Suffolk Bancorp 10-Q 2010
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF
THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended June 30, 2010
Commission file number 000-13580
(Exact Name of Registrant as Specified in Its Charter)
(Registrants Telephone Number, Including Area Code)
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes x No ¨
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes ¨ No ¨
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of large accelerated filer, accelerated filer and smaller reporting company in Rule 12b-2 of the Exchange Act.
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes ¨ No x
Indicate the number of shares outstanding of each of the issuers classes of common stock, as of the latest practicable date.
9,660,459 SHARES OF COMMON STOCK OUTSTANDING AS OF July 30, 2010
This page left blank intentionally.
SUFFOLK BANCORP AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CONDITION
(in thousands of dollars except for share and per share data)
See accompanying notes to consolidated financial statements.
CONSOLIDATED STATEMENTS OF INCOME
(in thousands of dollars except for share and per share data)
See accompanying notes to consolidated financial statements.
CONSOLIDATED STATEMENTS OF INCOME
(in thousands of dollars except for share and per share data)
See accompanying notes to consolidated financial statements.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(in thousands of dollars)
See accompanying notes to consolidated financial statements.
NOTES TO THE UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
(1) Basis of Presentation
In the opinion of management, the accompanying unaudited consolidated financial statements of Suffolk Bancorp (Suffolk) and its consolidated subsidiaries, primarily Suffolk County National Bank (the Bank), have been prepared to reflect all adjustments (consisting solely of normally recurring accruals) necessary for a fair presentation of the financial condition and results of operations for the periods presented. Certain information and footnotes normally included in consolidated financial statements prepared in accordance with generally accepted accounting principles in the United States of America (U.S. GAAP) have been condensed or omitted. Notwithstanding, management believes that the disclosures are adequate to prevent the information from misleading the reader, particularly when the accompanying consolidated financial statements are read in conjunction with the audited consolidated financial statements and notes thereto included in the Registrants Annual Report on Form 10-K, for the year ended December 31, 2009. Certain reclassifications have been made to the prior years consolidated financial statements that conform with the current years presentation. Such reclassifications had no impact on net income.
The results of operations for the six months ended June 30, 2010 are not necessarily indicative of the results of operations to be expected for the remainder of the year.
(2) Stock-based Compensation
At June 30, 2010, Suffolk had one stock-based employee compensation plan, the Suffolk Bancorp 2009 Stock Incentive Plan (the Plan), under which 500,000 shares of Suffolks common stock were originally reserved for issuance to key employees and directors, and of which none had yet been issued at that date. Options are awarded by a committee appointed by the Board of Directors. The Plan provides that the option price shall not be less than the fair value of the common stock on the date the option is granted. All options are exercisable for a period of ten years or less. The Plan provides for but does not require the grant of stock appreciation rights that the holder may exercise instead of the underlying option. When the stock appreciation right is exercised, the underlying option is canceled. The optionee receives shares of common stock or cash with a fair market value equal to the excess of the fair value of the shares subject to the option at the time of exercise (or the portion thereof so exercised) over the aggregate option price of the shares set forth in the option agreement. The exercise of stock appreciation rights is treated as the exercise of the underlying option. Options vest after one year and expire after ten years except as otherwise specified in the option agreement.
Stock based compensation for all share-based payments to employees, including grants of employee stock options, are recorded in the financial statements based on their fair values. During the three months ended June 30, 2010, no compensation expense was recorded for stock-based compensation. During the six months ended June 30, 2010, $8,000 of compensation expense, net of a tax benefit of $3,000, was recorded for stock-based compensation. As of June 30, 2010, there was no unrecognized compensation cost related to non-vested options under the Plan.
The following table presents the options granted, exercised, or expired during the six months ended June 30, 2010:
The following table presents certain information about the valuation of options outstanding on June 30, 2010 and December 31, 2009:
The following table details contractual weighted-average lives of outstanding options at various prices:
(3) Income Taxes
Suffolk uses an asset and liability approach to accounting for income taxes. The asset and liability approach requires the recognition of deferred tax assets and liabilities for the expected future tax consequences of temporary differences between the carrying amounts and the tax bases of assets and liabilities. Deferred tax assets are recognized if it is more likely than not that a future benefit will be realized. It is managements position that no valuation allowance is necessary against any of Suffolks deferred tax assets. Suffolk accounts for income taxes in accordance with Financial Accounting Standards Board (FASB) Accounting Standards Codification (ASC) 740, Income Taxes, which prescribes the recognition and measurement criteria related to tax positions taken or expected to be taken in a tax return. Suffolk had unrecognized tax benefits including interest of approximately $35,000 as of June 30, 2010. Suffolk recognizes interest and penalties accrued relating to unrecognized tax benefits in income tax expense.
(4) Fair Value
Suffolk records investments available for sale and impaired loans at fair value. Fair value measurement is determined based on the assumptions that market participants would use in pricing the asset or liability in an exchange. The definition of fair value includes the exchange price which is the price in an orderly transaction between market participants to sell an asset or transfer a liability in the principal market for the asset or liability. Market participant assumptions include assumptions about risk, the risk inherent in a particular valuation technique used to measure fair value and/or the risk inherent in the inputs to the valuation technique, as well as the effect of credit risk on the fair value of liabilities. Suffolk uses three levels of the fair value inputs to measure assets, as described below.
Basis of Fair Value Measurement:
Level 1 Unadjusted, quoted prices in active markets that are accessible at the measurement date for identical, unrestricted assets or liabilities;
Level 2 Quoted prices in markets that are not active, or inputs that use pricing models or matrix pricing;
Level 3 Prices or valuation techniques that require inputs that are both significant to the fair value measurement and unobservable (i.e., supported by little or no market activity).
The following table presents the carrying amounts and fair values of Suffolks financial instruments. FASB ASC 825, Financial Instruments, defines the fair value of a financial instrument as the amount at which the instrument could be exchanged in a current transaction between willing parties, other than in a forced sale or liquidation: (in thousands)
Fair value estimates are made at a specific point in time and may be based on judgments regarding losses expected in the future, risk, and other factors that are subjective in nature. The methods and assumptions used to produce the fair value estimates follow.
Short-term financial instruments are valued at the carrying amounts included in the consolidated statements of condition, which are reasonable estimates of fair value due to the relatively short term of the instruments. This approach applies to cash and cash equivalents; federal funds purchased; accrued interest receivable; non-interest-bearing demand deposits; N.O.W., money market, and saving accounts; accrued interest payable; and other borrowings. Federal Home Loan Bank advances/borrowings are measured using a discounted replacement cost of funds approach.
Fair values are estimated for portfolios of loans with similar characteristics. Loans are segregated by type. The fair value of performing loans was calculated by discounting scheduled cash flows through the estimated maturity using estimated market discount rates that reflect the credit and interest rate risk of the loan. Estimated maturity is based on the Banks history of repayments for each type of loan and an estimate of the effect of the current economy. Fair value for significant non-performing loans is based on recent external appraisals of collateral, if any. If appraisals are not available, estimated cash flows are discounted using a rate commensurate with the associated risk. Assumptions regarding credit risk, cash flows, and discount rates are made using available market information and specific borrower information.
The carrying amount and fair value of loans were as follows: (in thousands)
Other assets measured at fair value are as follows: (in thousands)
Impaired loans are evaluated and valued at the time the loan is identified as impaired, at the lower of cost or market value, and classified at level 3 in the fair value hierarchy. Market value is measured based on the value of the collateral securing these loans or techniques that are not supported by market activity for loans that are not collateral dependent and require managements judgment. Collateral may be real estate and/or business assets including equipment, inventory and/or accounts receivable. The value of real estate collateral is determined based on appraisals by qualified licensed appraisers hired by Suffolk. The value of business equipment may be based on an appraisal by qualified licensed appraisers hired by Suffolk if significant, or may be valued based on the equipments net book value on the business financial statements. Inventory and accounts receivable collateral may be valued based on independent field examiner review or aging reports, if significant.
Reviews by field examiners may be conducted based on the loan exposure and reliance on this type of collateral. Appraised and reported values may be discounted based on managements historical knowledge, changes in market conditions from the time of valuation, and/or managements expertise and knowledge of the client and clients business. Impaired loans are reviewed and evaluated on at least a quarterly basis for additional impairment and adjusted accordingly, based on the same factors identified above.
The fair value of the investment portfolio, including mortgage-backed securities, was based on quoted market prices or market prices of similar instruments.
The following tables summarizes the valuation of financial instruments measured at fair value on a recurring basis in the consolidated statements of condition at June 30, 2010 and December 31, 2009, including the additional requirement to segregate classifications to correspond to the major security type classifications utilized for disclosure purposes: (in thousands)
The types of instruments valued based on quoted market prices in active markets include most U.S. government debt and agency debt securities. Such instruments are generally classified within level 1 and level 2 of the fair value hierarchy. Suffolk does not adjust the quoted price for such instruments.
The types of instruments valued based on quoted prices in markets that are not active, broker or dealer quotations, or alternative pricing sources with reasonable levels of price transparency include state and municipal obligation, mortgage-backed securities and collateralized mortgage obligations. Such instruments are generally classified within level 2 of the fair value hierarchy.
FASB ASC 820, Fair Value Measurements and Disclosures, provides additional guidance in determining fair values when the volume and level of activity for the asset or liability have significantly decreased, particularly when there is no active market or where the price inputs being used represent distressed sales. It also provides guidelines for making fair value measurements more consistent with principles, reaffirming the need to use judgment to ascertain if a formerly active market has become inactive and in determining fair values when markets become inactive. Suffolk adopted this codification effective April 1, 2009. The adoption did not have a material impact on Suffolks financial condition and results of operations. The additional disclosures are included herein.
The fair value of certificates of deposit is calculated by discounting cash flows with applicable origination rates. At June 30, 2010, the fair value of certificates of deposit less than $100,000 totaling $105,878,000 had a carrying value of $104,627,000. At June 30, 2010, the fair value of certificates of deposit more than $100,000 totaling $224,950,000 had a carrying value of $223,902,000.
The fair value of commitments to extend credit was estimated by either discounting cash flows or using the fees currently charged to enter into similar agreements, taking into account the remaining terms of the agreements and the current creditworthiness of the counterparties.
Credit in the form of revolving open-end lines secured by one-to-four-family residential properties, commercial real estate, construction and land development loans, and lease financing arrangements was $129,180,000 and $148,309,000 as of June 30, 2010 and December 31, 2009, respectively.
The estimated fair value of written financial guarantees and letters of credit is based on fees currently charged for similar agreements. The contractual amounts of these commitments were $64,175,000 and $70,654,000 at June 30, 2010 and December 31, 2009, respectively. The fees charged for the commitments were not material in amount.
(5) Investment Securities
The amortized cost, estimated fair values, and gross unrealized gains and losses of Suffolks investment securities available for sale and held to maturity at June 30, 2010 and December 31, 2009, respectively, were: (in thousands)
The amortized cost, maturities, and approximate fair value of Suffolks investment securities at June 30, 2010 are as follows: (in thousands)
As a member of the Federal Reserve system, the Bank owns Federal Reserve Bank stock with a book value of $652,000. The stock has no maturity and there is no public market for the investment.
As a member of the Federal Home Loan Bank of New York (FHLB), the bank owns FHLB stock with a book value of $5,462,000. As of June 30, 2010, the Bank owns 17,314 shares valued at $1,731,000 as its membership portion. The remaining $3,731,000 in stock is owned based on borrowing activity requirements. The stock has no maturity and there is no public market for the investment. Assets pledged as collateral to FHLB as of June 30, 2010 and December 31, 2009, totaled $365,542,000 and $330,471,000, respectively, consisting of eligible loans and investment securities as determined under FHLB guidelines.
At June 30, 2010, investment securities carried at $408,000,000 were pledged to secure trust deposits and public funds on deposit.
The table below indicates the length of time individual securities, both held-to-maturity and available-for-sale, have been held in a continuous unrealized loss position at the date indicated: (in thousands)
Management has considered factors such as market value, cash flows, and analysis of underlying collateral regarding other-than-temporarily impaired securities and determined that there are no other-than-temporarily impaired securities as of June 30, 2010.
The unrealized losses in collateralized mortgage obligations at June 30, 2010 were caused by volatile interest rates, a significant widening of credit spreads across markets for these securities, and illiquidity and uncertainty in the financial markets. These securities include three private issues held at a continuous, unrealized loss for twelve months or longer. Each of these securities has some level of credit enhancement, and none are collateralized by sub-prime loans. With the assistance of a third party, management reviews the characteristics of these securities periodically, including levels of delinquency and foreclosure, projected losses at various degrees of severity, and credit enhancement and coverage. These securities are performing according to their terms, and, in the opinion of management, will continue to do so.
The unrealized losses in municipal securities at June 30, 2010 were the result of volatile interest rates, and uncertainty in the financial markets. These securities are performing according to their terms, and, in the opinion of management, will continue to do so.
Suffolk does not have the intent to sell these securities and does not anticipate that it will be necessary to sell these securities before the full recovery of principal and interest due, which may be at maturity. Therefore, Suffolk did not consider these investments to be other-than-temporarily impaired at June 30, 2010.
(6) Allowance for Loan Losses
The following table presents information about the allowance for loan losses: (in thousands of dollars except for ratios)
Please refer to Managements Discussion and Analysis of Financial Condition and Results of Operations, page 24, for discussion of the allowance for loan losses.
(7) Comprehensive Income
Comprehensive income includes net income and all other changes in equity during a period except those resulting from investments by owners and distributions to owners. Other comprehensive income includes revenues, expenses, gains, and losses that under generally accepted accounting principles are included in comprehensive income but excluded from net income. Comprehensive income and accumulated other comprehensive income are reported net of related income taxes. Accumulated other comprehensive income for the Bank consists of unrealized holding gains or losses on securities available for sale, and gains or losses on the unfunded projected benefit obligation of the pension plan.
The following table summarizes the changes in accumulated other comprehensive (loss) income as of June 30, 2010 and December 31, 2009: (in thousands)
The unrealized gain at June 30, 2010, is mainly attributable to a $2,745,000 increase in the market value of collateralized mortgage obligations and $551,000 of obligations of state and political subdivisions. This is offset by a $52,000 decrease in the market value of U.S. treasury securities and $35,000 of U.S. government agency debt.
(8) Retirement Plan
Suffolk accounts for its retirement plan in accordance with FASB ASC 715, Compensation Retirement Benefits and FASB ASC 960, Plan Accounting Defined Benefit Pension Plans, which require an employer that is a business entity and sponsors one or more single-employer defined benefit plans to recognize the funded status of a benefit plan in its statement of financial position; recognize as a component of other comprehensive income, net of tax, the gains or losses and prior service costs or credits that arise during the period but are not recognized as components of net periodic benefit cost; measure defined benefit plan assets and obligation as of the date of fiscal year-end statement of financial position (with limited exceptions); and disclose in the notes to financial statements additional information about certain effects of net periodic benefit cost for the next fiscal year that arise from delayed recognition of the gains or losses, prior service costs or credits,
and transition asset and obligation. Plan assets and benefit obligations shall be measured as of the date of its statement of financial position and in determining the amount of net periodic benefit cost. Suffolk has adopted the provisions of the codification, which have been recorded in the accompanying consolidated statement of condition and disclosures.
Suffolk presents information concerning net periodic defined benefit pension expense for the quarter and year to date periods ended June 30, 2010 and 2009, including the following components: (in thousands)
There is no minimum required contribution for the pension plan year ending September 30, 2010. There were no additional contributions required to be made to the plan in the six months ended June 30, 2010.
(9) Recent Accounting Pronouncements
In January 2010, the FASB issued ASU No. 2010-06, which amends the authoritative accounting guidance under ASC Topic 820 Fair Value Measurements and Disclosures. The update requires the following additional disclosures. 1) Separately disclose the amounts of significant transfers in and out of Level 1 and Level 2 fair value measurements and describe the reasons for the transfers. 2) Information about purchases, sales, issuances and settlements need to be disclosed separately in the reconciliation for fair value measurements using Level 3. The update provides for amendments to existing disclosures as follows. 1) Fair value measurement disclosures are to be made for each class of assets and liabilities. 2) Disclosures about valuation techniques and inputs used to measure fair value for both recurring and nonrecurring fair value measurements. The update also includes conforming amendments to guidance on employers disclosures about postretirement benefit plan assets. The update is effective for interim and annual reporting periods beginning after December 15, 2009, except for the disclosures about purchases, sales, issuances and settlements in the roll forward of activity in Level 3 fair value measurements. Those disclosures are effective for fiscal years beginning after December 15, 2010, and for interim periods within those fiscal years. Suffolk has evaluated the provisions of ASU No. 2010-06 and determined there is no material effect on its disclosures, results of operations or financial condition.
In February 2010, the FASB issued ASU No. 2010-09, which amends the authoritative accounting guidance under ASC Topic 855 Subsequent Events. The update provides that a Securities and Exchange Commission (SEC) filer is required to evaluate subsequent events through the date financial statements are issued. However, an SEC filer is not required to disclose the date through which subsequent events has been evaluated. The update was effective as of the date of issuance. Adoption of this update did not have a material effect on Suffolks disclosures, results of operations or financial condition.
In April 2010, the FASB issued ASU No. 2010-18, which provides authoritative accounting guidance on ASC Subtopic 310-30 Receivables Loans and Debt Securities Acquired with Deteriorated Credit Quality. The update provides that modifications of loans that are accounted for within a pool under Subtopic 310-30 do not result in the removal of those loans from the pool even if the modification of those loans would otherwise be considered a troubled debt restructuring. An entity will continue to be required to consider whether the pool of assets in which the loan is included is impaired if expected cash flows for the pool change. This update is effective for modification of loans accounted for within pools under Subtopic 310-30 occurring in the first interim or annual period ending on or after July 15, 2010. The amendments are to be applied prospectively. No additional disclosures are required. Suffolk has evaluated the provisions of this update and determined there is no material effect on its disclosures, results of operations or financial condition.
In July 2010, the FASB issued ASU No. 2010-20 which amends the authoritative accounting guidance under ASC Topic 310, Receivables. The update amends existing disclosures about an entitys financing receivables on a disaggregated basis to require: (1) a rollforward schedule of the allowance for credit losses from the beginning of the reporting period to the end of the reporting period on a portfolio segment basis, with the ending balance further disaggregated on the basis of impairment method; (2) for each disaggregated ending balance in item (1) above, the related recorded investment in financing receivables; (3) the nonaccrual status of financing receivables by class of financing receivables; and (4) impaired financing receivables by class of financing receivables. In addition, the amendments require an entity to provide the following additional disclosures about its financing receivables: (1) credit quality indicators of financing receivables at the end of the
reporting period by class of financing receivables; (2) the aging of past due financing receivables at the end of the reporting period by class of financing receivables; (3) the nature and extent of troubled debt restructurings that occurred during the period by class of financing receivables and their effect on the allowance for credit losses; (4) the nature and extent of financing receivables modified as troubled debt restructurings within the previous 12 months that defaulted during the reporting period by class of financing receivables and their effect on the allowance for credit losses; and (5) significant purchases and sales of financing receivables during the reporting period disaggregated by portfolio segment. The disclosures as of the end of a reporting period are effective for interim and annual reporting periods ending on or after December 15, 2010. The disclosures about activity that occurs during a reporting period are effective for interim and annual reporting periods beginning after December 15, 2010. Suffolk does not expect the provisions of this update to have a material effect on its results of operations or financial condition.
MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
For the Quarters and Six Month Periods ended June 30, 2010 and 2009
During the second quarter of 2010, the amount of credit available to borrowers industry-wide was limited as banks awaited clear action by Congress with regard to financial regulatory reform. Uncertainty about capital requirements, as well as uncertainty about the direction of the economy, restrained banks in their traditional lending activity. However, loans for commercial real estate continued to stagnate, both in terms of quality and demand, and consumer spending remained depressed. The value of residential real estate stabilized in many markets and the volume of sales and re-sales climbed from the same period during 2009, although the effect of the expiration of first-time-buyer subsidies on demand for housing was not yet clear. Short-term rates remained near zero, and the yield curve remained comparatively steep in comparison with historic averages, with the margins between short- and long-term rates unusually wide. This continued to increase most banks net interest margin. Low short term rates were primarily the result of continuing, low short-term targets by the Federal Reserve Board for federal funds and discount rates. It was also the result of continuing concern about the possibility of inflation over the longer term as a result of deficit spending by the federal government, and the development of an offsetting concern late during the quarter that the recovery might stall, leading to deflation. Rates of unemployment declined slightly during the quarter, but remained high by historic standards. In fact, it did not result in either significant capital spending or hiring in the private sector.
As disclosed previously, the prolonged slump in the economy has strained the resources of some of Suffolks borrowers. Suffolk is a community bank that relies upon net interest income generated by the relationships it builds with the owners of small and medium-sized businesses, in contrast to certain large banks that profit from the proprietary trading of securities and derivatives. Therefore, our prospects are tied more to Main Street than to Wall Street. At the start of the current recession, Suffolks primary market area was wealthier than many other markets. Owners of small businesses and other customers appeared to have greater financial reserves than similar customers in other regions of the nation, and the development of real estate, both residential and commercial, was more mature and therefore less speculative. This contributed to a steadier and less dramatic decline than elsewhere; and Suffolks borrowers remained current in their obligations longer. However, as time has passed, the economy appears to have stabilized at lower levels of output and higher levels of unemployment than before 2008.
At Suffolk, interest income decreased slightly, but net interest income increased because of reduced interest expense. The net interest margin decreased to 5.05 percent in the second quarter of 2010, down from 5.11 percent during the second quarter of 2009. Net interest income was offset, however, by substantially higher provisions for loan losses, which increased by 184.1 percent over the second quarter of 2009. The net interest margin on a year to date basis decreased to 5.03 percent in 2010, down slightly from 5.04 percent for the comparable period in 2009. Net interest income was offset by substantially higher provisions for loan losses, which increased by 483.7 percent over the comparable prior period.
At June 30, 2010, of the $36,097,000 of non-performing loans, $31,966,000 was secured by collateral valued at approximately $57,493,000, having an average loan-to-value ratio of approximately 56 percent. The unsecured portion of $4,131,000 amounted to 36 basis points of net loans at quarter end. To determine the adequacy of the allowance for loan losses Suffolk considered not only the status of non-performing loans on its books, but the performance of Suffolks peers. Although Suffolk continues to work with borrowers to ensure the collection of nonperforming credits, some of these loans were being paid more slowly than originally anticipated. This increased the allowance for loan losses to $20,866,000 at June 30, 2010, up from $12,333,000 at December 31, 2009. The majority of non-performing loans are commercial and industrial
loans, and loans secured by commercial real estate. The allowance is established through a provision for loan losses based on managements evaluation of the risk inherent in the various components of the loan portfolio and other factors, including Suffolks own historical loan loss experience as well as Suffolks peer bank loss experiences. Suffolk increased its provision for loan loss and its allocated reserve to reflect the deterioration of the overall economy, credit quality trends in the portfolios of Suffolks peer banks, and regulatory guidance and expectations. See Allowance for Loan Losses.
While non-performing assets as a percent of total assets increased much later at Suffolk than in peer banks in some other regions, they increased from 126 basis points at June 30, 2009, to 144 basis points at September 30, 2009, to 173 basis points at December 31, 2009, to 185 basis points at March 31, 2010, and 212 basis points at June 30, 2010. Non-performing loans to total loans amounted to 186 basis points at June 30, 2009, 215 basis points at September 30, 2009, 253 basis points at December 31, 2009, 270 basis points at March 31, 2010, and 311 basis points at June 30, 2010. Of the $36,097,000 not accruing interest, $7,736,000 represents credit to one borrower which, in consultation with the primary regulator of Suffolk County National Bank, Suffolks banking subsidiary, management determined to place on non-accrual status, although all payments are current and have been since inception, and has a ratio of loan-to-current appraised-value (June 2010) of 59.5 percent. Without this credit, nonperforming assets would have decreased to $28,361,000 or 245 basis points as a percent of total loans. As noted in the discussion above, most non-performing loans are well-collateralized. However, as they remain non-accruing over a period of time, on the basis of objective and selective criteria, Suffolk may or may not elect to charge these and other loans off prudentially, even when they remain in collection and there is the reasonable remaining expectation of the recovery of amounts owed and expenses incurred in collection. These charge-offs may or may not mirror trends, on a trailing basis, in ratios of non-performing assets to assets and non-performing loans to total loans. The amounts charged off may be substantial in comparison with Suffolks past loss history, although they may result in net recoveries at some point in the future if the economy improves and borrowers financial condition strengthen, although there can be no assurance that this will happen. Further discussion concerning the determination of the provision for loan losses, is found in the following under the caption, Allowance for Loan Losses.
Basic Performance and Current Activities
Return on average equity decreased to 13.75 percent for the second quarter in 2010, down from 18.94 percent during the second quarter of 2009, and basic earnings-per-share decreased from $0.59 in the second quarter of 2009 to $0.50 in the second quarter of 2010. For the first six months of 2010, return on average equity decreased to 9.13 percent, down from 19.27 percent during the comparable period of 2009.
Although Suffolks net interest income after the provision for loan losses decreased, Suffolks net interest income and core performance improved. Key to maintaining performance was disciplined management of the balance sheet. These steps included:
Net income was $4,792,000 for the second quarter of 2010, down 16.0 percent from $5,708,000 posted during the same period last year. Basic earnings-per-share for the quarter were $0.50 versus $0.59, a decrease of 15.3 percent. Net income was $6,324,000 for the six months ended June 30, 2010, down from $11,367,000 posted during the same period last year. Earnings-per-share were $0.66 for the six month period ended June 30, 2010, down from $1.18 posted last year. The key reason for the decline was an increased provision for loan losses.
Interest income was $21,849,000 for the second quarter of 2010, down 0.8 percent from $22,028,000 posted for the same quarter in 2009. Average net loans during the second quarter of 2010 totaled $1,145,213,000 compared to $1,117,737,000 for the same period of 2009. During the second quarter of 2010, the yield on a fully taxable-equivalent basis was 5.67 percent on average earning assets of $1,612,753,000 down from 5.91 percent on average earning assets of $1,552,353,000 during the second quarter of 2009. Interest income remained relatively flat from quarter to quarter. Interest income was $43,766,000 for the first six months of 2010, up 0.1 percent from $43,728,000 recorded in the first six months of 2009. During the first six months of 2010, the yield on a fully taxable-equivalent basis was 5.67 percent on average earning assets of $1,612,747,000, down from 5.90 percent on average earning assets of $1,542,585,000 during the first six months of 2009.
Interest expense for the second quarter of 2010 was $2,505,000, down 19.7 percent from $3,119,000 for the same period of 2009. During the second quarter of 2010, the cost of funds was 0.95 percent on average interest-bearing liabilities of $1,057,269,000, down from 1.22 percent on average interest-bearing liabilities of $1,023,111,000 during the second quarter of 2009. Interest expense was $5,176,000 for the first six months of 2010, down 22.5 percent from $6,680,000 recorded last year to date. During the first six months of 2010, the cost of funds was 0.97 percent on average interest-bearing liabilities of $1,068,106,000, down from 1.29 on average interest-bearing liabilities of $1,034,142,000 during the first six months of 2009. Interest expense decreased due to decreased rates paid for all interest-bearing liabilities, in addition to a decrease in average borrowings outstanding.
A portion of the Banks demand deposits are reclassified as savings accounts on a daily basis. The purpose of the reclassification is to reduce the non-interest-bearing reserve balances that the Bank is required to maintain with the Federal Reserve Bank, and thereby increase funds available for investment. Although these balances are classified as saving accounts for regulatory purposes, they are included in demand deposits in the accompanying consolidated statements of condition.
Net Interest Income
Net interest income, before the provision for loan losses, is the largest component of Suffolks earnings. It was $19,344,000 for the second quarter of 2010, up 2.3 percent from $18,909,000 during the same period of 2009. The net interest margin for the quarter, on a fully taxable-equivalent basis, was 5.05 percent compared to 5.11 percent for the same period of 2009.
The following table details the components of Suffolks net interest income for the quarter on a taxable-equivalent basis: (in thousands)
For the six months ended June 30, 2010, net interest income was $38,590,000, up 4.2 percent from $37,048,000, during the same period of 2009. The net interest margin on a fully taxable-equivalent basis was 5.03 percent compared to 5.04 percent for the same period of 2009.
The following details the components of Suffolks net interest income for the first six months of the year on a taxable-equivalent basis: (in thousands)
The table below presents a summary of changes in interest income, interest expense, and the resulting net interest income on a taxable-equivalent basis for the quarterly period presented. Because of numerous, simultaneous changes in volume and rate during the period, it is not possible to allocate precisely the changes between volumes and rates. In this table changes not due solely to volume or to rate have been allocated to these categories based on percentage changes in average volume and average rate as they compare to each other: (in thousands)
The table below presents a summary of changes in interest income, interest expense, and the resulting net interest income on a taxable-equivalent basis for the six month periods presented: (in thousands)
Other income decreased to $2,622,000 for the quarter compared to $2,824,000 the previous year, down 7.2 percent. Service charges on deposits were down 5.4 percent. Service charges, including commissions and fees other than for deposits, increased by 8.1 percent. Fiduciary fees were down 18.0 percent. Other operating income decreased by 43.3 percent, mainly attributable to a decrease in the sale of residential mortgage loans to the secondary market. Proceeds received in connection with sales of securities resulted in a net gain of $12,000, during the second quarter of 2010. Other income for the six months ended June 30, 2010, was $5,130,000, down 8.2 percent from $5,587,000 for the comparable year to date period. Service charges on deposits were down 5.1 percent. Service charges, including commissions and fees other than for deposits, decreased 4.4 percent. Fiduciary fees were down 4.6 percent. Other operating income decreased by 32.6 percent, mainly attributable to a decrease in the sale of residential mortgage loans to the secondary market.
Other expense for the second quarter of 2010 was $12,399,000, down 1.1 percent from $12,531,000 for the comparable period in 2009. FDIC assessments decreased by $637,000 or 50.5 percent and equipment expense decreased by 5.2 percent. The higher assessment during the second quarter of 2009 includes a special assessment of approximately $800,000 charged by the FDIC. The decreases were partially offset by increases in employee compensation of 4.7 percent, net occupancy expense of 2.2 percent, and other operating expense of 7.1 percent.
Other expense for the first six months of 2010, was $24,282,000, up 0.3 percent from $24,207,000 compared to the first six months of 2009. Employee compensation increased 3.8 percent and net occupancy expense increased 4.1 percent. The increases were partially offset by decreases in equipment expense of 6.0 percent, and other operating expense of 0.6 percent. FDIC assessments decreased by 27.2 percent as a result of a special assessment of approximately $800,000 charged by the FDIC in June 2009.
Stockholders equity totaled $143,196,000 on June 30, 2010, an increase of 4.4 percent from $137,171,000 on December 31, 2009. This was the result of net income, as well as an increase in the appreciation in the market value of securities available for sale, offset by cash dividends declared. The ratio of equity to assets was 8.4 percent at June 30, 2010 and 8.1 percent December 31, 2009, respectively.
The following table details amounts and ratios of Suffolks regulatory capital: (in thousands of dollars except ratios)
Suffolk makes loans based on its evaluation of the creditworthiness of the borrower. Even with careful underwriting, some loans may not be repaid as originally agreed. To provide for this possibility, Suffolk maintains an allowance for loan losses, based on an analysis of the performance of the loans in its portfolio. The analysis includes subjective factors based on managements judgment as well as quantitative evaluation. Estimates should produce an allowance that will provide for a range of losses. According to U.S. GAAP, a financial institution should record its best estimate. Appropriate factors contributing to the estimate may include changes in the composition of the institutions assets, or potential economic slowdowns or downturns. Also important is the geographical or political environment in which the institution operates. Suffolks management considers all of these factors when determining the provision for loan losses. Please refer to page 24 for further discussion of the allowance for loan losses.
Suffolk has financial and performance letters of credit. Financial letters of credit require Suffolk to make payment if the customers financial condition deteriorates, as defined in the agreements. Performance letters of credit require Suffolk to make payments if the customer fails to perform certain non-financial contractual obligations. The maximum potential undiscounted amount of future payments of these letters of credit as of June 30, 2010 is $29,189,000 and they expire as follows: (in thousands)
Amounts due under these letters of credit would be reduced by any proceeds that Suffolk would be able to obtain in liquidating the collateral for the loans, which varies depending on the customer. The allowance for contingent liabilities includes a provision of $44,000 for losses based on the letters of credit outstanding as of June 30, 2010.
Critical Accounting Policies, Judgments and Estimates
Suffolks accounting and reporting policies conform to U.S. GAAP and general practices within the financial services industry. The preparation of the financial statements in conformity with U.S. GAAP requires management to make estimates and assumptions that affect the amounts reported in the financial statements and the accompanying notes. Actual results could differ from those estimates.
Allowance for Loan Losses
Suffolk considers the determination of the allowance for loan losses to involve a higher degree of judgment and complexity than its other significant accounting policies. Suffolk maintains allowances for loan losses at a level that management believes will be adequate to absorb probable losses on existing loans that may become uncollectible based on evaluations of collectability. The national and regional economy has generally been considered to be in a recession since December 2007, with the national and regional economy deteriorating further throughout 2008 and 2009 and into 2010. Suffolks underwriting standards generally require a loan-to-value ratio of 75 percent or less, and when applicable, a debt coverage ratio of at least 120 percent, at the time a loan is originated. Suffolk has not been directly affected by the recent increase in defaults of sub-prime mortgages as Suffolk does not originate, or hold in portfolio, sub-prime mortgages. The allowance for loan losses is determined by continuous analysis of the loan portfolio. That analysis includes changes in the size and composition of the portfolio, Suffolks own historical loan losses, current and anticipated economic trends, and details about individual loans. It also includes estimates of the actual value of collateral, other possible sources of repayment and estimates that are susceptible to significant changes due to changes in appraisal values of collateral, national and regional economic conditions and other factors. The analysis also considers the loan loss history of Suffolks peers with similar characteristics. In assessing the adequacy of the allowance, Suffolk reviews its loan portfolio by separate categories which have similar risk and collateral characteristics; e.g. commercial loans, commercial real estate, construction loans, residential mortgages, home equity loans, and consumer loans. Management conducts a monthly analysis of the loan portfolio which evaluates any loan designated as having a high risk profile including but not limited to, loans classified as Substandard or Doubtful as defined by regulation, loans criticized internally or designated as Special Mention, delinquencies, expirations, overdrafts, loans to customers having experienced recent operating losses and loans identified by management as impaired. The analysis is performed to determine the amount of the allowance which would be adequate to absorb probable losses contained in the loan portfolio. The analytical process is regularly reviewed and adjustments may be made based on the assessments of internal and external influences on credit quality. During 2010, Suffolk experienced an increase in classified and criticized loans based on the current condition of borrowers. This was further noted in Suffolks review of the report of the Banks third-party loan reviewer.
Impaired loans are segregated and reviewed separately. Impaired loans secured by collateral are reviewed based on their collateral and the estimated time required to recover Suffolks investment in the loan as well as the cost of doing so, and the estimate of the recovery anticipated. Reserves are allocated to impaired loans based on this review. The allocated reserve is an estimation of losses specific to individual impaired loans. Allocated reserves are established based on an analysis of the most probable sources of repayment and liquidation of collateral. Reserves allocated to impaired loans were $6.4 million and $3.0 million as of June 30, 2010 and December 31, 2009, respectively. While every nonperforming loan is evaluated
individually, not every loan requires an allocated reserve. Allocated reserves fluctuate based on changes in the underlying loans, anticipated sources of repayment, and charge-offs.
Suffolk evaluates classified and criticized loans that are not impaired by categorizing loans by type of risk and applying reserves based on loan type and corresponding risk.
Suffolk also records reserves on Suffolks non-criticized and non-classified loan balances. This represents a general allowance for homogeneous loan pools where the loans are not individually evaluated for impairment, though rated according to loan product type and risk rating. This amount is determined by applying loss factors to pools of loans within the portfolio having similar risk characteristics.
In addition, external factors are considered for areas of concern that cannot be fully quantified in the allocation based on historical net charge-off ratios. External factors include:
For performing loans, an estimate of adequacy is made by applying external factors specific to the portfolio to the period-end balances. Suffolk used a higher percentage factor for criticized and classified loans, given their potential for greater loss. Consideration is also given to the type and collateral of the loans with particular attention paid to commercial real estate construction loans, due to the inherent risk of this type of loan. Allocated and general reserves are available for any identified loss.
Delinquent, nonperforming, and classified loans have trended upward. These are primary factors in the determination of the allowance. At June 30, 2010, delinquent and nonperforming loans totaled $36,097,000 as compared with $29,372,000 at December 31, 2009. When compared to total loans, nonperforming loans rose to 3.11 percent at June 30, 2010, up from 2.53 percent at December 31, 2009. Commercial mortgages and commercial and industrial loans were primarily responsible for the increase. Delinquent loans are considered non-performing loans and include nonaccrual loans, restructured loans and loans 90 days or more delinquent.
The following table summarizes Suffolks non-performing loans by category: (in thousands)
Included in nonperforming loans are restructured loans of $9,860,000. Subsequent to restructure, there have been no advances funded on restructured loans outstanding as of June 30, 2010.
As of June 30, 2010, classified loans amounted to 7.66 percent of total loans, as compared with 3.48 percent at December 31, 2009. The increase is attributable to the prolonged national and regional economic slowdown which has increased the amount of time necessary to work out troubled loans.
Commercial mortgages and commercial real estate construction loans totaled $508,652,000 as of June 30, 2010, up from $507,516,000 as of December 31, 2009, representing 43.9 percent and 43.7 percent of the total loan portfolio, respectively. Commercial mortgages and commercial real estate construction loans consisted of the following as of June 30, 2010: 4 percent vacant land loans, 16 percent commercial construction loans, 25 percent for non-owner-occupied commercial mortgages and 54 percent for owner-occupied commercial mortgages. Commercial mortgages and commercial real estate construction loans consisted of the following as of December 31, 2009: 7 percent vacant land loans, 19 percent commercial construction loans, 25 percent for non-owner-occupied commercial mortgages and 49 percent for owner-occupied commercial mortgages. Commercial real estate construction loans were generally underwritten on the basis of reasonable ratios of loan-to-value, evaluations of projected cash flows, and commitments for permanent financing in place prior to granting an interim credit. Non-performing commercial mortgages and commercial real estate construction loans have increased to $26,104,000 at June 30, 2010, up from $20,483,000 at December 31, 2009. These loans have been evaluated for impairment and appropriate provisions have been made to recognize impaired balances.
Suffolk recorded a provision for the second quarter of 2010 of $2,983,000. The total provision recorded for the first six months of 2010 totaled $11,820,000, which represents an increase of $9,795,000 as compared to the first six months of 2009. During the second quarter of 2010, Suffolk recorded $3,249,000 in net loan charge-offs compared to $167,000 for the second quarter of 2009. Suffolk believes that the allowance for loan losses of $20,866,000, or 1.80 percent of total loans at June 30, 2010, is adequate based on its review of overall credit quality indicators and ongoing loan monitoring processes.
The allowance for loan losses is summarized by category below: (in thousands)
There can be no assurance that the allowance is, in fact, adequate. When a loan, in full or in part, is deemed uncollectible, it is charged against the allowance. This happens when it is past due and the borrower has not shown the ability or intent to make the loan current, or the borrower does not have enough assets to pay the debt, or the value of the collateral is less than the balance of the loan and not likely to improve soon. In the future, the provision for loan losses may change as a percentage of total loans. To the extent actual performance differs from managements estimates, additional provisions for loan losses may be required that would reduce or may substantially reduce earnings in future periods, and no assurances can be given that Suffolk will not sustain loan losses, in any particular period, that are sizable in relation to the allowance for loan losses.
Deferred Tax Assets and Liabilities
Suffolk recognizes deferred tax assets and liabilities. Deferred income taxes occur when income taxes are allocated through time. Some items are temporary, resulting from differences in the timing of a transaction under generally accepted accounting principles, and for the computation of income tax. Examples would include the future tax effects of temporary differences for such items as deferred compensation and the provision for loan losses. Estimates of deferred tax assets are based upon evidence available to management that future realization is more likely than not. If management determines that Suffolk may be unable to realize all or part of net deferred tax assets in the future, a direct charge to income tax expense may be required to reduce the recorded value of the net deferred tax asset to the amount that management expects to realize.
Suffolk evaluates unrealized losses on securities to determine if any reduction in the fair value is other than temporary. This amount will continue to be dependent on market conditions, the occurrence of certain events or changes in circumstances of the issuer of the security, and the Companys intent and ability to hold the impaired investment at the time the valuation is made. If management determines that an impairment in the investments value is other than temporary, earnings would be charged.
Suffolk originates and invests in interest-earning assets and solicits interest-bearing deposit accounts. Suffolks operations are subject to market risk resulting from fluctuations in interest rates to the extent that there is a difference between the amounts of interest-earning assets and interest-bearing liabilities that are prepaid, withdrawn, mature, or re-priced in any given period of time. Suffolks earnings or the net value of its portfolio (the present value of expected cash flows from liabilities) will change when interest rates change. The principal objective of Suffolks asset/liability management program is to maximize net interest income while keeping risks acceptable. These risks include both the effect of changes in interest rates, and risks to liquidity. The program also provides guidance to management in funding Suffolks investment in loans and securities. Suffolks exposure to interest-rate risk has not changed substantially since December 31, 2009.
Business Risks and Uncertainties
This report contains some statements that look to the future. These may include remarks about Suffolk Bancorp, the banking industry, the economy in general, expectations of the business environment in which Suffolk operates, projections of future performance, and potential future credit experience. These forward-looking statements are based upon current management expectations, and may, therefore, involve risks and uncertainties that cannot be predicted or quantified and are beyond Suffolks control and are subject to a variety of uncertainties that could cause future results to vary materially from Suffolks historical performance, or from current expectations. Factors affecting Suffolk Bancorp include particularly, but are not limited to: changes in interest rates; increases or decreases in retail and commercial economic activity in Suffolks market area; variations in the ability and propensity of consumers and businesses to borrow, repay, or deposit money, or to use other banking and financial services, results of regulatory examinations; and the potential that net charge-offs are higher than expected. Further, it could take Suffolk longer than anticipated to implement its strategic plans to increase revenue and manage non-interest expense, or it may not be possible to implement those plans at all. Finally, new and unanticipated legislation, regulation, or accounting standards may require Suffolk to change its practices in ways that materially change the results of operation.
Controls and Procedures
Suffolks Chief Executive Officer and Chief Financial Officer (collectively, the Certifying Officers) are responsible for establishing and maintaining disclosure controls and procedures as defined in Rules 13a-15(e) of the Securities Exchange Act of 1934 for Suffolk. Based upon their evaluation of these controls and procedures as of June 30, 2010, the Certifying Officers have concluded that Suffolks disclosure controls and procedures are effective.
In addition, there has been no significant change in Suffolks internal controls over financial reporting that occurred during Suffolks most recent fiscal quarter that has materially affected, or is reasonably likely to materially affect, Suffolks internal controls over financial reporting.
There are no material changes from any of the risk factors previously disclosed in Suffolks 2009 Form 10-K in response to Part I, Item 1A other than the addition of the following risk factor:
Our results may be adversely affected if we continue to suffer higher than expected losses on our loans or are required to further increase our allowance for loan losses.
We assume credit risk from the possibility that we will suffer losses because borrowers, guarantors, and related parties fail to perform under the terms of their loans. We try to minimize and monitor this risk by adopting and implementing what we believe are effective underwriting and credit policies and procedures, including how we establish and review the allowance
for loan losses. The allowance for loan losses is determined by continuous analysis of the loan portfolio and the analytical process is regularly reviewed and adjustments may be made based on the assessments of internal and external influences on credit quality. Those policies and procedures may still not prevent unexpected losses that could adversely affect our results. Weak economic conditions could adversely impact the ability of borrowers to repay outstanding loans or the value of collateral securing those loans. In addition, deterioration in economic conditions affecting borrowers, new information regarding existing loans, identification of additional problem loans, changes in regulation and regulatory interpretation and other factors, both within and outside of our control, may require an increase in the allowance for loan losses. See the section captioned Allowance for Loan Losses in Item 2. Managements Discussion and Analysis of Financial Condition and Results of Operations located elsewhere in this report for further discussion related to our loan portfolio and our process for determining the appropriate level of the allowance for possible loan losses.
Recent financial reforms and related regulations may affect our results of operations, financial condition or liquidity.
The Dodd-Frank Wall Street Reform and Consumer Protection Act (the Dodd-Frank Act), signed into law on July 21, 2010, makes extensive changes to the laws regulating financial services firms. The Dodd-Frank Act also requires significant rulemaking and mandates multiple studies which could result in additional legislative or regulatory action. Under the Dodd-Frank Act federal banking regulatory agencies are required to draft and implement enhanced supervision, examination and capital standards for depository institutions and their holding companies. The enhanced requirements include, among other things, changes to capital, leverage and liquidity standards and numerous other requirements. The Dodd-Frank Act authorizes various new assessments and fees, expands supervision and oversight authority over nonbank subsidiaries, increases the standards for certain covered transactions with affiliates and requires the establishment of minimum leverage and risk-based capital requirements for insured depository institutions. The Dodd-Frank Act also establishes a new federal Consumer Financial Protection Bureau with broad authority and permits states to adopt stricter consumer protection laws and enforce consumer protection rules issued by the Consumer Financial Protection Bureau. At this time, it is difficult to predict the extent to which the Dodd-Frank Act or the resulting regulations will impact Suffolks business. However, compliance with these new laws and regulations will likely result in additional costs, these additional costs may adversely impact our results of operations, financial condition or liquidity.
Unregistered Sales of Equity Securities and Use of Proceeds
The following table presents information about repurchases of common stock:
Exhibits and Reports on Form 8-K
CERTIFICATION OF PERIODIC REPORTExhibit 31.1
CERTIFICATION OF PERIODIC REPORTExhibit 31.2
CERTIFICATION OF PERIODIC REPORTExhibit 32.1
CERTIFICATION OF PERIODIC REPORTExhibit 32.2
The following reports were filed on Form 8-K during the three month period ended June 30, 2010.
Current Report on Form 8-K the Companys press release titled, SUFFOLK BANCORP ANNOUNCES EARNINGS FOR THE FIRST QUARTER OF 2010, dated April 13, 2010.
Current Report on Form 8-K the Companys SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS, dated April 16, 2010.
Current Report on Form 8-K the Companys press release titled, SUFFOLK BANCORP ANNOUNCES REVISED PROVISION FOR LOAN LOSSES, dated April 26, 2010.
Current Report on Form 8-K the Companys press release titled, SUFFOLK BANCORP ANNOUNCES REGULAR
QUARTERLY DIVIDEND, dated May 25, 2010.
Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.