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| SNBC > SEC Filings for SNBC > Form 10-Q on 9-Nov-2009 | All Recent SEC Filings |
9-Nov-2009
Quarterly Report
Critical Accounting Policies, Judgments and Estimates
The discussion and analysis of the financial condition and results of operations are based on the Unaudited Condensed Consolidated Financial Statements, which are prepared in conformity with Generally Accepted Accounting Principles in the United States of America ("GAAP"). The preparation of these financial statements requires management to make estimates and assumptions affecting the reported amounts of assets and liabilities, disclosure of contingent assets and liabilities, and the reported amounts of income and expense. Management evaluates these estimates and assumptions on an ongoing basis, including those related to allowance for loan losses, goodwill, intangible assets, income taxes, stock-based compensation and the fair value of financial instruments. Management bases its estimates on historical experience and various other factors and assumptions that are believed to be reasonable under the circumstances. These form the basis for making judgments on the carrying value of assets and liabilities that are not readily apparent from other sources. Actual results may differ from these estimates under different assumptions or conditions.
Allowance for Loan Losses. Through Sun National Bank (the "Bank"), Sun Bancorp, Inc. (the "Company") originates loans that it intends to hold for the foreseeable future or until maturity or repayment. The Company may not be able to collect all principal and interest due on these loans. The allowance for loan losses represents management's estimate of probable credit losses inherent in the loan portfolio as of the balance sheet date. The determination of the allowance for loan losses requires management to make significant estimates with respect to the amounts and timing of losses and market and economic conditions. The allowance for loan losses is maintained at a level that management considers adequate to provide for estimated losses and impairment based upon an evaluation of known and inherent risk in the loan portfolio. Loan impairment is evaluated based on the fair value of collateral or estimated net realizable value. A provision for loan losses is charged to operations based on management's evaluation of the estimated losses that have been incurred in the Company's loan portfolio. It is the policy of management to provide for losses on unidentified loans in its portfolio in addition to classified loans.
Management monitors its allowance for loan losses at least quarterly and makes adjustments to the allowance through the provision for loan losses as economic conditions and other pertinent factors indicate. The quarterly review and adjustment of the qualitative factors employed in the allowance methodology and the updating of historic loss experience allow for timely reaction to emerging conditions and trends. In this context, a series of qualitative factors are used in a methodology as a measurement of how current circumstances are affecting the loan portfolio. Included in these qualitative factors are:
? Levels of past due, classified and non-accrual loans, troubled debt restructurings and modifications
? Nature and volume of loans
? Changes in lending policies and procedures, underwriting standards, collections, charge-offs and recoveries, and for commercial loans, the level of loans being approved with exceptions to policy
? Experience, ability and depth of management and staff
? National and local economic and business conditions, including various market segments
? Quality of the Company's loan review system and degree of Board oversight
? Concentrations of credit by industry, geography and collateral type, with a specific emphasis on real estate, and changes in levels of such concentrations
? Effect of external factors, including the deterioration of collateral values, on the level of estimated credit losses in the current portfolio
As changes in the Company's operating environment occur and as recent loss experience fluctuates, the factors for each category of loan based on type and risk rating will change to reflect current circumstances and the quality of the loan portfolio. Given that the components of the allowance are based partially on historical losses and on risk rating changes in response to recent events, required reserves may trail the emergence of any unforeseen deterioration in credit quality.
Although the Company maintains its allowance for loan losses at levels considered adequate to provide for the inherent risk of loss in its loan portfolio, if economic conditions differ substantially from the assumptions used in making the evaluations there can be no assurance that future losses will not exceed estimated amounts or that additional provisions for loan losses will not be required in future periods. Accordingly, the current decline in the national economy and the local economies of the areas in which the loans are concentrated could result in an increase in loan delinquencies, foreclosures or repossessions resulting in increased charge-off amounts and the need for additional loan loss allowances in future periods. In addition, the Company's determination as to the amount of its allowance for loan losses is subject to review by the Bank's primary regulator, the Office of the Comptroller of the Currency (the "OCC"), as part of its examination process, which may result in the establishment of an additional allowance based upon the judgment of the OCC after a review of the information available at the time of the OCC examination.
Accounting for Income Taxes. The Company accounts for income taxes in accordance with FASB ASC 740, Income Taxes. FASB ASC 740 requires the recording of deferred income taxes that reflect the net tax effects of temporary differences between the carrying amounts of assets and liabilities for financial reporting purposes and the amounts used for income tax purposes. Management exercises significant judgment in the evaluation of the amount and timing of the recognition of the resulting tax assets and liabilities. The judgments and estimates required for the evaluation are updated based upon changes in business factors and the tax laws. If actual results differ from the assumptions and other considerations used in estimating the amount and timing of tax recognized, there can be no assurance that additional expenses will not be required in future periods. The Company recognizes, when applicable, interest and penalties related to unrecognized tax benefits in the provision for income taxes in the Unaudited Condensed Consolidated Statement of Income. Assessment of uncertain tax positions under FASB ASC 740 requires careful consideration of the technical merits of a position based on management's analysis of tax regulations and interpretations. Significant judgment may be involved in applying the requirements of FASB ASC 740.
Management expects that the Company's adherence to FASB ASC 740 may result in increased volatility in quarterly and annual effective income tax rates as FASB ASC 740 requires that any change in judgment or change in measurement of a tax position taken in a prior period be recognized as a discrete event in the period in which it occurs. Factors that could impact management's judgment include changes in income, tax laws and regulations, and tax planning strategies.
FSP FASB ASC 820 establishes a fair value hierarchy, which prioritizes the inputs to valuation techniques used to measure fair value into three broad levels. The fair value hierarchy gives the highest priority to quoted prices in active markets for identical assets or liabilities (Level 1) and the lowest priority to unobservable inputs (Level 3). A financial instrument's categorization within the fair value hierarchy is based upon the lowest level of input that is significant to the instrument's fair value measurement. The three levels within the fair value hierarchy are described as follows:
? Level 1 - Quoted prices (unadjusted) in active markets for identical assets or liabilities.
? Level 2 - Inputs other than quoted prices included within Level 1 that are observable for the asset or liability, either directly or indirectly. Level 2 inputs include: quoted prices for similar assets or liabilities in active markets; quoted prices for identical or similar assets or liabilities in markets that are not active; inputs other than quoted prices that are observable for the asset or liability; and inputs that are derived principally from or corroborated by observable market data by correlation or other means.
? Level 3 - Unobservable inputs that are supported by little or no market activity and that are significant to the fair value of the assets or liabilities. Level 3 assets and liabilities include financial instruments whose value is determined using pricing models, discounted cash flow methodologies, or similar techniques, as well as instruments for which the determination of fair value requires significant management judgment or estimation.
The Company measures financial assets and liabilities at fair value in accordance with FASB ASC 820. These measurements involve various valuation techniques and models, which involve inputs that are observable, when available, and include the following significant financial instruments: investment securities available for sale and derivative financial instruments. The following is a summary of valuation techniques utilized by the Company for its significant financial assets and liabilities which are valued on a recurring basis.
Investment securities available for sale. Where quoted prices are available in an active market, securities are classified within Level 1 of the valuation hierarchy. If quoted market prices are not available, then fair values are estimated using quoted prices of securities with similar characteristics or discounted cash flows based on observable market inputs and are classified within Level 2 of the fair value hierarchy. In certain cases where there is limited activity or less transparency around inputs to the valuation, securities are classified within Level 3 of the valuation hierarchy. Level 3 market value measurements include an internally developed discounted cash flow model combined with using market data points of similar securities with comparable credit ratings in addition to market yield curves with similar maturities in determining the discount rate. In addition, significant estimates and unobservable inputs are required in the determination of Level 3 market value measurements. If actual results differ significantly from the estimates and inputs applied, it could have a material effect on the Company's Unaudited Condensed Consolidated Financial Statements.
In addition, certain assets are measured at fair value on a nonrecurring basis; that is, the instruments are not measured at fair value on an ongoing basis but are subject to fair value adjustments in certain circumstances (for example, when there is evidence of impairment). The Company measures loans held for sale, impaired loans, Small Business Administration ("SBA") servicing assets, restricted equity investments and loans or bank properties transferred into other real estate owned at fair value on a non-recurring basis.
Valuation techniques and models utilized for measuring financial assets and liabilities are reviewed and validated by the Company at least quarterly.
Goodwill. Goodwill is the excess of the fair value of liabilities assumed over the fair value of tangible and identifiable intangible assets acquired in a business combination. Goodwill is not amortized but is tested for impairment annually or more frequently if events or changes in circumstances indicate that the asset might be impaired. Generally, the Company tests goodwill for impairment annually. However, due to capital market turmoil, especially regarding bank stocks and the Company's stock, as well as declines in credit quality, the Company deemed it appropriate to perform a goodwill analysis at September 30, 2009. FASB ASC 350-20-35-12 outlines a two-step goodwill impairment test. Significant judgment is applied when goodwill is assessed for impairment. Step one, which is used to identify potential impairment, compares the fair value of the reporting unit with its carrying amount, including goodwill. As defined in FASB ASC 280, a reporting unit is an operating segment, which the Company has one reportable operating segment, "Community Banking" defined in Note 1 of the Notes to Unaudited Condensed Consolidated Financial Statements. If the fair value of a reporting unit exceeds its carrying value, goodwill of the reporting unit is considered not impaired and step two is therefore unnecessary. If the carrying amount of the reporting unit exceeds its implied fair value, the second step is performed to measure the amount of the impairment loss, if any. An implied loss is recorded to the extent that the carrying amount of goodwill exceeds its implied fair value.
In performing step one and step two of the impairment analysis, the Company estimated the fair value of the Company through the consideration of its quoted market valuation, market earnings multiples of peer companies, market earnings multiples of peer companies adjusted to include a control premium (i.e., its acquisition value relative to its peers) and a discounted economic value which is based on internal forecasts, recent financials and the projected outlook for the industry. The considerations above are sensitive to both the fluctuation of the Company's stock price and the stock price of peer companies. The step one impairment test indicated that the Company's fair value was less than its carrying value, and therefore the Company performed a step two analysis. In performing the second step of the analysis to determine the implied fair value of goodwill, the estimated fair value of the Company was allocated to all assets and liabilities including any recognized or unrecognized intangible assets. The allocation is done as if the Company had been acquired in a business combination, and the fair value was the price paid to acquire the Company. A hypothetical purchase price allocation involves the assessment of core deposit intangibles, the fair value of outstanding advances and other borrowings, and assessing the fair value of our loan portfolio. These assessments involve valuation techniques that require the use of, among other things, Level 2 and Level 3 market inputs. For example, the fair value adjustment on our outstanding advances and borrowings is based upon observable trades or modeled prices using current yield curves and market spreads. The valuation of our loan portfolio included consideration of discounts that we believe were consistent with transactions occurring in the marketplace.
The results of this analysis at September 30, 2009 indicated the implied fair value of the Company's goodwill exceeded the carrying amount of goodwill, and therefore, goodwill was not impaired. However, given the continued turmoil in the capital markets and with bank stocks in general, it is possible that our assumptions and conclusions regarding the valuation of our Company could change adversely and could result in impairment of our goodwill. While any charge resulting from a partial or full write down of goodwill would be a non-cash charge and have no impact on the Company's regulatory capital, the charge could have a material adverse impact on our financial position and results of operations. For more information on goodwill, see Note 1 of the Notes to Unaudited Condensed Consolidated Financial Statements.
Determining the fair value of stock-based awards at the date of grant requires judgment, including estimating the expected term of the stock options and the expected volatility of the Company's stock. In addition, judgment is required in estimating the amount of stock-based awards that are expected to be forfeited. If actual results differ significantly from these estimates or different key assumptions were used, it could have a material effect on the Company's Unaudited Condensed Consolidated Financial Statements. See Note 2 of the Notes to Unaudited Condensed Consolidated Financial Statements for additional information regarding stock-based compensation.
Market Overview
During 2008, the U.S. and global economy declined more than many economists had originally expected. Economists predicted in the early part of 2009 that the recession, which started in December 2007, would be the longest recession since World War II. While this recession is often compared to the Great Depression, the aggressiveness of policy measures by the government is thought to have significantly reduced the probability of a near-depression. In addition to the actions taken during 2008 to stabilize the housing market and the banking system, the U.S. Treasury implemented a series of initiatives in 2009 as part of its Financial Stability Plan that along with the American Recovery and Reinvestment Act of 2009 ("ARRA") would lay the foundations for economic recovery. The components of the Financial Stability Plan include investments made by the Treasury under the Public-Private Investment Program ("PPIP"), the Financial Stability Trust, and the Homeowner Affordability and Stability Plan ("HASP").
The ARRA is intended to provide a stimulus to the U.S. economy in the wake of the economic downturn brought about by the sub-prime mortgage crisis and the resulting credit crunch. The bill includes federal tax cuts, expansion of unemployment benefits and other social welfare provisions, and domestic spending in education, healthcare, and infrastructure, including the energy structure. The new law also includes numerous non-economic recovery related items, including a limitation on executive compensation in federally aided banks.
Troubled real estate-related assets, comprised of legacy loans and securities, are at the forefront of the issues currently impacting the U.S. financial system. The PPIP is a program by which the Treasury will make targeted investment in multiple PPIP's that will purchase legacy real estate-related assets which should help improve the health of the financial institutions where they are held, leading to increased flow of credit throughout the economy and helping improve market functioning in the near-term.
The Financial Stability Trust includes a comprehensive stress test for major banks, increased balance sheet transparency and disclosure and the Capital Assistance Program ("CAP"). It is intended to restore confidence throughout the financial system that the nation's largest banking institutions have a sufficient capital cushion against larger than expected future losses, should they occur due to a more severe economic environment and, and to support lending to creditworthy borrowers. The federal banking regulators will conduct forward-looking assessments to evaluate the capital needs of major U.S. banking institutions under a more challenging economic environment. While banks will be encouraged to access private markets to raise any additional capital needed to establish this buffer, a financial institution that has undergone a comprehensive "stress test" will have access to a Treasury provided "capital buffer."
The HASP is intended to stem home foreclosures and to provide low cost mortgage refinancing opportunities for certain homeowners suffering from declining home prices, including but not limited to the creation of financial incentives for homeowners, investors, and servicers, to refinance or modify certain existing mortgages which are delinquent or at risk of becoming delinquent.
While analysts say there are several challenges ahead, including decreased consumption and a reduction of wealth as a result of declines in the stock and housing markets, the general consensus of analysts is that the recession will end sometime in the second half of 2009, with growth expected to reenter positive territory, while still sluggish, sometime in 2010. After four straight quarterly declines, the gross domestic product ("GDP") rose at a 3.5% annual rate in the third quarter of 2009, the strongest signal yet that the recession has ended. While the national unemployment rate at September 30, 2009 is the highest it has ever been since 1983, at 9.8% (9.8% in New Jersey), the pace of job loss continued to trend lower during the third quarter. Furthermore, labor productivity increased at a 9.5% annual rate during the third quarter 2009, the largest gain in productivity since the third quarter of 2003, and unit labor costs decreased at a 5.2% annual rate, as companies produced more with fewer workers.
The above actions, together with the overall economy, will continue to affect the markets in which the Company and its customers do business and may adversely impact the Company's results in the future, depending upon the duration and severity of such conditions. The following discussion provides further detail on the financial condition and results of operations of the Company at and for the three and nine months ended September 30, 2009.
Financial Condition
Total assets decreased $76.5 million, or 2.1%, to $3.55 billion at September 30, 2009 as compared to $3.62 billion at December 31, 2008. Total loans before allowance for loan losses decreased $30.1 million, or 1.1%, investment securities decreased $24.1 million, or 5.5%, and other assets decreased $20.5 million, or 19.4%. Total liabilities decreased $80.4 million, or 2.5%, to $3.18 billion at September 30, 2009 compared to $3.26 billion at December 31, 2008. Federal funds purchased decreased $65.5 million, or 91.6%, combined with a decrease in advances from the Federal Home Loan Bank of New York ("FHLBNY") of $26.6 million, or 63.1%, and a decrease in other liabilities of $28.7 million, or 23.9%. These decreases were offset by an increase in deposits of $36.5 million, or 1.3%.
Total loans receivable before allowance for loan losses decreased $30.1 million, or 1.1%, to $2.71 billion at September 30, 2009. Organic loan growth for the first nine months of 2009, adjusted for approximately $59.6 million in prepayments, was approximately 1.1%. Despite various economic challenges and an overall softened loan demand, the Company continues to maintain a healthy lending channel.
Total non-performing loans were $84.4 million at September 30, 2009, or 3.1% of total loans, compared to $46.8 million, or 1.7%, at December 31, 2008. Non-performing loans primarily increased as a result of an increase in non-accrual loans of $38.1 million, or 90.2%. Non-accrual loans increased $65.5 million, offset by reductions of $27.4 million, resulting in a net increase of $38.1 million. The increase in non-accrual loans during the nine months ended September 30, 2009 was primarily due to the addition of 21 separate commercial relationships spread among several different industries whose loans totaled $35.4 million, the addition of 9 separate construction and land development relationships with an aggregate loan balance of $5.8 million and $1.6 million in home equity lines of credit. One of the commercial relationships added to . . .
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