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SBBX > SEC Filings for SBBX > Form 10-Q on 14-Nov-2012All Recent SEC Filings

Show all filings for SUSSEX BANCORP

Form 10-Q for SUSSEX BANCORP


14-Nov-2012

Quarterly Report


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

MANAGEMENT STRATEGY

We are a community-oriented financial institution serving northern New Jersey, northeastern Pennsylvania and Orange County, New York. While offering traditional community bank loan and deposit products and services, we obtain non-interest income through our insurance brokerage operations and the sale of non-deposit products.

We continue to focus on strengthening our core operating performance by improving our net interest income and margin by closely monitoring our yield on earning assets and adjusting the rates offered on deposit products. The economic downturn continues to impact our level of nonperforming assets and in turn has increased our provision for loan losses. We have been focused on building for the future and strengthening our core operating results within a risk management framework.

RECENT LEGISLATIVE UPDATES

In June 2012, the FRB, the Office of the Comptroller of the Currency and the FDIC issued three proposals that would amend the existing regulatory risk-based capital adequacy requirements of banks and bank holding companies. The proposed rules implement the "Basel III" regulatory capital reforms and changes required by the Dodd-Frank Act. The Basel III proposal would increase the minimum levels of required capital, narrow the definition of capital, and place much greater emphasis on common equity. The proposed rules were subject to a comment period through September 7, 2012.

The proposed rules include new risk-based capital and leverage ratios, which would be phased in from 2013 to 2019, and would refine the definition of what constitutes "capital" for purposes of calculating those ratios. The proposed new minimum capital level requirements applicable to us and the Bank under the proposals would be: (i) a new common equity Tier 1 capital ratio of 4.5%; (ii) a Tier 1 capital ratio of 6% (increased from 4%); (iii) a total capital ratio of 8% (unchanged from current rules); and (iv) a Tier 1 leverage ratio of 4% for all institutions. The proposed rules would also establish a "capital conservation buffer" of 2.5% above the new regulatory minimum capital requirements, which must consist entirely of common equity Tier 1 capital and would result in the following minimum ratios: (i) a common equity Tier 1 capital ratio of 7.0%, (ii) a Tier 1 capital ratio of 8.5%, and (iii) a total capital ratio of 10.5%. The new capital conservation buffer requirement would be phased in beginning in January 2016 at 0.625% of risk-weighted assets and would increase by that amount each year until fully implemented in January 2019. An institution would be subject to limitations on paying dividends, engaging in share repurchases and paying discretionary bonuses if its capital level falls below the buffer amount. These limitations would establish a maximum percentage of eligible retained income that could be utilized for such actions.

The proposed rules also implement revisions and clarifications consistent with Basel III regarding the various components of Tier 1 capital, including common equity, unrealized gains and losses, as well as certain instruments that will no longer qualify as Tier 1 capital, such as trust preferred securities, which would be phased out over time. Although the Dodd-Frank Act only required the phase out of such instruments for institutions with total consolidated assets of $15 billion or more, the proposed rules would require almost all institutions to phase out instruments that will no longer qualify as Tier 1 capital, albeit on a longer time frame than for institutions with total consolidated assets of $15 billion or more.

The federal bank regulatory agencies also proposed revisions to the prompt corrective action framework, which is designed to place restrictions on insured depository institutions, including the Bank, if their capital levels begin to show signs of weakness. These revisions would take effect January 1, 2015. We are still in the process of assessing the impacts of these complex proposals.

CRITICAL ACCOUNTING POLICIES

Our consolidated financial statements are prepared in accordance with U.S. GAAP and practices within the banking industry. Application of these principles requires management to make estimates, assumptions, and judgments that affect the amounts reported in the financial statements and accompanying notes. These estimates, assumptions, and judgments are based on information available as of the date of the financial statements; accordingly, as this information changes, the financial statements could reflect different estimates, assumptions, and judgments. Actual results could differ from those estimates.

Critical accounting estimates are necessary in the application of certain accounting policies and procedures, and are particularly susceptible to significant change. Critical accounting policies are defined as those that are reflective of significant judgments and uncertainties, and could potentially result in materially different results under different assumptions and conditions. For additional information on our critical accounting policies, please refer to the information contained in Note 1 of the accompanying unaudited consolidated financial statements and Note 1 of the consolidated financial statements included in our 2011 Annual Report on Form 10-K.

COMPARISION OF OPERATING RESULTS FOR THREE MONTHS ENDED SEPTEMBER 30, 2012 AND
2011

Overview - We reported net income of $546 thousand for the third quarter of 2012 as compared to net income of $534 thousand for the same period in 2011. Basic and diluted earnings per share for the three months ended September 30, 2012 were $0.17, compared to the basic and diluted earnings per share of $0.16 for the comparable period of 2011. The increase in net income was largely due to improved non-interest income resulting from an increase in gains on sale of securities and insurance commissions and fees, which was largely offset by higher provision for loan losses and expenses and write-downs related to foreclosed real estate.

Net income before taxes for our Tri-State segment increased $110 thousand, or 103.8%, resulting in a net income before taxes of $106 thousand for the third quarter of 2012 compared to a $4 thousand loss for the same period in 2011. This increase was due to insurance commission and fee income increasing $139 thousand, or 25.5%, between the two periods.

Comparative Average Balances and Average Interest Rates

The following table presents, on a fully taxable equivalent basis, a summary of
our interest-earning assets and their average yields, and interest-bearing
liabilities and their average costs for the three month periods ended September
30, 2012 and 2011.



                                                                  Three Months Ended September 30,
(Dollars in thousands)                                   2012                                          2011
                                        Average                         Average       Average                         Average
                                        Balance      Interest (1)      Rate (2)       Balance      Interest (1)      Rate (2)
Earning Assets:
Securities:
Tax exempt (3)                         $  32,199     $         442          5.46 %   $  30,059     $         448          5.90 %
Taxable                                   86,766               241          1.10 %      48,890               313          2.54 %
Total securities                         118,965               683          2.28 %      78,949               761          3.82 %
Total loans receivable (4)               342,502             4,467          5.19 %     338,393             4,687          5.49 %
Other interest-earning assets             10,405                 4          0.15 %      35,530                20          0.22 %
Total earning assets                     471,872     $       5,154          4.35 %   $ 452,872     $       5,468          4.79 %

Non-interest earning assets               43,319                                        41,159
Allowance for loan losses                 (6,671 )                                      (7,261 )
Total Assets                           $ 508,520                                       486,770

Sources of Funds:
Interest bearing deposits:
NOW                                    $  95,611     $          36          0.15 %   $  77,676     $          85          0.44 %
Money market                              14,506                11          0.30 %      16,564                23          0.55 %
Savings                                  162,762               133          0.33 %     168,419               287          0.68 %
Time                                     104,128               407          1.55 %     102,725               411          1.59 %
Total interest bearing deposits          377,007               587          0.62 %     365,384               806          0.88 %
Borrowed funds                            26,196               268          4.07 %      26,000               268          4.09 %
Junior subordinated debentures            12,887                60          1.85 %      12,887                55          1.69 %
Total interest bearing liabilities       416,090     $         915          0.87 %   $ 404,271     $       1,129          1.11 %

Non-interest bearing liabilities:
Demand deposits                           48,702                                        41,012
Other liabilities                          2,676                                         2,613
Total non-interest bearing
liabilities                               51,378                                        43,625
Stockholders' equity                      41,052                                        38,874
Total Liabilities and Stockholders'
Equity                                 $ 508,520                                     $ 486,770

Net Interest Income and Margin (5)                           4,239          3.57 %                         4,339          3.80 %
Tax-equivalent basis adjustment                               (150 )                                        (152 )
Net Interest Income                                  $       4,089                                 $       4,187

(1) Includes loan fee income

(2) Average rates on securities are calculated on amortized costs

(3) Full taxable equivalent basis, using a 39% effective tax rate and adjusted for TEFRA (Tax and Equity Fiscal Responsibility Act) interest expense disallowance

(4) Loans outstanding include non-accrual loans

(5) Represents the difference between interest earned and interest paid, divided by average total interest-earning assets

Net Interest Income - Net interest income is the difference between interest and fees on loans and other interest-earning assets and interest paid on interest-bearing liabilities. Net interest income is directly affected by changes in volume and mix of interest-earning assets and interest-bearing liabilities that support those assets, as well as changing interest rates when differences exist in repricing dates of assets and liabilities.

Net interest income, on a fully tax equivalent basis, declined $100 thousand, or 2.3%, to $4.2 million for the third quarter of 2012 as compared to $4.3 million for same period in 2011. The decrease in net interest income was largely due to the Company's net interest margin declining 23 basis points to 3.57% for the third quarter of 2012 compared to the same period last year. The decline in the net interest margin was mostly due to a 30 basis point decline in the average rate earned on loans. This decline in net interest income was partially offset by a decrease in the average rate paid on total interest bearing liabilities, which decreased 24 basis points to 0.87% for the third quarter of 2012 from 1.11% for the same period in 2011. The decline was in part offset by a $19.0 million, or 4.2%, increase in average interest earning assets, principally securities.

Interest Income - Our total interest income, on a fully taxable equivalent basis, decreased $314 thousand, or 5.8%, to $5.2 million for the quarter ended September 30, 2012, as compared to the same period last year. The decline was due to lower earning asset yields, which decreased 45 basis points to 4.35% for the quarter ended September 30, 2012 as compared to the same period in 2011.

Our total interest income earned on loans receivable decreased $220 thousand, or 4.7%, to $4.5 million for the third quarter of 2012 as compared to the same period in 2011. The decline was driven by a 30 basis point decline in average yields to 5.19% for the quarter end September 30, 2012, as compared to the same period in 2011.

Our total interest income earned on securities, on a fully taxable equivalent basis, decreased $79 thousand, to $683 thousand for the quarter ended September 30, 2012, from $761 thousand for the same period in 2011. This decrease was largely due to a decline in the average rate earned on securities, which declined 155 basis points for the quarter ended September 30, 2012, as compared to the same period last year. The lower yields on securities reflect investment in securities in a low market rate environment. The decrease in interest income on securities was offset by a $40.0 million, or 50.7%, increase in average balance of securities for the three months ended September 30, 2012 as compared to same period last year. The increase resulted from investing excess liquidity generated from deposit growth outpacing loan growth.

Other interest-earning assets include federal funds sold and interest bearing deposits in other banks. Our interest earned on total other interest-earning assets decreased $16 thousand for the third quarter of 2012 as compared to the same period in 2011 due to a decline in average balances. The average balances in other interest-earning assets decreased $25.1 million to $10.4 million in the third quarter of 2012 from $35.5 million during the third quarter a year earlier.

Interest Expense -Our interest expense for the three months ended September 30, 2012 decreased $214 thousand, or 19.0%, to $915 thousand from $1.1 million for the same period in 2011. The improvement was principally due to lower average rates paid on total interest-bearing liabilities, which declined 24 basis points from 1.11% for the three months ended September 30, 2011, to 0.87% for the same period in 2012. The improvement in interest expense was partly offset by an increase in average balances in interest-bearing liabilities, which grew $11.8 million, or 2.9%, to $416.1 million for the third quarter in 2012 from $404.3 million for the same period in 2011.

Our interest expense on deposits declined $219 thousand, or 27.2%, for the quarter ended September 30, 2012, as compared to the same period last year. The decline was largely attributed to lower rates on total interest bearing deposits, which decreased 26 basis points to 0.62% for the third quarter 2012 as compared to the same period in 2011. The decrease in rates on deposit products reflects managements' asset/liability strategies and a lower market rate environment between the two third quarter periods. The aforementioned benefit from the decline in rates paid on deposits was partly offset by $11.6 million, or 3.2%, increase in interest bearing deposits.

Provision for Loan Losses - The loan loss provision for the third quarter of 2012 increased $367 thousand, or 49.8%, to $1.1 million compared to a provision of $737 thousand in the third quarter of 2011. The provision for loan losses reflects management's judgment concerning the risks inherent in our existing loan portfolio and the size of the allowance necessary to absorb the risks, as well as the activity in the allowance during the periods. Management reviews the adequacy of its allowance on an ongoing basis and will provide additional provisions, as management may deem necessary.

Non-Interest Income - Our non-interest income increased $756 thousand, or 62.7%, to $2.0 million for the quarter ended September 30, 2012, as compared to the same period last year. The increase in non-interest income was largely due to a $570 thousand increase in gain on the sale of securities and a $139 thousand, or 25.5%, growth in insurance commissions and fees.

Non-Interest Expense - Our non-interest expenses increased $270 thousand, or 6.7%, to $4.3 million for the quarter ended September 30, 2012 as compared to the same period last year. The increase for the third quarter of 2012 versus the same period in 2011 was largely due to an increase in expenses related to foreclosed real estate and other expenses, which increased $160 thousand and $67 thousand, respectively.

Income Taxes - Our income tax expense, which includes both federal and state taxes, was $106 thousand for the three months ended September 30, 2012, representing a 16.3% effective tax rate, compared to income tax expense of $97 thousand for the third quarter of 2011, representing a 15.4% effective tax rate. The effective tax rate benefited from tax exempt income from securities and bank-owned life insurance policies.

COMPARISION OF OPERATING RESULTS FOR NINE MONTHS ENDED SEPTEMBER 30, 2012 AND
2011

Overview - We reported net income of $832 thousand for the nine months ended September 30, 2012, as compared to net income of $2.0 million for the same period in 2011. Basic and diluted earnings per share for the nine months ended September 30, 2012 were $0.26 and $0.25, respectively, compared to the basic and diluted earnings per share of $0.60 and $0.59, respectively, for the comparable period of 2011. The decline in net income was largely attributed to expenses and write-downs related to the prospective sales of several foreclosed real estate properties. In addition, expenses related to additional commercial lending staff, technology upgrades, increased advertising and promotion and FDIC assessment costs (due to deposit growth) also added to the decrease in net income. The aforementioned declines were partly offset by improved non-interest income resulting from increases in gains on sale of securities and insurance commissions and fees.

Net income before taxes for our Tri-State segment increased $62 thousand, or 40.6%, resulting in a net income before taxes of $216 thousand for the first nine months of 2012 compared to $154 thousand for the same period in 2011. This increase was due to insurance commission and fee income increasing $168 thousand, or 9.74%, between the two periods.

Comparative Average Balances and Average Interest Rates

The following table presents, on a fully taxable equivalent basis, a summary of our interest-earning assets and their average yields, and interest-bearing liabilities and their average costs for the nine month periods ended September 30, 2012 and 2011.

                                                                       Nine Months September 30,
(Dollars in thousands)                                    2012                                           2011
                                        Average                          Average       Average                          Average
                                        Balance       Interest (1)      Rate (2)       Balance       Interest (1)      Rate (2)
Earning Assets:
Securities:
Tax exempt (3)                         $  29,444     $        1,253          5.68 %   $  29,962     $        1,332          5.94 %
Taxable                                   84,774                994          1.57 %      52,398                989          2.52 %
Total securities                         114,218              2,247          2.63 %      82,360              2,321          3.77 %
Total loans receivable (4)               339,839             13,292          5.22 %     341,123             14,210          5.57 %
Other interest-earning assets             21,095                 30          0.19 %      23,319                 35          0.20 %
Total earning assets                     475,152     $       15,569          4.38 %     446,802     $       16,566          4.96 %

Non-interest earning assets               42,076                                         38,020
Allowance for loan losses                 (7,335 )                                       (7,227 )
Total Assets                           $ 509,893                                      $ 477,595

Sources of Funds:
Interest bearing deposits:
NOW                                    $  94,578     $          129          0.18 %   $  78,923     $          305          0.52 %
Money market                              16,962                 47          0.37 %      14,838                 61          0.55 %
Savings                                  163,331                492          0.40 %     169,360                881          0.70 %
Time                                     107,389              1,270          1.58 %      94,898              1,095          1.54 %
Total interest bearing deposits          382,260              1,938          0.68 %     358,019              2,342          0.87 %
Borrowed funds                            26,066                797          4.08 %      26,859                797          3.97 %
Junior subordinated debentures            12,887                183          1.90 %      12,887                164          1.70 %
Total interest bearing liabilities       421,213     $        2,918          0.93 %     397,765     $        3,303          1.11 %

Non-interest bearing liabilities:
Demand deposits                           45,949                                         39,423
Other liabilities                          2,209                                          2,427
Total non-interest bearing
liabilities                               48,158                                         41,850
Stockholders' equity                      40,522                                         37,980
Total Liabilities and Stockholders'
Equity                                 $ 509,893                                      $ 477,595

Net Interest Income and Margin (5)                   $       12,651          3.56 %                 $       13,263          3.97 %
Tax-equivalent basis adjustment                                (426 )                                         (453 )
Net Interest Income                                  $       12,225                                 $       12,810

(1) Includes loan fee income

(2) Average rates on securities are calculated on amortized costs

(3) Full taxable equivalent basis, using a 39% effective tax rate and adjusted for TEFRA (Tax and Equity Fiscal Responsibility Act) interest expense disallowance

(4) Loans outstanding include non-accrual loans

(5) Represents the difference between interest earned and interest paid, divided by average total interest-earning assets

Net Interest Income - Net interest income, on a fully taxable equivalent basis, decreased $612 thousand, or 4.6%, to $12.7 million for the nine months ended September 30, 2012, as compared to $13.3 million for same period in 2011. Our net interest margin declined 41 basis points to 3.56% for the nine months ended September 30, 2012, compared to 3.97% for the same period last year. The decline was mostly attributed to a 35 basis point decline in the average rate earned on loans to 5.22%, which was partly offset by a 18 basis point decrease in the average rate paid on interest bearing liabilities to 0.93% for the nine month period ended September 30, 2012, as compared to the same period last year. The decline was in part offset by a $28.3 million, or 6.3%, increase in average interest earning assets, principally securities.

Interest Income - Our total interest income, on a fully taxable equivalent basis, decreased $997 thousand, or 6.0%, to $15.6 million for the nine months ended September 30, 2012, as compared to the same period last year. The decline was due to lower earning asset yields, which decreased 58 basis points to 4.38% for the nine months ended September 30, 2012, as compared to the same period in 2011.

Our total interest income earned on loans receivable decreased $918 thousand, or 6.5%, to $13.3 million for the nine months ended September 30, 2012, as compared to the same period in 2011. The decline was driven by a 35 basis point decline in average yields to 5.22% for the nine months ended September 30, 2012, as compared to the same period in 2011. The decline in interest income earned on loans receivable was also impacted by a $1.3 million decline in average balances on loans receivable to $339.8 million for the nine months ended September 30, 2012, as compared to the same period in 2011.

Our total interest income earned on securities, on a fully taxable equivalent basis, decreased $74 thousand, or 3.2%, to $2.2 million for the nine months ended September 30, 2012, as compared to the same period in 2011. This decrease was largely due to a decrease in the average rate earned on securities, which declined 114 basis points for the nine months ended September 30, 2012, as compared to the same period last year. The lower yields on securities reflect investment in securities in a low market rate environment. The decrease in interest income on securities was offset by a $31.9 million, or 38.7%, increase in average balance of securities for the nine months ended September 30, 2012 as compared to same period last year. The increase resulted from investing excess liquidity generated from deposit growth outpacing loan growth.

Other interest-earning assets include federal funds sold and interest bearing deposits in other banks. Our interest earned on total other interest-earning assets decreased $5 thousand for the nine months ended September 30, 2012, as compared to the same period in 2011 due to a $2.2 million decrease in average balances.

Interest Expense - Our interest expense for the nine months ended September 30, 2012 decreased $385 thousand, or 11.7%, to $2.9 million from $3.3 million for the same period in 2011. The improvement was principally due to lower average rates paid on total interest-bearing liabilities, which declined 18 basis points from 1.11% for the nine months ended September 30, 2011, to 0.93% for the same period in 2012. The improvement in interest expense was partly offset by an increase in average balances in interest-bearing liabilities, which grew $23.4 million, or 5.9%, to $421.2 million for the nine months ended September 30, 2012, from $397.8 million for the same period in 2011.

Our interest expense on deposits declined $404 thousand, or 17.3%, for the nine months ended September 30, 2012, as compared to the same period last year. The decline was largely attributed to lower rates on total interest bearing deposits, which decreased 19 basis points for the nine months ended 2012 as compared to the same period in 2011. The decrease in rates on deposit products reflects managements' asset/liability strategies and a lower market rate environment between the two periods. The aforementioned benefit from the decline in rates paid on deposits was partly offset by $24.2 million, or 6.8%, increase in interest bearing deposits.

Provision for Loan Losses - The loan loss provision for the first nine months of 2012 increased $234 thousand, or 8.7%, to $2.9 million compared to a provision of $2.7 million for the same period in 2011. The provision for loan losses reflects management's judgment concerning the risks inherent in our existing loan portfolio and the size of the allowance necessary to absorb the risks, as well as the activity in the allowance during the periods. Management reviews the adequacy of its allowance on an ongoing basis and will provide additional provisions, as management may deem necessary.

Non-Interest Income - Our non-interest income increased $753 thousand, or 19.1%, to $4.7 million for the nine months ended September 30, 2012, as compared to the same period last year. The increase in non-interest income was largely due to increases in gain on sale of securities, insurance commissions and fees and other income, which increased $495 thousand, $168 thousand and $114 thousand, respectively.

Non-Interest Expense - Our non-interest expenses increased $1.7 million, or 14.6%, to $13.3 million for the nine months ended September 30, 2012, as compared to the same period last year. The increase during the first nine months of 2012 compared to the same period in 2011 was largely due to increases in expenses and write-downs related to foreclosed real estate and salaries and benefits of $722 thousand and $532 thousand, respectively. The increase in expenses and write-downs related to foreclosed real estate was principally due . . .

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