Volkswagen 10-K 2010
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K /A
(Amendment No. 1)
x ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the Fiscal Year Ended December 31, 2009
o TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from ___________________ to ______________________
Commission File Number: 000-52178
ES Bancshares, Inc.>
(Exact Name of Registrant as Specified in its Charter)
(Issuer’s Telephone Number including area code)
Securities Registered Pursuant to Section 12(b) of the Act:
Securities Registered Pursuant to Section 12(g) of the Act:
Common Stock, par value $0.01 per share
Warrants to purchase common stock, par value $0.01 per share
Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. YES o NO x
Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or 15(d) of the Act. YES o NO x
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 reports), and (2) has been subject to such requirements for the past 90 days.
(1) YES x NO o
(2) YES x NO o
Indicate by check mark whether the Registrant has submitted electronically and posted on its corporate website, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or such shorter period that the Registrant was required to submit and post such files). YES o NO o
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K (§229.405) is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. x
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 o NO x
As of June 30, 2009 the aggregate market value of the voting and non-voting common stock held by non-affiliates of the registrant, computed by reference to the closing price of the common stock as of June 30, 2009 was $8.0 million.
As of March 30, 2010, there were 2,071,070 shares of the Registrant’s common stock, par value $0.01 per share, outstanding.
DOCUMENTS INCORPORATED BY REFERENCE
This Amendment No. 1 filed on Form 10-K/A is being filed for the sole purpose to add a signature that was inadvertently omitted from the signature page of the Registrant's Annual Report on Form 10-K for the fiscal year ended December 31, 2009 filed with the SEC on March 30, 2010.
Other than this additional signature, there are no other amendments or revisions to the Form 10-K.
ES BANCSHARES, INC.
ANNUAL REPORT ON FORM 10-K
DECEMBER 31, 2009
Table of Contents
Item 1. Business
This Report on Form 10-K includes “forward-looking statements” within the meaning of the Securities Act of 1933, as amended, and the Securities Exchange Act of 1934, as amended, that are based on the current beliefs of, as well as assumptions made by and information currently available to, the management of the Company. All statements other than statements of historical facts included in this Report, including, without limitation, statements contained under the caption “Management’s Discussion and Analysis” regarding the Company’s business strategy and plans and objectives of the management of the Company for future operations, are forward-looking statements. When used in this Report, the words “anticipate,” “believe,” “estimate,” “project,” “predict,” “expect,” “intend” or words or phrases of similar import, as they relate to the Company or the Company’s management, are intended to identify forward-looking statements. Although the Company believes that the expectations reflected in such forward-looking statements are reasonable, such expectations may not prove to be correct. All forward-looking statements are subject to risks and uncertainties that could cause actual results to differ materially from those anticipated, believed, estimated, projected, predicted, expected or intended including: statements of our goals, intentions and expectations; statements regarding our business plans and prospects and growth and operating strategies; statements regarding the asset quality of our loan and investment portfolios and estimates of our risks and future costs and benefits. Among the factors which could cause our actual results of financial condition to differ materially are those set forth in Item 1A as well as the following: our ability to manage the risk in our loan portfolio; significantly increased competition among depository and other financial institutions; our ability to execute our plan to grow our assets on a profitable basis; our ability to execute on a favorable basis any plan we may have to acquire other institutions or branches or establish new offices; changes in the interest rate environment that reduce our margins or reduce the fair value of financial instruments and inflation; general economic conditions, either nationally or in our market area, future deposit premium levels, adverse changes in the securities and national and local real estate markets (including real estate values); our ability to grow our new Staten Island office; legislative or regulatory changes that adversely affect our business; our ability to enter new markets successfully and take advantage of growth opportunities; changes in consumer spending, borrowing and savings habits; the effect of a dramatically slowing economy on our lending portfolio including our commercial real estate, business, construction, multifamily, and home equity loans; the impact of the U.S. government’s economic stimulus program and its various financial institution rescue plans, changes in accounting policies and practices, as may be adopted by the bank regulatory agencies and the authoritative accounting and auditing bodies; and changes in our organization, compensation and benefit plans.
The Company does not intend to update these forward-looking statements. All subsequent written and oral forward-looking statements attributable to the Company or persons acting on its behalf are expressly qualified in their entirety by applicable cautionary statements.
Who We Are and How We Generate Income
ES Bancshares, Inc. (the “Registrant” or “Company”) was incorporated under the laws of the State of Maryland in August 2006, to serve as the bank holding company for the previously formed nationally chartered commercial bank, Empire State Bank, National Association (the “Bank”). The Registrant was organized at the direction of the Board of Directors of the Bank for the purpose of becoming a bank holding company pursuant to a plan of reorganization under which the former shareholders of the Bank became the shareholders of the Company. Since the reorganization, the Registrant has functioned primarily as the holder of all of the Bank’s common stock.
The Bank commenced operations in June 2004 as a national bank chartered by the Office of the Comptroller of the Currency (the “OCC”). Effective March 9, 2009, the Bank converted its charter to a New York State commercial bank.
As a community-oriented full service commercial bank, the Bank offers a variety of financial services to meet the needs of communities in its market area. The Bank’s mission is to help its customers by offering a full range of consumer and business deposit and lending products tailored to meet each customer’s specific financial needs coupled with in-depth knowledge and service from the Bank’s experienced staff. The Bank engages in full service commercial and consumer banking business, including accepting time and demand deposits from consumers, businesses and local municipalities surrounding its branch offices. These deposits, together with funds generated from operations and borrowings, are invested primarily in both owner and non-owner occupied commercial real estate, one to four family, multi-family, home equity, commercial, construction and consumer loans; GNMA, FNMA, and FHLMC mortgage-backed securities; U.S. government agency securities and certificates of deposit at other financial institutions. Additionally, the Bank offers non-deposit products such as annuities and mutual funds, merchant credit and debit card processing, automated teller machines, cash management services, online banking services, safe deposit boxes and individual retirement accounts.
The information in this Annual Report on Form 10-K reflects principally the financial condition and results of operations of the Bank. The Bank’s results of operations are primarily dependent on its net interest income, which is mainly the difference between interest income on loans and investments and interest expense on deposits and borrowings as well as the level of its provision for loan losses. The Bank also generates non interest income, such as fee income on deposit accounts, the sale of residential mortgages and the sale of mutual funds and annuities. The level of its non interest expense, such as salaries and benefits, occupancy and equipment costs, and other general and administrative expenses further affects the Bank’s net income. Certain reclassifications have been made to prior year amounts and the related discussion and analysis to conform to the current year presentation.
Our primary market area is the New York counties of Orange and Ulster, and the Borough of Staten Island, New York. The Bank also conducts business in certain other communities within Dutchess, Putnam, Rockland, Westchester and Nassau counties, New York as well as the other boroughs of New York City.
The Bank’s headquarters are located in Orange County located at 68 North Plank Road in Newburgh, New York. Newburgh is located along the Hudson River approximately sixty miles north of New York City and sixty miles south of Albany. Additionally, the Bank operates a second full service office in New Paltz, within the county of Ulster, approximately twenty miles northeast of its main office. Among other things, New Paltz is home to the State University of New York (SUNY) at New Paltz and Mohonk Mountain House, a five-star, world renowned resort. These cities and the surrounding areas are generally known as the Mid-Hudson Valley, which is located along New York State’s Hudson River and amidst its Catskill Mountains. The Newburgh-New Paltz area consists of many small towns that have experienced economic growth and social transformation. The area offers affordable housing; and therefore, people continue to relocate to the community.
We also have a growing presence in Staten Island, NY. In December of 2008, the Bank relocated its full service Staten Island office into a larger space, allowing for a larger operation that was outgrowing its space. The office in Staten Island is located approximately ninety miles south of the Bank’s Newburgh location. The borough of Staten Island is primarily comprised of numerous suburban-style residential neighborhoods and small businesses.
Deposit generation primarily stems from the areas surrounding our branch offices including, but not limited to, the Town of Newburgh, the Village of New Paltz and the borough of Staten Island. However, the Bank’s electronic remote deposit service (“remote capture”) allows customers to make deposits from their own business premises without visiting the Bank’s branch office allowing for deposit growth from the communities without full service branches. During the first quarter of 2008, the Bank closed its loan production office in Lynbrook, Nassau County, New York.
The market for financial services is rapidly changing and intensely competitive and is likely to become more competitive as the number and types of market entrants increase. The Bank faces substantial competition for both deposits and loans from inside and outside the market area, and all phases of the Bank’s business are highly competitive. The Bank faces direct competition from a significant number of financial institutions operating in its market areas, many with a statewide or regional presence, and in some cases, a national presence. Several branches of these financial institutions aggressively compete for the same local customer base. Most of these competitors are significantly larger than the Bank, and therefore have greater financial and marketing resources and lending limits than those of the Bank. Most of its competitors have been in business for a number of years with well established client bases. The Bank considers its major competition to be other commercial banks, savings and loan associations, savings banks and credit unions many of which are substantially larger than we are. Other larger competitors include mortgage brokers and financial services firms other than financial institutions such as investment and insurance companies as well as other institutional lenders. Increased competition within the Bank’s market areas may limit growth and profitability. Additionally, the fixed cost of regulatory compliance remains high for smaller community banks such as the Bank, as compared to their larger competitors that are able to achieve economies of scale.
We offer a variety of loan products, including commercial real estate loans secured by owner occupied commercial real estate, as well as mortgage loans secured by one- to-four family residences; loans secured by investment real estate owned by individuals who meet certain financial requirements; commercial revolving lines of credit and term loans; home equity loans and lines of credit; multi-family real estate loans; construction or development loans; and to a lesser extent consumer loans. Generally, we engage in secondary market sales of our fixed rate and adjustable rate residential mortgage originations. During 2009, the Bank selectively retained a portion of its mortgage originations in portfolio where the credit spread was deemed favorable. During the same period, we reduced our construction and development loan originations in light of the deteriorated economic conditions. At December 31, 2009, there were no loans held for sale on the Bank’s balance sheet. Also during 2009, the Bank significantly decreased its concentration in commercial real estate loans.
During 2009, the Bank continued to experience lending growth trends. Although these loans are made to a diversified pool of unrelated borrowers across numerous businesses, concentration of loans in our primary market areas may increase risk. Unlike larger banks that are more geographically diversified, the Bank’s loan portfolio consists primarily of real estate loans secured by commercial, residential, and multifamily real estate properties or loans to businesses located in the Bank’s principal lending areas in the Mid Hudson Valley region of New York as well as the boroughs of Staten Island and Brooklyn in New York City. While these communities represent our principal markets, the Bank has made loans outside these areas where the nature and quality of such loans was consistent with the Bank’s lending policies. Local economic conditions have a significant impact on the volume of loan originations and the quality of our loans, the ability of borrowers to repay these loans, and the value of collateral securing these loans. The sustained economic downturn (including significant layoffs in the financial services industry within the greater New York metropolitan area) continues to adversely impact local economic conditions and could negatively affect the financial results of the Bank’s operations. While the Bank has decreased its concentration in non-owner occupied commercial real estate loans, it still has a significant amount of loans in this category, so decreases in tenant occupancy may also have a negative effect on the ability of borrowers to make timely repayments of their loans, which would have an adverse impact on the Bank’s earnings.
The interest rates charged by the Bank on loans are affected primarily by the demand for such loans, the supply of money available for lending purposes, the rates offered by its competitors, the Bank’s relationship with the customer, and the related credit risks of the transaction. These factors are affected by general and economic conditions including, but not limited to, monetary policies of the federal government, including the Federal Reserve Board, legislative policies and governmental budgetary matters.
Loan Portfolio Composition.> The following table sets forth the composition of our loan portfolio in dollars and percentages by type of loan including a reconciliation of gross loans receivable after consideration of the allowance for loan losses and net deferred costs. The Bank had no loans held for sale at December 31, 2009 or 2008.
Loan Maturity Schedule. >The following table shows the remaining contractual maturity of our loans at December 31, 2009. Loans are shown as due based on their contractual terms to maturity. Demand loans, loans having no stated repayment schedule or contractual maturity and overdrafts, are reported as due in one year or less. Adjustable rate loans are shown as maturing in the period during which the contract is due. The schedule does not reflect the effects of possible prepayments or enforcement of due-on-sale clauses.
The following table sets forth the scheduled repayments of fixed- and adjustable-rate loans at December 31, 2009 that are contractually due after December 31, 2010.
Loans are shown in the period based on final contractual maturity. The total amount of loans due after December 31, 2009 which have predetermined interest rates is $36.8 million, while the total amount of loans due after such date which have floating or adjustable interest rates is $54.5 million. The Bank’s residential mortgage portfolio is underwritten to conventional secondary market guidelines and does not include any subprime loans.
The Bank is subject to limits on the amount we may lend to one borrower. At December 31, 2009, the regulatory limit on loans to one borrower was approximately $3.0 million, and the largest credit facility to one borrower was $1.5 million. This relationship consists of a $1.5 million line of credit to a large law firm which is secured by the firm’s receivables and backed by personal guarantees. At December 31, 2009, this obligation was performing in accordance with its repayment terms.
There are risks, including the risk of non-payment, associated with each type of loan that the Bank markets. All loan originations are subject to written underwriting standards and loan origination procedures. Decisions on loan applications are made on the basis of detailed applications submitted by the prospective borrower and, in the case of certain real estate secured loans, property valuations prepared by independent appraisers in accordance with the Bank’s appraisal policy. Underwriting guidelines, which may include analysis of significant factors such as credit reports, financial statements, tax returns, and confirmations, are designed primarily to determine the borrower’s ability to repay. The Bank’s lending policy places the responsibility on the employee processing an application to ensure that all required support documentation is obtained prior to the submission of the application to a loan officer for approval. In addition, the loan officer verifies that the application meets underwriting guidelines as approved by the Bank’s Board of Directors under its credit policy. Additionally, each application file is reviewed to assure its accuracy and completeness. A quality control process includes reviews by an independent third party of underwriting decisions, appraisals and documentation.
Generally, the Bank requires title insurance or abstracts on mortgage loans as well as fire and extended coverage casualty insurance in amounts at least equal to the principal amount of the loan or the value of improvements on the property, depending on the type of loan. In certain instances, federal regulations or the Bank’s terms of the credit approval require flood insurance on the property collateralizing the loan.
The primary risks associated with consumer loans relate to the borrower, such as the risk of a borrower’s unemployment as a result of deteriorating economic conditions or the amount and nature of a borrower’s other existing indebtedness, and the value of the collateral securing the loan if the Bank must take possession of the collateral. Commercial loans also have risks associated with concentrations of credit in a single business.
Largest loan concentration by industry is the real estate industry, followed by the construction industry. At December 31, 2009, the Company had no other concentrations of loans in any one industry exceeding 10% of its total loan portfolio. An industry for this purpose is defined as a group of businesses that are engaged in similar activities and have similar economic characteristics that would cause their ability to meet contractual obligations to be similarly affected by changes in economic or other conditions.
Commercial Real Estate and Multi-family Lending. >Mixed-use properties as well as other income producing properties located in our market area secure our commercial real estate loans. Multi-family real estate loans are generally secured by rental properties that may include walk-up apartments. Management anticipates that the majority of commercial real estate and multi-family loans originated over the next few years will have balances of $1.0 million or less.
Commercial real estate and multi-family loans generally carry a maximum term of twenty five years with rates that adjust based on a specific index plus a margin. These loans are generally originated in amounts of up to 80% of the lesser of the appraised value or the purchase price of the property, with a projected debt service coverage ratio of at least 120%. An independent appraiser approved by the Bank values the properties securing commercial real estate and multi-family loans, and subsequently management reviews all appraisals on multi-family or commercial real estate loans. In addition, underwriting procedures require verification of the borrower’s credit history, income and financial statements, banking relationships, references and income projections for the property. When feasible, personal guarantees are obtained on these loans. For loans in excess of $250,000, an environmental study may be performed.
Set forth below is information regarding the types of commercial real estate and multi-family loans in our loan portfolio at December 31, 2009 and 2008.
Commercial real estate and multi-family loans generally present a higher level of risk than loans secured by one- to four- family residences. This greater risk is due to several factors, including the generally larger loan amounts to borrowers that are typically dependant on the income generated by the project. In addition, such loans are vulnerable to adverse economic conditions, such as today’s economic crisis, which impact tenants’ ability to pay rent on a timely basis and thus impact the borrower’s ability to repay the loan. There can be no assurance regarding the amount of credit problems we experience in our commercial real estate and multi-family loans.
Commercial Business Lending. >The Bank offers term loans and lines of credit to local businesses for working capital, machinery and equipment purchases, expansion and other business purposes. The terms of these loans generally do not exceed seven years while commercial lines of credit are generally renewed annually. The interest rates on such loans are generally variable and indexed to the highest prime rate published in The Wall Street Journal plus or minus a margin although some loans are contracted under fixed rate agreements. Recently we have begun making floating rate loans with rate floors. At December 31, 2009 we had $20.1 million of commercial business loans outstanding, representing 18.8% of the total loan portfolio and an additional $6.4 million of funds committed, but undrawn, under commercial lines of credit.
The Bank’s commercial business lending policy requires credit file documentation, analysis of the borrower’s capacity to repay the loan, a review of the adequacy of the borrower’s capital and collateral, and an evaluation of conditions affecting the borrower. Analysis of the borrower’s present and future cash flows is also an important aspect of the current credit analysis.
Primary risks associated with commercial business loans are the cash flow of the business, the experience and quality of the borrower’s management, the business climate, and the impact of economic factors. Unlike residential mortgage loans, which are secured by real property whose value tends to be more easily ascertainable, commercial business loans are of higher risk and typically are made on the basis of the borrower’s ability to make repayment from the cash flow of the borrower’s business. As a result, the availability of funds for the repayment of commercial business loans may be substantially dependent on the success of the business itself. For this reason and, particularly with respect to loans to builders, such loans may be negatively impacted by adverse changes in the economy, including today’s adverse economic environment. Further, the collateral securing such loans may depreciate over time, may be difficult to appraise and may fluctuate in value based on the success of the business.
Set forth below is information regarding the types of commercial business loans in our loan portfolio at December 31, 2009 and 2008.
One- to Four-Family and Home Equity Residential Real Estate Lending. At December 31, 2009, we had $34.8 million, or 32.6% of our total loan portfolio, in loans secured by one- to four- family residential properties including $6.4 million in advances under home equity lines of credit, and $1.6 million in home equity loans. We offer both fixed-rate and adjustable-rate one-to-four family residential first mortgage loans. Our fixed-rate one- to four-family loans are underwritten in accordance with Fannie Mae and Freddie Mac guidelines and may be sold in the secondary market, servicing released, in order to minimize interest rate risk exposure. During 2008 and 2009, we retained a greater percentage of our fixed-rate one-to-four family residential loans than in previous years as a part of our growth plan.
The interest rates on our adjustable rate one- to four-family loans are based on a specific index plus a margin and may be retained for portfolio purposes. Management believes that the conservatorship of Fannie Mae and Freddie Mac did not have, nor is expected to have, a material effect on the Company’s results of operations or financial position.
In underwriting one- to four-family residential real estate loans, we evaluate the borrower’s ability to make principal, interest and escrow payments, as well as the value of the property that will secure the loan and debt-to-income ratios. Currently the Bank originates residential mortgage loans for our portfolio with loan-to-value ratios of up to 80% for owner-occupied homes and up to 70% for non-owner occupied homes. With private mortgage insurance to reduce our exposure to 80% or less, the Bank will originate residential mortgage loans for our portfolio with loan-to-value ratios of up to 95% for owner-occupied homes. Originated residential mortgage loans that are immediately sold to the secondary market can have loan-to-value ratios of up to 100% for owner-occupied homes, and up to 85% for non-owner occupied homes. Residential mortgage loans customarily include due-on-sale clauses giving the Bank the right to declare the loan immediately due and payable in the event that, among other things, the borrower sells or otherwise disposes of the property subject to the mortgage and the loan is not repaid.
Home equity lines of credit and home equity term loans are secured by a lien on the borrower’s residence and are generally limited to a maximum of $200,000. Bank credit policy requires the same underwriting standards for home equity lines and loans as are used for one- to four-family residential first mortgage loans held in the Bank’s portfolio. However, because our home equity lines of credit tend to be originated at higher loan to values, and lower debt coverage ratios than our one-to four-family loans, they are generally considered to carry a higher degree of credit risk.
The interest rates for home equity lines of credit float at a stated margin above and below the highest prime rate published in The Wall Street Journal and are capped at 18.0% and a floor determined by the rate plus margin over the life of the loan. The Bank offers home equity lines of credit for terms of up to 30 years with interest only paid for the first ten years of the loan term. Loan-to-value ratio on new extensions of credit are limited to 75%. At December 31, 2009, we had $6.4 million of outstanding advances under home equity lines of credit and an additional $5.3 million of funds committed, but undrawn, under home equity lines of credit.
Home equity term loans are made at fixed interest rates and are offered at terms up to 15 years generally with loan-to-value ratios of up to 75%. At December 31, 2009, our home equity loans totaled $1.6 million. Home equity term loans represent loans originated in the Bank’s geographic markets.
Loans secured by residential co-ops and condominiums located in our market area are offered on substantially the same terms as one- to four-family loans. At December 31, 2009, we had $1.3 million in condominium and co-op loans.
Reflecting our conservative underwriting standards, we do not have any loans in our loan portfolio that are considered sub-prime.
Construction and Land Lending.> Construction loans are originated to builders and individuals for the construction of both residential and commercial real estate properties. Construction loan agreements generally provide that loan proceeds are disbursed in increments, subsequent to the Bank’s review of the progress of the construction of the dwelling, as the project progresses. At December 31, 2009, the construction loan portfolio totaled $2.8 million, or 2.6% of the total loan portfolio, and an additional $732 thousand of funds committed but undrawn. At December 31, 2009, our largest construction loan had a balance of $1.0 million for construction of a residential condominium project.
A limited number of land development loans are originated primarily for the purpose of developing residential subdivisions. These loans to builders and developers are for the development of one- to four-family lots in our market area. Land loans are originated with adjustable rates of interest tied to the prime rate of interest with terms of five years or less. Land loans are generally made in amounts up to a maximum loan-to-value ratio of 50% on raw land and up to 75% on developed building lots based upon an independent appraisal. At December 31, 2009, our land development loan portfolio was comprised of one loan with a balance of $816,000, or 0.8% of the total loan portfolio, and was made for the purpose of developing residential lots. This loan was nonaccrual at December 31, 2009.
Construction loans to builders of one- to four-family residences generally carry terms of up to two years with interest only payments required. The maximum loan-to-value ratio on loans to builders for the construction of residential real estate is 80%. When practical, the Bank seeks to obtain personal guarantees on such loans. We generally limit loans to builders for the construction of homes on speculation for sale to two homes per builder. At December 31, 2009, we had $296 thousand of speculative construction loans outstanding to a builder of one- to four- family residences, which was secured by real estate mortgages and backed by personal guarantees.
The Bank originates commercial real estate construction loans to experienced local developers only when there is a written take-out commitment from an acceptable financial institution or government agency, or when the Bank grants an internal commitment for permanent financing evidenced by a written document in the credit file. The maximum loan-to-value ratio on loans to builders for the construction of commercial real estate is 80%. At December 31, 2009, our commercial real estate construction portfolio consisted of one loan in the amount of $218 thousand. This loan was non-accrual as of December 31, 2009.
Construction loans to individuals for the construction of their residences convert to permanent residential mortgage loans at the end of the construction phase, which typically runs up to one year. Upon conversion to permanent mortgages, these loans have rates and terms comparable to those offered by the Bank on its one-to-four family residential mortgage loan products. During the construction phase the borrower pays interest only at a specified margin over the prime rate. The maximum loan-to-value ratio of owner-occupied single-family construction loans is 80%. Takeouts for residential construction loans are generally underwritten pursuant to the same guidelines used for originating permanent residential loans. At December 31, 2009, the Bank had two construction loans totaling $425 thousand outstanding to builders of one-to four family residences where the borrower intends to occupy the property upon completion.
Construction and land loans are obtained principally through referrals from management’s contacts in the business community as well as from existing and walk-in customers. The application process includes a submission of accurate plans, specifications and costs of the project to be constructed or developed. These items are used as a basis to determine the appraised value of the subject property. Loans are based on the lesser of current independent appraised value or the cost of land plus the building construction.
Pricing on construction and land development lending generally affords the Bank an opportunity to receive interest at rates higher than those obtainable from permanent residential loans and to receive higher origination and other loan fees. In addition, construction and land loans are generally made with adjustable rates of interest or for relatively short terms. Nevertheless, construction and land lending is generally considered to involve a higher level of credit risk than one- to four-family residential lending due to the concentration of principal in a limited number of loans and borrowers, as well as the effects of general economic conditions (including the current economic crisis and decline in real estate values) on development properties and on real estate developers. In addition, the nature of these loans is such that they are more difficult to evaluate and monitor. Finally, the risk of loss on a construction loan is largely dependent upon the accuracy of the initial estimate of the property’s value upon completion of construction, as compared to the estimated cost of construction, including interest, and upon the estimated time to sell or lease such properties. If the estimate of value proves to be inaccurate, or the length of time to sell or lease it is greater than anticipated, the property could have a value upon completion that is insufficient to assure full repayment of the loan. The Bank may be required to advance funds beyond the amount originally committed to allow completion of the project.
Consumer Lending.> The Bank originates a variety of consumer loans, including automobile, home improvement, deposit account and other loans for household and personal purposes. At December 31, 2009, consumer loans totaled $548 thousand, or 0.5% of total loans outstanding. Consumer loan terms vary according to the type of loan and value of collateral, length of contract and creditworthiness of the borrower. Our consumer loans are made at fixed or variable interest rates, with terms of up to 5 years.
The underwriting standards employed for consumer loans include a determination of the applicant’s payment history on other debts and the ability to meet existing obligations and payments on the proposed loan. Although creditworthiness of the applicant is a primary consideration, the underwriting process also includes a comparison of the value of the security, if any, in relation to the proposed loan amount.
Consumer loans may entail greater credit risk than residential mortgage loans, particularly in the case of consumer loans which are unsecured or are secured by rapidly depreciable assets. Collateral for a defaulted consumer loan may not provide an adequate source of repayment of the outstanding loan balance as a result of the greater likelihood of damage, loss or depreciation. In addition, consumer loan collections are dependent on the borrower’s continuing financial stability, and thus are more likely to be affected by adverse personal circumstances, including adverse personal circumstances caused by duress in the current economy. Furthermore, the application of various federal and state laws, including bankruptcy and insolvency laws, may limit the amount which can be recovered on such loans.
Originations, Purchases and Sales of Loans
Loan applications are taken at each of our offices as well as through mortgage originators. Applications are processed and approved at our Loan Center, which is located in the corporate headquarters. We also employ commissioned loan originators and utilize outside mortgage brokers for lending business development. Total loan originations amounted to $61.8 million for the year ended December 31, 2009. While we originate a variety of business and personal loans, our ability to originate loans is dependent upon the relative customer demand for loans in our market. Additionally, the local economy and the interest rate environment affect demand.
To reduce our vulnerability to changes in interest rates, we may sell into the secondary market our fixed-rate residential mortgage originations in addition to certain current year originations of adjustable-rate loans. Sales of loans amounted to $18.5 million for the year ended December 31, 2009. There were no loans held for sale on the Bank’s balance sheet at December 31, 2009 or 2008. At December 31, 2009 we did not service any of these loans for others.
The following table sets forth our loan originations, sales, repayments and other portfolio activity for the periods indicated.
Delinquency Procedures. When a borrower fails to make a required payment on a loan, attempts to cure the delinquency are first made by contacting the borrower. Late notices will be sent when a payment is more than sixteen days past due, and a late charge will generally be assessed at that time. Additional written and verbal contacts may be made with the borrower between thirty and ninety days after the due date. If the loan is contractually delinquent over sixty days, a thirty day demand letter is sent to the borrower and, after the loan is contractually delinquent over ninety days, appropriate action begins to foreclose on the property. If foreclosed, the property will be sold at auction and may be purchased by the Bank. Delinquent consumer loans are generally handled in a similar manner. Procedures for repossession and sale of consumer collateral are subject to various requirements under New York consumer protection laws.
Real estate acquired as a result of foreclosure or by deed in lieu of foreclosure will be classified as other real estate owned until it is sold. When property is acquired or expected to be acquired by foreclosure or deed in lieu of foreclosure, it will be recorded at estimated fair value less the estimated cost of disposition, with the resulting write-down charged to the allowance for loan losses. After acquisition, all costs incurred in maintaining the property will be expensed. Costs relating to the development and improvement of the property, however, will be capitalized.
Regulations require that the Company classify its assets on a regular basis and establish prudent valuation allowances based on such classifications. There are three classifications for problem assets: substandard, doubtful, and loss. Substandard assets have one or more defined weaknesses and are characterized by the distinct possibility that the institution will sustain some loss if the deficiencies are not corrected. Doubtful assets have the weaknesses of substandard assets, with the additional characteristics that the weaknesses make collection or liquidation in full on the basis of currently existing facts, conditions and values questionable, and there is a high possibility of loss. An asset classified as loss is considered uncollectible and of such little value that continuance as an asset on the balance sheet of the institution is not warranted. Assets classified as substandard or doubtful require the Company to establish general allowances for loan losses. If an asset or portion thereof is classified as loss, the Company must either establish specific allowances for loan losses in the amount of 100% of the portion of the asset classified loss, or charge off such amount. On the basis of management’s review, at December 31, 2009, the Bank had $249 thousand in assets classified as doubtful and $2.9 million classified as substandard. There were no assets classified as loss. At December 31, 2008 the Bank had $994 thousand in assets classified as substandard. There were no assets classified as doubtful or loss.
Loans are reviewed monthly and any loan whose collectability is doubtful is placed on nonaccrual status. Loans are placed on nonaccrual status when either principal or interest is 90 days or more past due, unless, in the judgment of management, the loan is well collateralized and in the process of collection. Interest accrued and unpaid at the time a loan is placed on nonaccrual status is reversed from interest income related to current year income and charged to the allowance for loan losses with respect to income that was recorded in the prior fiscal year. Subsequent payments are either applied to the outstanding principal balance or recorded as interest income, depending on the assessment of the ultimate collectability of the loan. At December 31, 2009 the Bank had a foreclosed asset acquired in settlement of loans. Attributed to the current downturn in the economic climate, the Bank has seen its non-performing assets increase at December 31, 2009 from the same period a year earlier.
The following table sets forth the amount and categories of our non-performing assets at the dates indicated. At December 31, 2009, we had two loans totaling $1.5 million which represented troubled debt restructures.
In connection with the filing of our periodic reports with the New York State Banking Department and in accordance with our classification of assets policy, we regularly review the problem loans in our portfolio to determine whether any loans require classification in accordance with applicable regulations. On the basis of this review of our assets, at December 31, 2009, we had classified the following assets:
Our classified assets consist of (i) non-performing loans and (ii) loans and other assets of concern discussed herein. As of the date hereof, these asset classifications are believed to be consistent with those of the New York State Banking Department. Certain classified assets are still accruing interest income at December 31, 2009. These loans consist of one additional commercial loan for $50 thousand which is performing.
Allowance for Loan Losses>. The allowance for loan losses is established and maintained through a provision for loan losses based on probable incurred losses inherent in the Bank’s loan portfolio. Management evaluates the adequacy of the allowance on a quarterly basis. If the allowance for loan losses is not sufficient to cover actual loan losses, the Bank’s earnings could decrease.
The allowance for loan losses consists of amounts specifically allocated to non-performing loans and potential problem loans as well as allowances determined for each major loan category. Loan categories such as single-family residential mortgages and consumer loans are generally evaluated on an aggregate or “pool” basis by applying loss factors to the current balances of the various loan categories. The loss factors are determined by management based on an evaluation of historical loss experience, delinquency trends, volume and type of lending conducted, and the impact of current economic conditions in our market area. Finally, management evaluates and considers the allowance ratios and coverage percentages of both peer group and regulatory agency data.
Management’s evaluation of the adequacy of the allowance, which is subject to periodic review by the New York State Banking Department and the Federal Reserve Bank of New York, takes into consideration such factors as the historical loan loss experience, peer group ratios, known and inherent risks in the portfolio, changes in the nature and volume of the loan portfolio, overall portfolio quality, review of specific problem loans, estimated value of underlying collateral, and current economic conditions that may affect borrowers’ ability to pay. Due to our brief period of operations, peer group information is the primary determinant. Other factors as discussed above will become more prominent in the methodology as we develop a history of experience. While management believes that it uses the best information available to determine the allowance for loan losses, unforeseen market conditions could result in adjustments to the allowance for loan losses, and net earnings could be significantly affected, if circumstances differ substantially from the estimates made in making the final determination.
The following table sets forth activity in the allowance for loan losses for the periods indicated.
The following table sets forth the breakdown of the allowance for loan losses by loan category at December 31, 2009 and December 31, 2008. The allocation of the allowance to each category is not necessarily indicative of future losses and does not restrict the use of the allowance to absorb losses in any category.
The Bank encounters certain environmental risks in our lending activities. The existence of hazardous materials may make it unattractive for a lender to foreclose on the properties securing its loans. In addition, under certain conditions, under federal and state environmental laws, lenders may become liable for costs of cleaning up hazardous materials found on property securing their loans. In addition, the presence of hazardous materials may have a substantial effect on the value of such property as collateral and may cause economic difficulties for the borrower, causing the loan to go into default. Although environmental risks are usually associated with loans secured by commercial real estate, risks may also exist for loans secured by residential real estate if, for example, there is nearby commercial contamination or if the residence was constructed on property formerly used for commercial purposes. To control our environmental risk, if we determine that the investigation of property securing a commercial mortgage loan is warranted, we will require an environmental assessment by an approved engineer as part of the underwriting review.
As of December 31, 2009, we were unaware of any environmental issues with respect to any of our mortgage loans that would subject us to any material liability at this time. Hidden or future environmental contamination could adversely affect the values of properties securing loans in our portfolio.
General.> The Bank’s investment policy is to invest funds among categories of investments and maturities based upon our asset/liability management policies, investment quality, loan and deposit volume, liquidity needs and performance objectives.
The FASB Accounting Standards Codification and the Hierarchy of Generally Accepted Accounting Principles requires that securities be classified into three categories: trading, held to maturity, and available for sale. Securities that are bought and held principally for the purpose of selling them in the near term are classified as trading securities and are reported at fair value with unrealized gains and losses included in earnings. Debt securities for which we have the positive intent and ability to hold to maturity are classified as held to maturity and reported at amortized cost. All other securities not classified as trading or held to maturity are classified as available for sale. Available for sale securities are reported at fair value with unrealized gains and losses included in a separate component of stockholders’ equity. At December 31, 2009 we had no securities classified as trading. During 2009 management elected to reclassify its entire investment portfolio as available for sale, and at December 31, 2009, the entire investment portfolio, or $28.8 million, was classified as available for sale. There were no investment securities of a single issuer which exceeded 10% of our stockholders’ equity, other than U.S. Government or federal agency obligations.
During 2009, we increased our holdings of mortgage backed securities as part of our strategy to deploy liquidity in investment alternatives other than commercial real estate. Mortgage-backed securities in our investment portfolio totaled $25.8 million at December 31, 2009. All are either expressly guaranteed by the United States federal government as in the case of Ginnie Mae securities, or hold the implied guarantee of the United States government as in the case of substantially all of the remaining mortgage backed securities held in our portfolio. All such securities are pass through securities.
A detail of our mortgage backed securities issuers are as follows:
In addition to mortgage-backed securities, we also invest in other high-quality securities such as United States agency obligations with various maturities. These totaled $1.6 million at December 31, 2009. See Note 2 of the Notes to Financial Statements for additional information regarding our securities portfolio.
We have also invested in a limited number of trust preferred securities totaling $1.3 million at year end issued individually by Wells Fargo, Deutsche Bank, HSBC, and Barclays Bank. Management believes that these investment securities remain within the Bank’s investment policy guidelines.
The Bank is a member of the Federal Reserve System (“FRB”) and as such is required to purchase stock in the FRB within the Federal Reserve district in which the Bank is located. In accordance with this requirement, at December 31, 2009, we owned 6,158 shares totaling $308 thousand in common stock of the Federal Reserve Bank of New York.
We are also a member of the Federal Home Loan Bank of New York (“FHLB-NY”). A condition of membership requires that the Bank purchase capital stock in the FHLB-NY. Pursuant to this requirement, at December 31, 2009, we owned 5,728 shares totaling $573 thousand in capital stock of the FHLB-NY.
The following table sets forth the amortized cost and fair value of our securities, by accounting classification category and by type of security, at the dates indicated. At December 31, 2009, we had no securities classified as held-to-maturity.
(1) Consisted of government sponsored agency issuances
The following table sets forth certain information regarding the amortized cost, fair value, weighted average yield and stated maturity of our securities at the dates indicated. The entire amortized cost and fair value of such securities are included in the maturity period that reflects the final security payment date. Accordingly, no effects are given to periodic repayments or possible prepayments. At December 31, 2009, there were no securities classified as held to maturity.
Sources of Funds
Deposits and Borrowings
General.> The Bank’s primary sources of funds are deposits although funds are also derived from loan and investment securities principal repayments and maturities, interest earned on loans and securities, lines of credit with other financial institutions including the Federal Home Loan Bank, FRB, and other funds provided from operations.
Deposits.> The Bank offers a variety of deposit accounts having a wide range of interest rates and terms which vary according to the minimum balance required, the time period the funds must remain on deposit and the interest rate, among other factors. We rely primarily on competitive pricing policies, marketing and quality customer service to attract and retain these deposits. The variety of deposit accounts offered allows the Bank to effectively compete to obtain funds and to respond with flexibility to changes in consumer demand. Pricing of deposits is managed in keeping with asset and liability objectives, taking into account both profitability and growth.
The variety of deposit accounts offered allows us to be competitive in obtaining funds and responding to changes in consumer demand. Based on our experience, we believe that demand, NOW, savings and money market accounts may be somewhat more stable sources of deposits than certificates of deposits. Also, we believe that our deposits allow us a greater opportunity to connect with our customers and offer them other financial services and products. As a result, we have used marketing and other initiatives to increase such accounts.
The following table sets forth the distribution of deposit accounts and the related weighted average rates at the dates indicated.
The following table sets forth, by interest rate ranges, the amount of savings certificate accounts outstanding at the dates indicated and the period to maturity of certificate of deposit accounts outstanding at December 31, 2009 and December 31, 2008.
The following table sets forth the maturity distribution and related weighted average interest rates for certificates of deposit at December 31, 2009:
Borrowings.> Borrowings, including Federal Funds purchased, lines of credit, outstanding balances on correspondent bank lines of credit and FHLB advances, remained relatively unchanged at $10.1 million at December 31, 2009 from the prior year-end. The Company had an outstanding balance of $1.6 million and $615 thousand drawn against its committed credit facility with its correspondent bank, Atlantic Central Bankers Bank at December 31, 2009 and 2008, respectively. Separately, the Bank has additional unused credit lines of $5.0 million, also with our correspondent bank, Atlantic Central Bankers Bank.
At December 31, 2009, the Bank had 34 full-time equivalent employees as compared to 36 at December 31, 2008. Employees are not represented by a collective bargaining unit, and the Bank’s relationship with its employees is considered to be good.
REGULATION AND SUPERVISION
General. >Effective March 9, 2009, the Bank converted to a New York State commercial bank charter, and as such, is regulated by the New York Banking Department (the “Department”) and the Federal Reserve Bank of New York (the “FRB”). The Bank is a member of the Federal Home Loan Bank of New York, and is also is a member of the Federal Reserve System.
This regulation and supervision establishes a comprehensive framework of activities in which the Bank may engage and is intended primarily for the protection of the insurance fund and depositors. The regulatory structure also gives the regulatory authorities extensive discretion in connection with their supervisory and enforcement activities and examination policies, including policies with respect to the classification of assets and the establishment of adequate loan loss reserves.
Insurance of Deposit Accounts.> The Bank is a member of the Deposit Insurance Fund, which is administered by the Federal Deposit Insurance Corporation (“FDIC”). Deposit accounts at the Bank are insured by the FDIC, generally up to a maximum of $100,000 for each separately insured depositor and up to a maximum of $250,000 for self-directed retirement accounts. However, the FDIC increased the deposit insurance available on all deposit accounts to $250,000, effective until December 31, 2013. In addition, certain noninterest-bearing transaction accounts maintained with financial institutions participating in the FDIC’s Temporary Liquidity Guarantee Program were fully insured regardless of the dollar amount until June 30, 2010. We opted to participate in the FDIC’s Temporary Liquidity Guarantee Program. See “—Temporary Liquidity Guarantee Program.”
The FDIC imposes an assessment against all depository institutions for deposit insurance. This assessment is based on the risk category of the institution and, prior to 2009, ranged from 5 to 43 basis points of the institution’s deposits. On February 27, 2009, the FDIC published a final rule raising the current deposit insurance assessment rates to a range from 12 to 45 basis points beginning April 1, 2009.
On May 22, 2009, the FDIC adopted a final rule imposing a 5 basis point special assessment on each insured depository institution’s assets minus Tier 1 capital as of June 30, 2009. The amount of the special assessment for any institution will not exceed 10 basis points times the institution’s assessment base for the second quarter 2009. Our total expense for the special assessment was $68 thousand.
The Company is participating in the FDIC’s Temporary Account Guarantee (“TAG”) program, which is a part of the FDIC’s TLG program. The purpose of the TLG is to strengthen confidence and encourage liquidity in the banking system. Under the TAG, funds in non-interest-bearing accounts, in interest-bearing transaction accounts with interest rate of 0.50% or less and in Interest on Lawyers Trust Accounts will have a temporary unlimited guarantee from the FDIC until June 30, 2010. The coverage of the TAG is in addition to and separate from coverage available under the FDIC’s general deposit insurance rules, which insure accounts up to $250,000.
Temporary Liquidity Guarantee Program.> On October 14, 2008, the FDIC announced a new program – the Temporary Liquidity Guarantee Program. This program has two components. One guarantees newly issued senior unsecured debt of a participating organization, up to certain limits established for each institution, issued between October 14, 2008 and June 30, 2009. The FDIC will pay the unpaid principal and interest on a FDIC-guaranteed debt instrument upon the uncured failure of the participating entity to make a timely payment of principal or interest in accordance with the terms of the instrument. The guarantee will remain in effect until June 30, 2012. In return for the FDIC’s guarantee, participating institutions will pay the FDIC a fee based on the amount and maturity of the debt. The Bank determined to participate in this component of the Temporary Liquidity Guarantee Program.
The other component of the program provides full federal deposit insurance coverage for non-interest bearing transaction deposit accounts, regardless of dollar amount, until December 31, 2009. An annualized 10 basis point assessment on balances in noninterest-bearing transaction accounts that exceed the existing deposit insurance limit of $250,000 will be assessed on a quarterly basis to insured depository institutions that have not opted out of this component of the Temporary Liquidity Guarantee Program. The Bank is participating in this component of the Temporary Liquidity Guarantee Program.
Bank Holding Company Regulation. >ES Bancshares, Inc., as a bank holding company controlling the Bank, is subject to the Bank Holding Company Act of 1956, as amended (“BHCA”), and the rules and regulations of the Federal Reserve Board under the BHCA applicable to bank holding companies. The Company is required to file reports with, and otherwise comply with the rules and regulations of the Federal Reserve Board.
Such regulation and supervision govern the activities in which a bank and its holding company may engage and are intended primarily for the protection of the insurance fund and depositors. These regulatory authorities have extensive enforcement authority over the institutions that they regulate to prohibit or correct activities that violate law, regulation or a regulatory agreement or which are deemed to be unsafe or unsound banking practices. Enforcement actions may include the appointment of a conservator or receiver, the issuance of a cease and desist order, the termination of deposit insurance, the imposition of civil money penalties on the institution, its directors, officers, employees and institution-affiliated parties, the issuance of directives to increase capital, the issuance of formal and informal agreements, the removal of or restrictions on directors, officers, employees and institution-affiliated parties, and the enforcement of any such mechanisms through restraining orders or other court actions. Any change in laws and regulations, whether by the Department, the FDIC, the Federal Reserve Board or through legislation, could have a material adverse impact on the Bank and the Company and their operations and stockholders. Additional information on regulatory requirements is set forth in Note 12 to the Consolidated Financial Statements.
The Company files certain reports with the Securities and Exchange Commission (“SEC”) under the federal securities laws. The Company’s operations are also subject to extensive regulation by other federal, state and local governmental authorities and it is subject to various laws and judicial and administrative decisions imposing requirements and restrictions on part or all of its operations. Management believes that the Company is in substantial compliance, in all material respects, with applicable federal, state and local laws, rules and regulations. Because the Company’s business is highly regulated, the laws, rules and regulations applicable to it are subject to regular modification and change. There can be no assurance that these proposed laws, rules and regulations, or any other laws, rules or regulations, will not be adopted in the future, which could make compliance more difficult or expensive or otherwise adversely affect the Company’s business, financial condition or prospects.
Loans to One Borrower. >Applicable law and regulation limit the amount that the Bank may lend to any one borrower to 15% of the Bank’s capital and surplus plus an additional 10% of the Bank’s capital and surplus if such additional amount is fully secured by readily marketable collateral. At December 31, 2009, the Bank’s regulatory limit on loans to one borrower was $3.1 million. At that date, we were in compliance with our legal lending limit.
Regulatory Capital Requirements.> Federally insured banks are required to maintain minimum levels of regulatory capital. Capital adequacy is measured within the guidelines defined as either Tier 1 or Tier 2 capital. Tier 1 capital consists primarily of common stock and retained earnings. Tier 2 capital consists primarily of certain debt instruments and a portion of loan loss reserves. There are two measures of capital adequacy for banks, the Tier 1 leverage ratio and the risk-based requirements. A bank must maintain a minimum Tier 1 leverage ratio of 4 percent of total assets. In addition, Tier 1 capital must equal 4 percent of risk-weighted assets and total Tier 1 and Tier 2 capital must equal 8 percent of risk-weighted assets. A bank’s total “risk based assets” is determined by assigning our assets and off-balance sheet items to one of four risk categories based upon our relative credit risks. The greater the risk associated with an asset, the greater the amount of such asset that will be subject to capital requirements.
Federal banking agencies, under certain circumstances, are required to take prompt corrective action against banks that fail to meet their capital requirements. The FRB is generally required to take action to restrict the activities of an “undercapitalized institution” (generally defined to be one with less than either a 4 percent Tier 1 leverage ratio, a 4 percent Tier 1 risk-based capital ratio or an 8 percent total Tier 1 and Tier 2 risk-based capital ratio). Any such bank may not increase its assets, acquire another institution, establish a branch or engage in any new activities, and generally may not make capital distributions. The FRB is authorized to impose the additional restrictions that are applicable to significantly undercapitalized associations.
To be considered “adequately capitalized,” a bank must generally have a leverage ratio of at least 4 percent, a Tier 1 capital to risk-weighted assets ratio of a least 4 percent and total Tier 1 and Tier 2 capital to risk-weighted assets ratio of a least 8 percent. To be categorized as “well capitalized,” a bank must maintain a minimum total risk-based capital ratio of 10 percent, a Tier1 risk-based capital ratio of at least 6 percent and a Tier 1 leverage ratio of at least 5 percent. At December 31, 2009, we met the definition of “well capitalized” under the regulatory framework for prompt corrective action.
Community Reinvestment Act and Fair Lending.> Under the federal Community Reinvestment Act (“CRA”), we have a continuing and affirmative obligation consistent with safe and sound banking practices, to help meet the credit needs of our entire community, including low and moderate, income neighborhoods. The CRA does not establish specific lending requirements or programs for financial institutions nor does it limit an institution’s discretion to develop the types of products and services that it believes are best suited to our particular community, consistent with the CRA. The CRA requires the Department, in connection with the examination of the Bank to assess our record of meeting the credit needs of our community and to take such record into account in our evaluation of certain applications, such as a merger or the establishment of a branch. The Department may use an unsatisfactory rating as the basis for the denial of an application. We must also comply with the Federal Equal Credit Opportunity Act and the New York Executive Law, which prohibits creditors from discrimination in their lending practices on basis specified in these statutes.
Transactions with Affiliates and Insiders.> Federal regulations govern transactions between the Bank and its affiliates. In general, an affiliate is any company that controls, is controlled by, or under common control, with the Bank. Federal law limits the extent to which the Bank or its subsidiaries may engage in “covered transactions” with any one affiliate to 10% of our capital stock and surplus, and contains an aggregate limit of 20% of our capital stock and surplus. Covered transactions include loans, asset purchases, the issuance of guarantees and similar transactions. Our loans to insiders are required to be made on terms that are as favorable to us as transactions with non-insiders and approved in advance by a majority of our disinterested directors.
The Bank’s authority to extend credit to its directors, executive officers and 10% shareholders, as well as to entities controlled by such persons, is currently governed by the requirements of Sections 22(g) and 22(h) of the Federal Reserve Act and Regulation O of the Federal Reserve Board. Among other things, these provisions require that extensions of credit to insiders (i) be made on terms that are substantially the same as, and follow credit underwriting procedures that are not less stringent than, those prevailing for comparable transactions with unaffiliated persons and that do not involve more than the normal risk of repayment or present other unfavorable features, and (ii) not exceed certain limitations on the amount of credit extended to such persons, individually and in the aggregate, which limits are based, in part, on the amount of The Bank’s capital. In addition, extensions of credit in excess of certain limits must be approved by The Bank’s Board of Directors. The Bank is in compliance with Regulation O.
Payment of Dividends. >Regulations of the New York State Banking Department and the FRB restrict the amount of dividends that the Bank can pay the Company. All dividends must be paid out of undivided profits and cannot be paid out from capital. In general, if all such capital requirements are satisfied both before and after a dividend payment, a dividend may be paid, in any year, equal to the current year’s net income plus retained net income for the preceding two years that is still available for dividend. A dividend may not be declared if the Bank is considered “undercapitalized” under New York State Banking Department regulations.
Federal Securities Law.> The stock of the Company is registered with the SEC under the Exchange Act. The Company is subject to the information, reporting, proxy solicitation, insider trading restrictions and other requirements of the SEC under the Exchange Act.
Federal Reserve Bank
As a member of the Federal Reserve Board system, the Bank is required to maintain a minimum investment in stock of the Federal Reserve Bank of New York (the “FRB”). Any excess may be redeemed by the Bank or called by the FRB at par. At its discretion, the FRB may declare dividends on this stock. The Bank had $308 thousand and $299 thousand invested in FRB stock at December 31, 2009 and December 31, 2008, respectively, which is carried at cost due to the fact that it is a restricted security.
Federal Reserve System.> The Federal Reserve Board requires all depository institutions to maintain non-interest bearing reserves at specified levels against their transaction accounts (primarily checking, NOW and Super NOW checking accounts) and non-personal time accounts. Since these reserves are maintained as vault cash or other low-interest bearing accounts, they have the effect of reducing a bank’s earnings. At December 31, 2009, we were in compliance with these reserve requirements.
USA PATRIOT Act. >The USA PATRIOT Act, signed into law in 2001, gives the federal government new powers to address terrorist threats through enhanced domestic security measures, expanded surveillance powers, increased information sharing and broadened anti-money laundering requirements. The USA PATRIOT Act also requires the federal banking agencies to take into consideration the effectiveness of controls designed to combat money-laundering activities in whether to approve a merger or other acquisition application of a member institution. Accordingly, if we engage in a merger or other acquisition, our controls to combat money laundering would be considered as part of the application process. We have established policies, procedures and systems designed to comply with these regulations.
Sarbanes-Oxley Act of 2002.> The Sarbanes-Oxley Act of 2002 addresses, among other issues, corporate governance, auditing and accounting, executive compensation, and enhanced and timely disclosure of corporate information. As directed by the Sarbanes-Oxley Act of 2002, our Chief Executive Officer and Chief Financial Officer each are required to certify that our quarterly and annual reports do not contain any untrue statement of a material fact. The rules adopted by the Securities and Exchange Commission under the Sarbanes-Oxley Act of 2002 have several requirements, including having these officers certify that: they are responsible for establishing, maintaining and regularly evaluating the effectiveness of our internal controls; they have made certain disclosures to our auditors and the audit committee of the board of directors about our internal controls; and they have included information in our quarterly and annual reports about their evaluation and whether there have been significant changes in our internal controls or in other factors that could significantly affect internal controls.
We incurred additional expense in 2009 in order to comply with the provisions of the Act and the regulations that have been promulgated to implement the Act, particularly those regulations relating to the establishment of internal controls over financial reporting.
Item 1A. Risk Factors
The risks set forth below, in addition to the other risks described in this Annual Report on Form 10-K, may adversely affect our business, financial condition and operating results. In addition to the risks set forth below and the other risks described in this annual report, there may also be additional risks and uncertainties that are not currently known to us or that we currently deem to be immaterial that could materially and adversely affect our business, financial condition or operating results. As a result, past financial performance may not be a reliable indicator of future performance, and historical trends should not be used to anticipate results or trends in future periods. Further, to the extent that any of the information contained in this Annual Report on Form 10-K constitutes forward-looking statements, the risk factors set forth below also are cautionary statements identifying important factors that could cause our actual results to differ materially from those expressed in any forward-looking statements made by or on behalf of us.
Risks Related to Recent Economic Conditions and Governmental Response Efforts
Our business has been and may continue to be adversely affected by current conditions in the financial markets and economic conditions generally. The global, United States and New York economies are experiencing significantly reduced business activity and consumer spending as a result of, among other factors, disruptions in the capital and credit markets. Dramatic declines in the housing market, with falling home prices and increasing foreclosures and unemployment, have resulted in significant write-downs of asset values by financial institutions, including government-sponsored entities and major commercial and investment banks. A sustained weakness or weakening in business and economic conditions generally or specifically in the principal markets in which we do business could have one or more of the following adverse effects on our business:
• a decrease in the demand for loans or other products and services offered by us;
• a decrease in the value of our loans or other assets secured by residential or commercial real estate;
• a decrease to deposit balances due to overall reductions in the accounts of customers;
• an impairment of our investment securities;
• an increase in the number of borrowers who become delinquent, file for protection under bankruptcy laws or default on their loans or other obligations to us. An increase in the number of delinquencies, bankruptcies or defaults could result in a higher level of nonperforming assets, net charge-offs and provision for credit losses, which would reduce our earnings.
Any future Federal Deposit Insurance Corporation insurance premium increases will adversely affect our earnings.
On May 22, 2009, the Federal Deposit Insurance Corporation adopted a final rule levying a five basis point special assessment on each insured depository institution’s assets minus Tier 1 capital as of June 30, 2009. We recorded an expense of $68 thousand during the quarter ended June 30, 2009, to reflect the special assessment. Any further special assessments that the Federal Deposit Insurance Corporation levies will be recorded as an expense during the appropriate period. In addition, the Federal Deposit Insurance Corporation increased the general assessment rate and our prior credits for federal deposit insurance were fully utilized during the quarter ended June 30, 2009. Therefore, our Federal Deposit Insurance Corporation general insurance premium expense will increase compared to prior periods.
Changes in laws and regulations and the cost of regulatory compliance with new laws and regulations may adversely affect our operations and our income.
Congress has taken actions that are intended to strengthen confidence and encourage liquidity in financial institutions, and the Federal Deposit Insurance Corporation has taken actions to increase insurance coverage on deposit accounts. In addition, there have been proposals made by members of Congress and others that would reduce the amount distressed borrowers are otherwise contractually obligated to pay under their mortgage loans and limit an institution’s ability to foreclose on mortgage collateral.
The potential exists for additional federal or state laws and regulations, or changes in policy, regarding lending and funding practices and liquidity standards, and bank regulatory agencies have been active in responding to concerns and trends identified in examinations, and have issued many formal enforcement orders. The New York Banking Department and the Federal Deposit Insurance Corporation govern the activities in which we may engage, primarily for the protection of depositors, and not for the protection or benefit of potential investors. In addition, new laws, regulations, and other regulatory changes may increase our costs of regulatory compliance and of doing business, and otherwise affect our operations. New laws, regulations, and other regulatory changes may significantly affect the markets in which we do business, the markets for and value of our loans and investments, and our ongoing operations, costs and profitability. Proposals limiting our rights as a creditor could result in credit losses or increased expense in pursuing our remedies as a creditor.
Future legislative or regulatory actions responding to perceived financial and market problems could impair our ability to foreclose on collateral.
There have been proposals made by members of Congress and others that would reduce the amount distressed borrowers are otherwise contractually obligated to pay under their mortgage loans and limit an institution’s ability to foreclose on mortgage collateral. Were proposals such as these, or other proposals limiting our rights as a creditor, to be implemented, we could experience increased credit losses or increased expense in pursuing our remedies as a creditor. In addition, there have been legislative proposals to create a federal consumer protection agency that may, among other powers, have the ability to limit our rights as a creditor.
Lack of Consumer Confidence in Financial Institutions May Decrease Our Level of Deposits.
Our level of deposits may be affected by lack of consumer confidence in financial institutions, which have caused fewer depositors to be willing to maintain deposits that are not FDIC-insured accounts. That may cause depositors to withdraw deposits and place them in other institutions or to invest uninsured funds in investments perceived as being more secure, such as securities issued by the U.S. Treasury. These consumer preferences may force us to pay higher interest rates to retain deposits and may constrain liquidity as we seek to meet funding needs caused by reduced deposit levels.
Our Emphasis on Commercial Real Estate Loans and Commercial Business Loans May Expose Us to Increased Lending Risks.
At December 31, 2009, $51.5 million, or 48.2% of our loan portfolio, consisted of commercial real estate loans, including construction and development loans. Commercial real estate loans constitute a greater percentage of our loan portfolio than any other loan category, including one-to four-family real estate loans, which totaled $26.8 million, or 25.1% of our total loan portfolio, at December 31, 2009. In addition, at December 31, 2009, $20.1 million, or 18.8% of our loan portfolio, consisted of commercial business loans.
Commercial real estate loans and commercial business loans generally expose a lender to a greater risk of loss than one- to four-family residential loans. Repayment of commercial real estate and commercial business loans generally depends, in large part, on sufficient income from the property or the borrower’s business, respectively, to cover operating expenses and debt service. Commercial real estate loans typically involve larger loan balances to single borrowers or groups of related borrowers compared to one- to four-family residential mortgage loans. Changes in economic conditions that are beyond the control of the borrower and lender (including today’s economic crisis) could affect the value of the security for the loan, the future cash flow of the affected property, or the marketability of a construction project with respect to loans originated for the acquisition and development of property. See “Business—Lending Activities.”
An Inadequate Allowance for Loan Losses Would Negatively Affect Our Results of Operations.
We are exposed to the risk that our customers will be unable to repay their loans according to their terms and that any collateral securing the payment of their loans will not be sufficient to avoid losses. Credit losses are inherent in the lending business and could have a material adverse effect on our operating results. Volatility and deterioration in the broader economy may also increase our risk of credit losses. The determination of an appropriate level of allowance for loan losses is an inherently uncertain process and is based on numerous assumptions. The amount of future losses is susceptible to changes in economic, operating and other conditions, including changes in interest rates, that may be beyond our control, and charge-offs may exceed current estimates. We evaluate the collectability of our loan portfolio and provide an allowance for loan losses that we believe is adequate based upon such factors as, including, but not limited to: the risk characteristics of various classifications of loans; previous loan loss experience; specific loans that have loss potential; delinquency trends; the estimated fair market value of the collateral; current economic conditions; the views of our regulators; and geographic and industry loan concentrations. If any of our evaluations are incorrect and borrower defaults result in losses exceeding our allowance for loan losses, our results of operations could be significantly and adversely affected. We cannot assure you that our allowance will be adequate to cover probable loan losses inherent in our portfolio.
The Need to Account for Assets at Market Prices May Adversely Affect Our Results of Operations.
We report certain assets, including investments and securities, at fair value. Generally, for assets that are reported at fair value we use quoted market prices or valuation models that utilize market data inputs to estimate fair value. Because we carry these assets on our books at their fair value, we may incur losses even if the asset in question presents minimal credit risk. Given the continued disruption in the capital markets, we may be required to recognize other-than-temporary impairments in future periods with respect to securities in our portfolio. The amount and timing of any impairment recognized will depend on the severity and duration of the decline in fair value of the securities and our estimation of the anticipated recovery period.
Other-Than-Temporary Impairment (OTTI) Could Reduce Our Earnings.
We evaluate our investment securities for other-than-temporary impairment (OTTI) as required by FASB Accounting Standards Codification and the hierarchy of Generally Accepted Accounting Principles. When a decline in fair value below cost is deemed to be other-than-temporary, the related loss must be recognized as a charge to earnings and the investment is recorded at fair value. In determining whether or not OTTI exists management considers several factors, including but not limited to, the length of time and extent that fair value has been less than cost, the financial condition and near term prospects of the issuer, And management does not intend to sell and it is not more likely than not that management would be required to sell the securities prior to their anticipated recovery.
Our Continuing Concentration of Loans in Our Primary Market Areas May Increase Our Risk.
Our success depends primarily on the general economic conditions in the counties in which we conduct business. Unlike large banks that are more geographically diversified, we provide banking and financial services to customers primarily in our market area. The local economic conditions in our market areas have a significant impact on our loans. A significant decline in general economic conditions caused by inflation, recession, unemployment or other factors beyond our control, would affect the local economic conditions and could adversely affect our financial condition and results of operations. Additionally, because we have a significant amount of commercial real estate loans, decreases in tenant occupancy also may have a negative effect on the ability of many of our borrowers to make timely repayments of their loans, which would have an adverse impact on our earnings.
Future Changes in Interest Rates Could Reduce Our Profits
Our ability to make a profit largely depends on our net interest income, which could be negatively affected by changes in interest rates. Net interest income is the difference between: