(IN THOUSANDS)
Unrealized gains (losses) on available for sale securities $(390) $735
Less reclassification adjustment for gains included in net income 133 -
--------------- ---------------
NET UNREALIZED GAINS (LOSSES) (523) 735
Tax effect (209) 296
--------------- ---------------
NET OF TAX AMOUNT $(314) $439
=============== ===============
F-27
NOTE 14 - EARNINGS PER SHARE
The following table sets forth the computations of basic and diluted earnings
per share (as adjusted for the 5% stock dividend declared in 2003):
INCOME SHARES PER SHARE
(NUMERATOR) (DENOMINATOR) AMOUNT
---------------- --------------- ---------------
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
YEAR ENDED DECEMBER 31, 2003:
Basic earnings per share:
Net income applicable to common stockholders $1,441 1,790 $0.80
===============
Effect of dilutive securities:
Stock options - 37
Deferred common stock payments for purchase of
insurance agency 6 32
---------------- ---------------
Diluted earnings per share:
Net income applicable to common stockholders and
assumed conversions $1,447 1,859 $0.78
================ =============== ===============
YEAR ENDED DECEMBER 31, 2002:
Basic earnings per share:
Net income applicable to common stockholders $1,156 1,748 $0.66
===============
Effect of dilutive securities:
Stock options - 19
Deferred common stock payments for purchase of
insurance agency 10 54
---------------- ---------------
Diluted earnings per share:
Net income applicable to common stockholders and
assumed conversions $1,166 1,821 $0.64
================ =============== ===============
NOTE 15 - STOCK OPTION PLANS
The following data have been adjusted to give retroactive effect to stock
dividends declared subsequent to option authorizations, grants and exercises.
During 1995, the stockholders approved a stock option plan for nonemployee
directors (the "Director Plan"). Options granted under the Plan are
non-qualified stock options. As of December 31, 2003, there were 2,344
authorized shares of the Company's common stock to be granted. The option price
under each grant shall not be less than the fair market value on the date of the
grant. Options are exercisable in their entirety six months after the date of
the grant and expire after ten years. As of December 31, 2003, 44,732 options
were outstanding under this plan.
During 1995, the stockholders approved an incentive stock option plan for
executives of the Company (the "Executive Plan"). The options granted under the
Plan are incentive stock options, subject to limitations under Section 422 of
the Internal Revenue Code. As of December 31, 2003, there were 51,164 authorized
shares of the Company's common stock to be granted. Executive Plan options are
granted at the sole discretion of the Board of Directors. The option price under
each grant shall not be less than the fair market value on the date of grant.
The Company may establish a vesting schedule that must be satisfied before the
options may be exercised, but not within six months after the date of grant. The
options may
F-28
have a term not longer than ten years from the date of grant. As of December 31,
2003, 89,020 options were outstanding under this plan.
During 2001, the stockholders approved the 2001 Stock Option Plan established to
provide equity incentives to selected persons. As of December 31, 2003, there
were 98,175 authorized shares of the Company's common stock to be granted.
Options may be granted to employees, officers and directors of the Company or
subsidiary. Options granted under the Plan may be either incentive stock options
or non-qualified stock options as designated at the time of grant. The shares
granted under the Plan to directors are non-qualified stock options. The shares
granted under the Plan to officers and other employees are incentive stock
options and are subject to limitations under Section 422 of the Internal Revenue
Code. The option price under each grant shall not be less than the fair market
value on the date of the grant. The Company may establish a vesting schedule
that must be satisfied before the options may be exercised, but not within six
months after the date of grant. As of December 31, 2003, 74,025 options were
outstanding under this Plan.
Transactions under all stock option plans are summarized as follows as adjusted
for the 5% stock dividend:
WEIGHTED
NUMBER OF RANGE OF EXERCISE AVERAGE EXERCISE
SHARES PRICE PER SHARE PRICE PER SHARE
---------------- ---------------- ---------------
Outstanding, December 31, 2001 74,447 $4.84 - $10.63 $ 7.46
Options granted 26,854 9.95 - 10.43 10.12
Options exercised (6,954) 4.84 - 9.76 7.01
Options expired (2,104) 7.98 - 9.39 8.94
---------------- ---------------- ---------------
Outstanding, December 31, 2002 92,243 4.84 - 10.63 8.17
Options granted 123,121 9.91 - 13.70 11.54
Options exercised (7,587) 4.84 - 10.00 5.60
---------------- ---------------- ---------------
Outstanding December 31, 2003 207,777 $4.84 - $13.70 $10.27
================ ================ ===============
Exercisable, December 31, 2002 71,169 $4.84 - $10.63 $ 7.70
================ ================ ===============
Exercisable, December 31, 2003 96,199 $4.84 - $10.63 $ 8.61
================ ================ ===============
The weighted-average remaining contractual life of the above options is
approximately 10.2 years.
The following table summarizes information about stock options outstanding at
December 31, 2003:
EXERCISE NUMBER REMAINING NUMBER
PRICE OUTSTANDING CONTRACTUAL LIFE EXERCISABLE
----------------- -------------------- -------------------- ----------------------
$ 4.84 22,130 1.8 years 22,130
7.69 2,481 6.8 years 2,481
7.87 3,374 2.8 years 3,374
8.09 2,821 1.1 years 2,116
8.14 2,205 3.8 years 2,205
9.68 4,410 4.8 years 4,410
9.76 9,450 7.8 years 9,450
9.90 51,124 9.1 years 12,781
9.95 17,404 8.1 years 8,702
10.00 7,695 2.1 years 3,848
10.05 9,450 9.8 years 9,450
10.05 9,976 9.1 years 2,494
10.43 9,450 8.8 years 9,450
10.63 3,307 5.8 years 3,308
13.70 52,500 19.5 years -
-------------------- ----------------------
207,777 96,199
==================== ======================
F-29
NOTE 16 - INCOME TAXES
The components of income tax expense for the years ended December 31, 2003 and
2002 are as follows:
2003 2002
--------------- ---------------
(IN THOUSANDS)
Current:
Federal $509 $523
State 199 173
--------------- ---------------
708 696
--------------- ---------------
Deferred:
Federal (154) (129)
State (49) (41)
--------------- ---------------
(203) (170)
--------------- ---------------
$505 $526
=============== ===============
A reconciliation of the statutory federal income tax at a rate of 34% to the
income tax expense included in the statements of income for the years ended
December 31, 2003 and 2002 is as follows:
2003 2002
---------------------------- ----------------------------
% OF % OF
PRE-TAX PRE-TAX
AMOUNT INCOME AMOUNT INCOME
------------ ------------ ------------ ------------
(DOLLAR AMOUNTS IN THOUSANDS)
Federal income tax at statutory rate $662 34 % $572 34 %
Tax exempt interest (234) (12) (152) (9)
State income tax, net of federal
income tax effect 99 5 87 5
Other (22) (1) 19 1
------------ ------------ ------------ ------------
$505 26 % $526 31 %
============ ============ ============ ============
The income tax provision includes $53,000 and $-0- in 2003 and 2002,
respectively, of income tax expense related to net gains on sales of securities.
F-30
NOTE 16 - INCOME TAXES (CONTINUED)
The components of the net deferred tax asset at December 31, 2003 and 2002 are
as follows:
2003 2002
--------------- ---------------
(IN THOUSANDS)
Deferred tax assets:
Allowance for loan losses $692 $554
Deferred compensation 158 101
Other 95 86
--------------- ---------------
TOTAL DEFERRED TAX ASSETS 945 741
--------------- ---------------
Deferred tax liabilities:
Bank premises and equipment (106) (105)
Unrealized gains on securities available for sale (166) (375)
--------------- ---------------
TOTAL DEFERRED TAX LIABILITIES (272) (480)
--------------- ---------------
NET DEFERRED TAX ASSET $673 $261
=============== ===============
NOTE 17 - TRANSACTIONS WITH EXECUTIVE OFFICERS, DIRECTORS AND PRINCIPAL
STOCKHOLDERS
The Company has had, and may be expected to have in the future, banking
transactions in the ordinary course of business with its executive officers,
directors, principal stockholders, their immediate families and affiliated
companies (commonly referred to as related parties), on the same terms,
including interest rates and collateral, as those prevailing at the time for
comparable transactions with others. The related party loan activity for the
year ended December 31, 2003 is summarized as follows (in thousands):
Balance, beginning $3,798
Disbursements 1,688
Repayments (1,986)
------------
Balance, ending $3,500
============
Certain related parties of the Company provided legal, tax accounting, real
estate appraisal and construction services to the Company. Such services totaled
$27,000 during both 2003 and 2002. The Company also paid rent to a related party
for a branch location in the amount of $22,000 for both 2003 and 2002.
NOTE 18 - FINANCIAL INSTRUMENTS WITH OFF-BALANCE SHEET RISK
The Company is a party to financial instruments with off-balance sheet risk in
the normal course of business to meet the financing needs of its customers.
These financial instruments include commitments to extend credit and letters of
credit. Those instruments involve, to varying degrees, elements of credit risk
in excess of the amount recognized in the balance sheet.
The Company's exposure to credit loss in the event of nonperformance by the
other party to the financial instrument for commitments to extend credit is
represented by the contractual amount of those instruments. The Company uses the
same credit policies in making commitments and conditional obligations as it
does for on-balance sheet instruments.
F-31
A summary of the Company's financial instrument commitments at December 31, 2003
and 2002 is as follows:
2003 2002
------------ ------------
(IN THOUSANDS)
Commitments to grant loans $ 6,211 $ 3,379
Unfunded commitments under lines of credit 26,893 18,828
Outstanding standby letters of credit 1,002 597
Commitments to extend credit are agreements to lend to a customer as long as
there is no violation of any condition established in the contract. Since many
of the commitments are expected to expire without being drawn upon, the total
commitment amounts do not necessarily represent future cash requirements.
Commitments generally have fixed expiration dates or other termination clauses
and may require payment of a fee. The Company evaluates each customer's credit
worthiness on a case-by-case basis. The amount of collateral obtained, if deemed
necessary by the Company upon extension of credit, is based on management's
credit evaluation. Collateral held varies but may include personal or commercial
real estate, accounts receivable, inventory and equipment.
Outstanding letters of credit written are conditional commitments issued by the
Company to guarantee the performance of a customer to a third party. The
Company's exposure to credit loss in the event of nonperformance by the other
party to the financial instrument for standby letters of credit is represented
by the contractual amount of those instruments. These standby letters of credit
expire within the next twelve months. The credit risk involved in issuing
letters of credit is essentially the same as that involved in extending other
loan commitments. The Company requires collateral and personal guarantees
supporting these letters of credit as deemed necessary. Management believes that
the proceeds obtained through a liquidation of such collateral and enforcement
of personal guarantees would be sufficient to cover the maximum potential amount
of future payments required under the corresponding guarantees. The current
amount of the liability as of December 31, 2003 for guarantees under standby
letters of credit issued is not material.
NOTE 19 - CONCENTRATION OF CREDIT RISK
The Company grants commercial, residential and consumer loans to customers
primarily located in Sussex County and adjacent counties in the states of
Pennsylvania, New Jersey and New York. The concentration of credit by type of
loan is set forth in Note 5. Although the Company has a diversified loan
portfolio, its debtors' ability to honor their contracts is influenced by the
region's economy.
NOTE 20 - REGULATORY MATTERS
The Company is required to maintain cash reserve balances with the Federal
Reserve Bank. The total of those reserve balances was approximately $4,441,000
at December 31, 2003.
The Company and the Bank are subject to various regulatory capital requirements
administered by the federal banking agencies. Failure to meet the minimum
capital requirements can initiate certain mandatory and possibly additional
discretionary actions by regulators that, if undertaken, could have a direct
material effect on the Company's financial statements. Under capital adequacy
guidelines and the regulatory framework for prompt corrective action, the
Company and the Bank must meet specific capital guidelines that involve
quantitative measures of the Company's assets, liabilities and certain
off-balance sheet items as calculated under regulatory accounting practices. The
Company's and the Bank's capital amounts and classification are also subject to
qualitative judgments by the regulators about components, risk-weightings and
other factors.
Quantitative measures established by regulation to ensure capital adequacy
require the Company and the Bank to maintain minimum amounts and ratios (set
forth below) of total and Tier 1 capital (as defined in the regulations) to
risk-weighted assets, and of Tier 1 capital to average assets. Management
believes, as of December 31, 2003, that the Company and the Bank meet all
capital adequacy requirements to which they are subject.
F-32
As of December 31, 2003, the most recent notification from the Federal Deposit
Insurance Corporation categorized the Bank as well capitalized under the
regulatory framework for prompt corrective action. There are no conditions or
events since that notification that management believes have changed the Bank's
category.
The Company's and the Bank's actual capital amounts and ratios at December 31,
2003 and 2002 are presented below:
TO BE WELL
CAPITALIZED UNDER
FOR CAPITAL ADEQUACY PROMPT CORRECTIVE
ACTUAL PURPOSES ACTION PROVISIONS
---------------------- -------------------- ----------------------
AMOUNT RATIO AMOUNT RATIO AMOUNT RATIO
-------- --------- -------- --------- -------- ---------
(DOLLAR AMOUNTS IN THOUSANDS)
AS OF DECEMBER 31, 2003:
Total capital (to risk-weighted assets):
Company $18,682 12.37 % $>12,086 >8.00 % N/A N/A
= = C>
Bank 18,253 12.11 >12,063 >8.00 $>15,078 >10.00 %
= = = =
Tier 1 capital (to risk-weighted assets):
Company 16,832 11.14 > 6,043 >4.00 N/A N/A
= =
Bank 16,519 10.96 > 6,031 >4.00 > 9,047 > 6.00
= = = =
Tier 1 capital (to average assets):
Company 16,832 7.15 > 9,416 >4.00 N/A N/A
= =
Bank 16,519 7.02 > 9,411 >4.00 >11,764 > 5.00
= = = =
AS OF DECEMBER 31, 2002:
Total capital (to risk-weighted assets):
Company $16,951 13.36 % $>10,147 >8.00 % N/A N/A
= =
Bank 16,595 13.12 >10,117 >8.00 $>12,646 >10.00 %
= = = =
Tier 1 capital (to risk-weighted assets):
Company 14,935 11.77 > 5,074 >4.00 N/A N/A
= =
Bank 15,209 12.03 > 5,058 >4.00 > 7,588 > 6.00
= = = =
Tier 1 capital (to average assets):
Company 14,935 6.66 > 8,976 >4.00 N/A N/A
= =
Bank 15,209 6.78 > 8,968 >4.00 >11,210 > 5.00
= = = =
The Bank is subject to certain restrictions on the amount of dividends that it
may declare due to regulatory considerations. The State of New Jersey banking
laws specify that no dividend shall be paid by the Bank on its capital stock
unless, following the payment of each such dividend, the capital stock of the
Bank will be unimpaired and the Bank will have a surplus of not less than 50% of
its capital stock or, if not, the payment of such dividend will not reduce the
surplus of the Bank.
At December 31, 2003, the Bank's funds available for the payment of dividends
was $11,724,000. Accordingly, $7,503,000 of the Company's equity in the net
assets of the Bank was restricted at December 31, 2003. In addition, dividends
paid by the Bank to the Company would be prohibited if the effect thereof would
cause the Bank's capital to be reduced below applicable minimum capital
requirements.
NOTE 21 - FAIR VALUE OF FINANCIAL INSTRUMENTS
Management uses its best judgment in estimating the fair value of the Company's
financial instruments; however, there are inherent weaknesses in any estimation
technique. Therefore, for substantially all financial instruments, the fair
value estimates herein are not necessarily indicative of the amounts the Company
could have realized in a sales transaction on the dates indicated. The estimated
fair value amounts have been measured as of their respective year ends, and have
not been re-evaluated or updated for purposes of these financial statements
subsequent to those respective dates. As such, the estimated
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fair values of these financial instruments subsequent to the respective
reporting dates may be different than the amounts reported at each year end.
The following information should not be interpreted as an estimate of the fair
value of the entire Company since a fair value calculation is only provided for
a limited portion of the Company's assets and liabilities. Due to a wide range
of valuation techniques and the degree of subjectivity used in making the
estimates, comparisons between the Company's disclosures and those of other
companies may not be meaningful. The following methods and assumptions were used
to estimate the fair value of the Company's financial instruments at December
31, 2003 and 2002:
CASH AND CASH EQUIVALENTS
The carrying amounts for cash and cash equivalents approximate fair
value.
TIME DEPOSITS WITH OTHER BANKS
The fair value of time deposits with other banks is estimated by
discounting future cash flows using the current rates available for time
deposits with similar remaining maturities.
SECURITIES AND FEDERAL HOME LOAN BANK STOCK
The fair values for securities are based on quoted market prices or
dealer prices, if available. If quoted market prices or dealers prices
are not available, fair value is estimated using quoted market prices or
dealer prices for similar securities. The Federal Home Loan Bank stock
is restricted; accordingly, its carrying amount approximates its fair
value.
LOANS
The fair value of loans is estimated by discounting the future cash
flows, using the current rates at which similar loans with similar
remaining maturities would be made to borrowers with similar credit
ratings.
DEPOSITS
For demand, savings and club accounts, fair value is the carrying amount
reported in the consolidated financial statements. For fixed-maturity
certificates of deposit, fair value is estimated by discounting the
future cash flows, using the rates currently offered for deposits of
similar remaining maturities.
BORROWINGS AND MANDATORY REDEEMABLE CAPITAL DEBENTURES
The fair values of these borrowings and debentures are estimated by
discounting future cash flows, using rates currently available on
borrowings with similar remaining maturities.
ACCRUED INTEREST RECEIVABLE AND ACCRUED INTEREST PAYABLE
The carrying amounts of accrued interest receivable and payable
approximate fair value.
OFF-BALANCE SHEET INSTRUMENTS
The fair values of commitments to extend credit and standby letters of
credit are estimated using the fees currently charged to enter into
similar agreements, taking into account the remaining terms of the
agreements and the present creditworthiness of the counterparties. For
fixed-rate loan commitments, fair value also considers the difference
between current levels of interest rates and the committed rates. The
fair value of guarantees and letters of credit is based on fees
currently charged for similar agreements or on the estimated cost to
terminate them or otherwise settle the obligations with the
counterparties at the reporting date.
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The estimated fair values of the Company's financial instruments at December 31,
2003 and 2002 were as follows:
2003 2002
---------------------------- ----------------------------
CARRYING FAIR CARRYING FAIR
AMOUNT VALUE AMOUNT VALUE
----------- ------------- ------------ -------------
(IN THOUSANDS)
Financial assets:
Cash and cash equivalents $ 15,496 $ 15,496 $ 26,096 $ 26,096
Time deposits with other banks 3,500 3,500 3,600 3,600
Securities available for sale 76,545 76,545 72,720 72,720
Federal Home Loan Bank stock 760 760 750 750
Loans receivable, net of allowance 132,640 133,293 112,069 113,428
Accrued interest receivable 1,241 1,241 1,144 1,144
Financial liabilities:
Deposits 207,657 208,007 189,858 190,250
Borrowings 11,000 12,014 15,000 15,097
Mandatory redeemable capital debentures 5,000 5,059 5,000 5,067
Accrued interest payable 228 228 303 303
Off-balance sheet financial instruments:
Commitments to extend credit - - - -
Outstanding letters of credit - - - -
NOTE 22 - PARENT COMPANY ONLY FINANCIAL INFORMATION
Condensed financial statements of Sussex Bancorp (Parent Company only) follows:
BALANCE SHEETS
DECEMBER 31,
-----------------------------
2003 2002
------------ ------------
ASSETS (IN THOUSANDS)
Cash $ 175 $ 45
Investment in subsidiaries 19,475 18,324
Other assets 311 376
------------ ------------
TOTAL ASSETS $19,961 $18,745
============ ============
LIABILITIES AND STOCKHOLDERS' EQUITY
Liabilities:
Other liabilities $ 57 $ 65
Junior subordinated debentures 5,000 5,000
------------ ------------
TOTAL LIABILITIES 5,057 5,065
Stockholders' Equity 14,904 13,680
------------ ------------
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $19,961 $18,745
============ ============
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YEARS ENDED
DECEMBER 31,
-----------------------------
STATEMENTS OF INCOME 2003 2002
------------ ------------
(IN THOUSANDS)
Dividends from banking subsidiary $ 485 $ 416
Interest expense on junior subordinated debentures (248) (132)
Other expenses (88) (23)
------------ ------------
INCOME BEFORE INCOME TAX BENEFIT AND EQUITY IN 149 261
UNDISTRIBUTED NET INCOME OF BANKING SUBSIDIARY
Income tax benefits 134 62
------------ ------------
INCOME BEFORE EQUITY IN UNDISTRIBUTED NET 283 323
INCOME OF BANKING SUBSIDIARY
Equity in undistributed net income of banking subsidiary 1,158 833
------------ ------------
NET INCOME $1,441 $1,156
============ ============
YEARS ENDED
DECEMBER 31,
-----------------------------
STATEMENTS OF CASH FLOWS 2003 2002
------------ ------------
(IN THOUSANDS)
CASH FLOWS FROM OPERATING ACTIVITIES
Net income $1,441 $1,156
Adjustments to reconcile net income to net cash provided by
operating activities:
Net change in other assets and liabilities 57 111
Equity in undistributed net income of banking subsidiary (1,158) (833)
------------ ------------
NET CASH PROVIDED BY OPERATING ACTIVITIES 340 434
------------ ------------
CASH FLOWS FROM FINANCING ACTIVITIES
Cash dividends paid, net of reinvestments (228) (298)
Capital contribution to subsidiary - (5,255)
Proceeds from the issuance of capital debentures - 5,000
Purchase of treasury stock (25) (156)
Proceeds from exercise of stock options 47 49
Cash paid in lieu of fractional shares (4) -
------------ ------------
NET CASH USED IN FINANCING ACTIVITIES (210) (660)
------------ ------------
NET INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS 130 (226)
CASH AND CASH EQUIVALENTS - BEGINNING OF YEAR 45 271
------------ ------------
CASH AND CASH EQUIVALENTS - END OF YEAR $ 175 $ 45
============ ============
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