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SNBC > SEC Filings for SNBC > Form 10-Q on 8-Nov-2012All Recent SEC Filings

Show all filings for SUN BANCORP INC /NJ/ | Request a Trial to NEW EDGAR Online Pro

Form 10-Q for SUN BANCORP INC /NJ/


8-Nov-2012

Quarterly Report


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

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

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 expenses. Management evaluates these estimates and assumptions on an ongoing basis, including those related to the allowance for loan losses, goodwill, intangible assets, income taxes, 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 on a monthly basis 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

Additionally, historic loss experience over a three-year horizon, based on a rolling 12-quarter migration analysis, is taken into account for commercial loans and historic loss experience over the more conservative of either the trailing four or eight quarters is calculated for non-commercial loans. In determining the allowance for loan losses, management has established both specific and general pooled allowances. Values assigned to the qualitative factors and those developed from historic loss experience provide a dynamic basis for the calculation of reserve factors for both pass-rated loans (general pooled allowance) and those criticized and classified loans without reserves (specific allowance). A specific allowance is calculated on individually identified impaired loans. Loans not individually reviewed are evaluated as a group using reserve factor percentages based on historic loss experience and the qualitative factors described above. In determining the appropriate level of the general pooled allowance, management makes estimates based on internal risk ratings, which take into account such factors as debt service coverage, loan-to-value ratios and external factors. Estimates are periodically measured against actual loss experience.

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.


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Although the Company maintains its allowance for loan losses at levels considered adequate to provide for the inherent risk of loss in its loan portfolio, if economic conditions differ substantially from the assumptions used in making the evaluations, there can be no assurance that future losses will not exceed estimated amounts or that additional provisions for loan losses will not be required in future periods. Accordingly, the current state of the national economy and local economies of the areas in which the loans are concentrated and their slow recovery from a severe recession could result in an increase in loan delinquencies, foreclosures or repossessions resulting in increased charge-off amounts and the need for additional loan loss allowances in future periods. In addition, the Company's determination as to the amount of its allowance for loan losses is subject to review by the Bank's primary regulator, the 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 Financial Accounting Standards Board, ("FASB") Accounting Standards CodificationTM (the "Codification" or "ASC") 740, Income Taxes. ("FASB ASC 740"). FASB ASC 740 requires the recording of deferred income taxes that reflect the net tax effects of temporary differences between the carrying amounts of assets and liabilities for financial reporting purposes and the amounts used for income tax purposes. Management exercises significant judgment in the evaluation of the amount and timing of the recognition of the resulting tax assets and liabilities. The judgments and estimates required for the evaluation are updated based upon changes in business factors and the tax laws. If actual results differ from the assumptions and other considerations used in estimating the amount and timing of tax recognized, there can be no assurance that additional expenses will not be required in future periods. The Company recognizes, when applicable, interest and penalties related to unrecognized tax benefits in the provision for income taxes in the unaudited condensed consolidated statements of operations. Assessment of uncertain tax positions under FASB ASC 740 requires careful consideration of the technical merits of a position based on management's analysis of tax regulations and interpretations. Significant judgment 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.

Fair Value Measurement. The Company accounts for fair value measurement in accordance with FASB ASC 820, Fair Value Measurements and Disclosures, ("FASB ASC 820"). FASB ASC 820 establishes a framework for measuring fair value. FASB ASC 820 defines fair value as the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date, emphasizing that fair value is a market-based measurement and not an entity-specific measurement. FASB ASC 820 clarifies the application of fair value measurement in a market that is not active. FASB ASC 820 also includes additional factors for determining whether there has been a significant decrease in market activity, affirms the objective of fair value when a market is not active, eliminates the presumption that all transactions are not orderly unless proven otherwise, and requires an entity to disclose inputs and valuation techniques, and changes therein, used to measure fair value. FASB ASC 820 addresses the valuation techniques used to measure fair value. These valuation techniques include the market approach, income approach and cost approach. The market approach uses price or relevant information generated by market transactions involving identical or comparable assets or liabilities. The income approach involves converting future amounts to a single present value. The measurement is valued based on current market expectations about those future amounts. The cost approach is based on the amount that currently would be required to replace the service capacity of the asset.

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 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 the value of which are 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.


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The Company's policy is to recognize transfers that occur between the fair value hierarchy, Levels 1, 2 and 3, at the beginning of the quarter of when the transfer occurred.

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.

Derivative financial instruments. The Company's derivative financial instruments are not exchange-traded and therefore are valued utilizing models that use as their basis readily observable market parameters, specifically the London Interbank Offered Rate ("LIBOR") swap curve, and are classified within Level 2 of the valuation hierarchy.

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 impaired loans, SBA servicing assets, restricted equity investments and loans or bank properties transferred in 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. FASB ASC 350-20-35, Intangibles - Goodwill and Other - Goodwill, 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, Segment Reporting, a reporting unit is an operating segment or one level below an operating segment. The Company has one reportable operating segment, "Community Banking", as defined in Note 1 of the notes to the unaudited condensed consolidated financial statements. If the fair value of a reporting unit exceeds it carrying value, goodwill of the reporting unit is considered not impaired and step two is therefore unnecessary. If the carrying amount of the reporting unite exceeds it 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. The Company does not intend to perform the step zero impairment assessment option as described in FASB ASU 2011-08, but will continue to use the two-step goodwill impairment test annually at December 31, unless circumstances indicate that a test is required at an earlier date.

Recent Accounting Principles.

In September 2011, the FASB issued ASU 2011-08, Intangibles - Goodwill and Other (Topic 350): Testing Goodwill for Impairment. This guidance allows an entity to make a qualitative evaluation about the likelihood of goodwill impairment to determine whether it should calculate the fair value of a reporting unit. If, after assessing the totality of events or circumstances, an entity determines it is not more likely that not that the fair value of a reporting unit is less than its carrying amount, then performing the two-step goodwill impairment test is unnecessary. This guidance is effective for public entities for annual and interim goodwill impairment tests performed for fiscal years beginning after December 15, 2011; retroactive application of this guidance is permitted. The Company does not intend to apply this guidance allowing the Company to make a qualitative evaluation about the likelihood of goodwill impairment, but will continue to apply the two-step goodwill impairment test annually.

In December 2011, the FASB issued Accounting Standards Update ("ASU") 2011-11, Balance Sheet (Topic 210): Disclosures about Offsetting Assets and Liabilities. This amendment results in common offsetting requirements and disclosure requirements in GAAP and IFRS. This guidance is not intended to change, but enhance, the application requirements in Topic 210. This guidance is effective for public entities during interim and annual periods beginning after January 1, 2013. This guidance amends only the disclosure requirements and not the application of the accounting standard. The Company is currently evaluating the impact of the adoption of this accounting standards update on its financial condition.


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In July 2012, the FASB issued Accounting Standards Update ("ASU") 2012-02, Intangibles - Goodwill and Other (Topic 350): Testing Indefinite-Lived Intangible Assets for Impairment. This amendment provides an entity with the option first to assess qualitative factors to determine whether the existence of events and circumstances indicates that it is more likely than not that the indefinite-lived intangible asset is impaired. If, after assessing the totality of events and circumstances, an entity concludes that it is not more likely than not that the indefinite-lived intangible asset is impaired, then the entity is not required to take further action. However, if an entity concludes otherwise, then it is required to determine the fair value of the indefinite-lived intangible asset and perform the quantitative impairment test by comparing the fair value with the carrying amount in accordance with Subtopic 350-30. This amendment is effective for public entities for annual and interim impairment tests performed for fiscal years beginning after September 15, 2012. The Company is currently evaluating the impact of the adoption of this accounting standards update on its financial condition.

Market Overview

The economic recovery continued at a moderate pace into the third quarter of 2012. Interest rates remain near historical lows. While employment growth has been slow, the unemployment rate in the U.S. decreased to 7.9% in October 2012 from 8.5% in December 2011. According to recently released estimates, the U.S. gross domestic product for the third quarter of 2012 increased at an annual rate of 2.0% as compared to 1.5% growth in the second quarter of 2012. This growth was the result of increased consumer and government spending as well as improved spending on homebuilding and renovations. The housing sector has displayed some signs of improvement and inflation is expected to remain at or below 2%. Despite the recent signs of improvement, several downside risk factors exist for the economic environment, such as the debt crisis in Europe and the slowing growth in China as well as possible tax increases and government spending cuts coincident with the looming U.S. federal budget deadline.

At the state level, according to the latest South Jersey Business Survey produced by the Federal Reserve Bank of Philadelphia, steady business activity was reported, while little growth exists. Some pickup is anticipated in employment and companies are optimistic about growth opportunities over the next six months, but significant uncertainty still remains. In Northern New Jersey, business activity Is expected to continue to increase at a slow pace. Overall, New Jersey's unemployment rate remains one of the highest in the U.S at 9.8% as of September 2012.

In September, the Federal Reserve announced its next round of quantitative easing (QE3) through which they would purchase $40 billion per month of additional agency mortgage-backed securities. There was no specified end date for this action. The Fed will also continue to extend the average maturity of its holdings of treasuries through the end of 2012. These actions should ensure that interest rates remain at record lows for the near future. At its latest meeting in October 2012, the Federal Reserve decided to keep the Federal Funds target rate unchanged in a continued effort to help stimulate economic growth. Since December 2008, the Federal Reserve has kept the Federal Funds rate, a key indicator of short-term rates such as credit card rates and HELOC rates, at a range of 0.00%-0.25% with the intent of encouraging consumers and businesses to borrow and spend to help jump start the economy. Based upon low rates of resource utilization and a subdued outlook for inflation, the Open Market Committee expects to maintain the exceptionally low levels of its current target range through at least mid-2015.

The continued uncertainty with the economy, together with the challenging regulatory environment, will continue to affect the Company and the markets in which it does business, and may adversely impact the Company's results in the future. The following discussion provides further detail on the financial condition and results of operations of the Company at and for the three and six months ended September 30, 2012.

Impact of Hurricane Sandy

In late October 2012, many parts of New Jersey were devastated by the impact of Hurricane Sandy. The Company is currently evaluating the impact on its own customers and its business operations. Due to the recent occurrence of this event, the Company is unable to establish reasonably accurate estimates of damages and/or uninsured losses associated with the hurricane and it may take significant time to establish these estimates.

Financial Condition

Total assets were $3.18 billion at September 30, 2012 as and December 31, 2011. Loans receivable, net of allowance for loan losses, increased $12.5 million to $2.26 billion at September 30, 2012 as compared to $2.25 billion at December 31, 2011. Loans held-for-sale increased $37.5 million, or 161.6%. Total investments decreased $5.7 million, or 1.1%. Cash and cash equivalents decreased by $36.0 million, or 30.0% as excess cash balances were utilized to fund loan originations.

Total liabilities increased $18.2 million, or 0.6%, to $2.89 billion at September 30, 2012 compared to $2.87 billion at December 31, 2011. Stockholders' equity was $287.5 million at September 30, 2012 as compared to $309.1 million at December 31, 2011, with the decrease primarily as a result of the net loss of $25.5 million for the nine months ended September 30, 2012.


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Loans receivable, net of allowance for loan losses, increased $12.5 million to $2.26 billion at September 30, 2012 as compared to $2.25 billion at December 31, 2011. This increase was primarily the result of growth in the residential mortgage portfolio as of September 30, 2012.

Total non-performing loans increased $13.6 million to $120.8 million at September 30, 2012 from December 31, 2011, This increase was primarily due to the transfer of two credit relationships in the aggregate amount of $24 million into non-performing status at September 30, 2012; partially offset by $6.9 million in net paydowns out of the category. Total non-accruing troubled debt restructurings ("TDRs") at September 30, 2012 were $25.5 million.

As of September 30, 2012, the Company had $18.3 million outstanding on 14 residential construction, commercial construction and land development relationships which agreements included interest reserves. As of December 31, 2011, the Company had $31.4 million outstanding on 18 residential construction, commercial construction and land development relationships which agreements included interest reserves. The total amount available in those reserves to fund interest payments was $1.3 million and $956 thousand at September 30, 2012 and December 31, 2011, respectively. As of September 30, 2012, the Company had four residential construction relationships with aggregate interest reserves of $2.3 million on non-accrual status and two commercial construction relationships with interest reserves of $446 thousand on non-accrual status. As of December 31, 2011, the Company had six residential construction relationships with interest reserves of $2.4 million on non-accrual status. As these relationships are in technical default, no additional fundings of interest will be made. Construction projects are monitored throughout their lives by professional inspectors engaged by the Company. The budgets for loan advances and borrower equity injections are developed at the time the loan is underwritten in conjunction with the review of the plans and specifications for the project being financed. Advances of the Company's funds are based on the prepared budgets and will not be made unless the project has been inspected by the Company's professional inspector who must certify that the work related to the advance is in place and properly completed. As it relates to construction project financing, the Company does not extend, renew or restructure terms unless its borrower posts cash collateral in an interest reserve.

Table 1 provides detail regarding the Company's non-performing assets and TDRs at September 30, 2012 and December 31, 2011.

Table 1: Summary of Non-performing Assets and TDRs

                                                   September 30, 2012             December 31, 2011
Non-performing assets:
Non-accrual loans                                 $             95,383           $            89,656
Troubled debt restructuring, non-accruing                       25,463                        17,875
Loans past due 90 days and accruing                                 21                           154
Real estate owned                                                5,513                         5,020

Total non-performing assets                                    126,371                       112,705

The Company's allowance for losses on loans increased to $49.0 million, or 2.12% of gross loans receivable, at September 30, 2012 from $41.7 million, or 1.82% of gross loans receivable, at December 31, 2011. The provision for loan losses was $33.1 million for the nine months ended September 30, 2012 compared to $67.4 million for the same period in 2011. The increase in reserve balances is due primarily to deterioration in appraisal values of certain commercial land loans in the first quarter as well as the extension of the credit resolution process as compared to previous expectations. Across the commercial and consumer loan portfolio, the Company continues to closely monitor areas of weakness and take expedient and appropriate action as necessary to ensure adequate reserves are in place. Net charge-offs for the nine months ended September 30, 2012 were $25.7 million, or 1.11% of average loans outstanding.

Real estate owned increased $493 thousand to $5.5 million at September 30, 2012 as compared to $5.0 million at December 31, 2011. During the nine months ended . . .

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