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CBNJ > SEC Filings for CBNJ > Form 10-K on 15-Mar-2013All Recent SEC Filings

Show all filings for CAPE BANCORP, INC. | Request a Trial to NEW EDGAR Online Pro

Form 10-K for CAPE BANCORP, INC.


15-Mar-2013

Annual Report


ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

Overview/Business Strategy

Cape Bank was organized in 1923. Over the years, we have expanded primarily through internal growth. On January 31, 2008, we completed our mutual-to-stock conversion and initial public stock offering, and our acquisition of Boardwalk Bancorp and Boardwalk Bank. The merger of Cape Savings Bank (now Cape Bank) and Boardwalk Bancorp on January 31, 2008 created the largest community bank headquartered in Atlantic and Cape May Counties, with a total of 20 locations providing complimentary branch coverage. At December 31, 2012, we had total assets of $1.041 billion. The merger resulted in a well-capitalized community oriented bank with a significant commercial loan presence and an experienced executive management team. For the three years prior to the merger both banks had experienced strong asset quality and financial performance. The severe economic recession has affected the merged financial institution as a whole, as well as the loan portfolios of each of the constituent banks to the merger.


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Our principal business is acquiring deposits from individuals and businesses in the communities surrounding our offices and using these deposits to fund loans and other investments. More specifically, we offer personal and business checking accounts, commercial mortgage loans, residential mortgage loans, construction loans, home equity loans and lines of credit and other types of commercial and consumer loans. Our customers consist primarily of individuals and small and mid-sized businesses. At December 31, 2012, our retail market area primarily included the area surrounding our 15 offices located in Cape May and Atlantic Counties, New Jersey.

During 2013, Cape Bank will focus on the following initiatives:

Continue efforts to effectively manage the Bank's capital

Build core earnings

Continue efforts to reduce nonperforming assets

Complete the transition to a new core processing provider and broaden digital delivery

Continue efforts to effectively manage the Company's capital:

Despite the Company's problems with credit since the recession, we were able to maintain a strong capital position. With troubled assets posing a reduced concern, the Company reassessed the level of capital and believed a more active management was called for. In the fourth quarter of 2012, the Company paid its first cash dividend of $0.05 per common share. In addition, on February 22, 2013, the Company, with the approval of the regulators, declared a $0.05 per common share cash dividend to shareholders of record on March 8, 2013. The dividend is expected to be paid on March 22, 2013.

For 2013, current levels of equity appear to be higher than projected growth would require. As a result, uses of capital beyond the continued payment of a cash dividend have been considered.

Build core earnings:

During the economic downturn, Bank values were often a reflection of the perceived adequacy of equity often through the metric of tangible book value. Uncertainty with the economy in general, and with credit in particular, made capital a handy heuristic to gauge the soundness of a Bank.

These macro concerns have been receding as more institutions have gotten on sounder footing. As a result, valuations have begun to focus on earnings as a driver of value. In particular, core earnings are becoming an increasingly important metric.

Management recognizes this development and has made growth in core earnings an integral part of the 2013 Strategic Plan.

Continue efforts to reduce non-performing assets:

Management was able to reduce the level of non-performing assets during 2012 and believes that continued efforts to reduce them further will provide value to the shareholders. Several of the larger troubled credits have moved to OREO as the Bank attempts to move these properties promptly. This area will continue to get attention in 2013.

Complete the transition to a new core processing provider and broaden digital delivery:

The contract with the Bank's core processor ends in October 2013. Throughout 2012 the Bank conducted a review of processors and systems features, and in late 2012 signed a contract with FISERV. Work has begun on orchestrating a smooth transition to this new system and we expect completion in October. As consumers increasingly embrace digital channels, we focused our due diligence on systems that will further digital delivery.

2013 Outlook

Our market area has been affected by the recession and the modest recovery. Unemployment in Atlantic and Cape May County was 14.3% and 16.2% respectively as of December 2012. Residential real estate values decreased in 2011 in both Atlantic and Cape May counties by 4.1% and 5.2% respectively. Additionally, the number of residential building permits issued declined from 2008 to 2009, leveled off during 2010 and declined again in 2011.


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Income. Our primary source of income is net interest income. Net interest income is the difference between interest income (which is the income that we earn on our loans and investments) and interest expense (which is the interest that we pay on our deposits and borrowings). Changes in levels of market interest rates affect our net interest income.

The Bank's net interest margin is 3.75% for 2012. This has been achieved through active management of deposit pricing and steps taken to restructure borrowings. Throughout the recession and the recovery, FOMC policy has been effective in keeping interest rates low and the yield curve relatively flat. We have taken advantage of these lower rates and have reduced deposit costs on both term deposits and transaction accounts. For the year ended December 31, 2012, the Bank's cost of deposits was 0.65%, down from 2.68% for the year ended December 31, 2008, the start of the recession. While we anticipate some further reduction in the cost attendant to our CD portfolio as some remaining higher rate CDs mature in 2013, we recognize that much of the dramatic change has taken place and there is limited room to lower deposit rates in 2013. We remain committed to pricing transaction accounts to the low end of the market.

In June 2012, the Bank extinguished $20.0 million of fixed rate term FHLB borrowings prior to their scheduled maturity. In connection with the early repayment of these borrowings, the Bank incurred a charge of $921,000 to extinguish the debt which was recorded as other expense in the consolidated statements of income. In August 2012, the Company restructured $54.0 million in fixed rate FHLB borrowings, lowering the cost of funds. The replacement borrowings are adjustable rate, non-callable FHLB advances with maturities ranging from 5 years to 7 years. The interest rate is indexed to the 1 month LIBOR, with spreads that range from 0.42% to 0.52%. A prepayment penalty of $6.4 million was incurred related to the restructuring of the old debt and is being amortized as an adjustment to interest expense over the terms of the new borrowings using the interest method. As a result of both restructurings, net interest income is projected to increase by $1.3 million annually and the net interest margin is expected to benefit by 22 basis points annually. Management does not plan on any further restructuring of advances in 2013. There are $20.0 million in longer term fixed rate advances maturing in 2013 which we anticipate will be replaced by lower costing liabilities.

While the yield curve afforded opportunity to dramatically reduce the cost of liabilities, it also had the impact of reducing the yield on earning assets. From 2008 to 2012, the yield on earning assets declined from 5.98% for the year ended December 31, 2008 to 4.62% for the year ended December 31, 2012. Simultaneously, the level of non-earning assets increased as troubled credits moved into non-accrual status. We plan on growing the Bank's commercial loan portfolio and thus increasing earning assets in 2013. The very competitive market will lessen our ability to price loans at the levels we would prefer.

The Bank's non-interest income comes predominately from fees on deposit products. We expect to maintain our current fee structure in 2013 and anticipate a level of income comparable to our 2012 performance.

Allowance for Loan Losses. The amount of the allowance for loan losses is based on management's judgment of probable losses, and the ultimate losses may vary from such estimates as more information becomes available or conditions change.

Expenses. The non-interest expenses we incur in operating our business consist of salaries and employee benefits expenses, data processing expenses, occupancy expenses, depreciation, amortization and maintenance expenses and other miscellaneous expenses, such as advertising, insurance, professional services and printing and supplies expenses.

Our largest non-interest expense is salaries and employee benefits, which consist primarily of salaries and wages paid to our employees, payroll taxes, and expenses for health insurance, retirement plans and other employee benefits. We will recognize additional annual employee compensation expenses from our employee stock ownership plan, our Equity Incentive Plan and any additional stock-based benefit plans that we may adopt in the future.

We will be converting the Bank's core processing system in 2013, moving to FISERV. We will also be replacing the telephone system for the Bank and introducing a Call Center. We expect to cover the costs of the Call Center through a redeployment of costs from the branch network. The results of the above will provide a better opportunity to utilize multiple channels and more sophisticated digital delivery for our retail and commercial customers.

Growth and Expansion. In 2013, we will be expanding the Bank's reach through Market Development Offices ("MDOs"). The Bank has enjoyed success from the opening of a MDO in Burlington County, New Jersey in late 2010. This office has become the prototype for MDOs. The targeted market is the small business operator or professional with a focus on asset generation rather than deposits. The MDO will offer several services and products through multiple professionals, although these employees may not work from a common location. This expansion is important. Our traditional markets have not experienced growth since the recession and the new locations provide a geographic and industry diversification for the loan portfolio. In addition to our Burlington MDO, we have opened MDOs in Mercer County, New Jersey (November 2012) and in Radnor, Pennsylvania (March 2013).

In 2012, we had a change in the management of the residential mortgage department which resulted in a different focus. Greater emphasis was placed on the origination and sale of loans. For the year ended December 31, 2012, gains on the sale of residential mortgage loans totaled $591,000, an increase of 161% over the full year 2011 gains of $227,000. Residential mortgage closings for the year ended December 31, 2012 topped $90 million with a goal of $140 million for 2013. Some of the production is maintained in portfolio, although awareness of potential interest rate risk issues limits the Bank's appetite for this product.


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Critical Accounting Policies

In the preparation of our consolidated financial statements, we have adopted various accounting policies that govern the application of accounting principles generally accepted in the United States. Our significant accounting policies are described in Note 2 of the Notes to Consolidated Financial Statements.

Certain accounting policies involve significant judgments and assumptions by us that have a material impact on the carrying value of certain assets and liabilities. We consider these accounting policies to be critical accounting policies. The judgments and assumptions we use are based on historical experience and other factors, which we believe to be reasonable under the circumstances. Actual results could differ from these judgments and estimates under different conditions, resulting in a change that could have a material impact on the carrying values of our assets and liabilities and our results of operations.

Allowance for Loan Losses. We consider the allowance for loan losses to be a critical accounting policy. The allowance for loan losses is the amount estimated by management as necessary to cover losses inherent in the loan portfolio at the balance sheet date. The allowance is established through the provision for loan losses, which is charged to income. Determining the amount of the allowance for loan losses necessarily involves a high degree of judgment.

In evaluating the allowance for loan losses, management considers historical loss factors, the mix of the loan portfolio (types of loans and amounts), geographic and industry concentrations, current national and local economic conditions and other factors related to the collectability of the loan portfolio, including underlying collateral values and estimated future cash flows. All of these estimates are susceptible to significant change. Groups of homogenous loans are evaluated in the aggregate under FASB ASC Topic No. 450 Contingencies, using historical loss factors adjusted for economic conditions and other environmental factors. Other environmental factors include trends in delinquencies and classified loans, loan concentrations by loan category and by property type, seasonality of the portfolio, internal and external analysis of credit quality, and single and total credit exposure. Certain loans that indicate underlying credit or collateral concerns may be evaluated individually for impairment in accordance with FASB ASC Topic No. 310 Receivables. If a loan is impaired and repayment is expected solely from the collateral, the difference between the outstanding balance and the value of the collateral will be charged off. For potentially impaired loans where the source of repayment may include other sources of repayment, the evaluation may factor these potential sources of repayment and indicate the need for a specific reserve for any potential shortfall. This evaluation is inherently subjective, as it requires estimates that are susceptible to significant revision as more information becomes available or as projected events change.

Management reviews the level of the allowance quarterly. Although we believe that we use the best information available to establish the allowance for loan losses, future adjustments to the allowance may be necessary if economic conditions differ substantially from the assumptions used in making the evaluation. In addition, the FDIC and the New Jersey Department of Banking and Insurance, as an integral part of their examination process, periodically review our allowance for loan losses. Such agencies may require us to recognize adjustments to the allowance based on judgments about information available to them at the time of their examination. A large loss could deplete the allowance and require increased provisions to replenish the allowance, which would adversely affect earnings. See Note 2 - Summary of Significant Accounting Policies of the Notes to Consolidated Financial Statements.

Securities Impairment. The Company's investment portfolio includes twenty-two securities in pooled trust preferred collateralized debt obligations, fourteen of which have been principally issued by bank holding companies, and eight of which have been principally issued by insurance companies. The portfolio also includes one private label (non-agency) collateralized mortgage obligation ("CMO"). With the exception of the non-agency collateralized mortgage obligation, all of the aforementioned securities have below investment grade credit ratings. These investments may pose a higher risk of future impairment charges by the Company in a weakened U.S. economy and its potential negative effect on the future performance of the bank issuers and underlying mortgage loan collateral.


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Through December 31, 2012, all fourteen of the bank-issued pooled trust preferred collateralized debt obligation securities have had OTTI recognized in earnings due to credit impairment. Of those securities, eleven have been completely written-off and the three remaining bank-issued CDOs have a total book value of $524,000 and a fair value of $564,000 at December 31, 2012. These write-downs were a direct result of the impact that the credit crisis has had on the underlying collateral of the securities. Consequently many bank issuers have failed causing them to default on their security obligations while recent stress tests and potential recommendations by the U.S. Government and the banking regulators have resulted in some bank trust preferred issuers electing to defer future payments of interest on such securities. At December 31, 2012, the CDO securities principally issued by insurance companies, none of which have been OTTI, had an aggregate book value of $7.7 million and a fair value of $4.1 million. A continuation of issuer defaults and elections to defer payments could adversely affect valuations and result in future impairment charges.

Income Taxes. The Company is subject to the income and other tax laws of the United States and the State of New Jersey. These laws are complex and are subject to different interpretations by the taxpayer and the various taxing authorities. In determining the provisions for income and other taxes, management must make judgments and estimates about the application of these inherently complex laws, related regulations and case law. In the process of preparing the Company provision and tax returns, management attempts to make reasonable interpretations of applicable tax laws. These interpretations are subject to challenge by the taxing authorities upon audit or to reinterpretation based on management's ongoing assessment of facts and evolving case law.

The Company and its subsidiaries file a consolidated federal income tax return and separate entity state income tax returns. The provision for federal and state income taxes is based on income and expenses, as reported in the consolidated financial statements, rather than amounts reported on the Company's federal and state income tax returns. When income and expenses are recognized in different periods for tax purposes than for book purposes, applicable deferred tax assets and liabilities are recognized for the future tax consequences attributable to the differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. The effect on deferred tax assets and liabilities of a change in tax rates is recognized as income or expense in the period that includes the enactment date. Deferred federal and state tax assets are reduced by a valuation allowance when, in the opinion of management, it is more likely than not that some portion or all of the deferred tax assets will not be realized. During 2011, $12.2 million of the valuation allowance was released and was based on a pattern of sustained earnings exhibited by the Company over the most recent 7 quarters through September 30, 2011, projected future taxable income and a tax strategy to facilitate ordinary loss treatment by the Company of certain investment losses when such losses are recognized for tax purposes. As of December 31, 2012, a valuation allowance in the amount of approximately $1.9 million had been established against the Company's deferred tax assets.

On a quarterly basis, management assesses the reasonableness of its effective federal and state tax rate based upon its current best estimate of net income and the applicable taxes expected for the full year.

Comparison of Financial Condition at December 31, 2012 and December 31, 2011

The Company's total assets at December 31, 2012 totaled $1.041 billion, a decrease of $30.3 million, or 2.83%, from the December 31, 2011 level of $1.071 billion. The decrease was primarily attributable to a $19.9 million decrease in investment securities.

Cash and cash equivalents decreased $1.3 million or 4.89%, to $24.2 million at December 31, 2012 from $25.5 million at December 31, 2011. A decline in interest-bearing bank balances of $2.1 million was partially offset by an increase of $800,000 in cash and due from financial institutions. The increase was primarily attributable to a large deposit that was made at the end of the year that, due to the timing, was not reinvested.

Interest-bearing time deposits decreased $569,000, or 5.79%, to $9.3 million at December 31, 2012 from $9.8 million at December 31, 2011. The Company invests in time deposits of other banks generally for terms ranging from one to two years and not to exceed $250,000, which is the amount currently insured by the Federal Deposit Insurance Corporation.

Total loans decreased $4.8 million, or 0.65%, to $724.2 million at December 31, 2012 from $729.0 million at December 31, 2011. Net loans decreased $1.9 million, net of a decrease in the allowance for loan losses of $2.8 million. An increase in commercial loans was more than offset by decreases in mortgage and consumer loans. Mortgage loans decreased $16.5 million as a result of early payoffs and the Bank selling approximately 54% of originations made during the year in an effort to manage interest rate risk. An increase in commercial loan activity within our market resulted in net growth of $13.4 million. Consumer loans declined $1.7 million. Loan charge-offs for the year ended December 31, 2012 totaled $7.5 million and $10.2 million of loans were transferred to OREO. Delinquent loans decreased $14.7 million to $15.98 million or 2.20% of total gross loans at December 31, 2012 from $30.6 million, or 4.20% of total loans at December 31, 2011. Total delinquent loans by portfolio at December 31, 2012 were $9.6 million of commercial mortgages, $4.3 million of residential mortgages, $141,000 of construction loans, $681,000 of commercial business loans, $1.1 million of home equity loans, and $44,000 of other consumer loans. Delinquent loan balances by number of days delinquent were: 31 to 59 days - $1.8 million; 60 to 89 days - $1.2 million; and 90 days and greater - $12.9 million.


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At December 31, 2012, the Company had $19.4 million in non-performing loans, or 2.67% of total loans, compared to $27.4 million, or 3.77% of total loans, at December 31, 2011. Included in non-performing loans are troubled debt restructurings totaling $3.5 million at December 31, 2012 and $405,000 at December 31, 2011, respectively. At December 31, 2012, non-performing loans by loan portfolio category were as follows: $14.2 million of commercial mortgage loans; $3.5 million of residential mortgage loans; $141,000 of construction loans; $681,000 of commercial business loans; and $842,000 of home equity loans.

At December 31, 2012, commercial non-performing loans had collateral type concentrations of $3.5 million (13 loans or 24%) secured by commercial buildings and equipment, $4.1 million (15 loans or 28%) secured by retail stores, $1.5 million (11 loans or 10%) secured by residential, duplex and multi-family properties, $2.9 million (7 loans or 19%) secured by B&B and hotels, $1.4 million (2 loans or 10%) secured by restaurant properties, $1.3 million (1 loan or 8%) secured by marinas and $172,000 (1 loan or 1%) secured by land and building lots. The three largest relationships in this category of non-performing loans are $2.8 million, $1.7 million, and $1.3 million.

We believe we have appropriately charged-off, written-down or established adequate loss reserves on problem loans that we have identified. For 2013, we anticipate a gradual decrease in the amount of problem assets. This improvement is due, in part, to our disposing of assets collateralizing loans that have gone through foreclosure. We are aggressively managing all loan relationships, and where necessary, we will continue to apply our loan work-out experience to protect our collateral position and actively negotiate with mortgagors to resolve these non-performing loans.

Total investment securities decreased $19.8 million, or 10.40%, to $170.9 million at December 31, 2012 from $190.7 million at December 31, 2011. At December 31, 2012 and December 31, 2011 all of the Company's investment securities were classified as available-for-sale (AFS). The decrease in the portfolio is primarily a result of investment security sales. A portion of these proceeds were used by the Company to restructure the balance sheet as $20.0 million in FHLB fixed rate term borrowings were extinguished. The Company also experienced additional OTTI related to its bank-issued CDOs portfolio during the year ended December 31, 2012 and recorded an $8,000 charge to earnings related to the credit loss portion of impairment.

Total deposits increased $10.2 million, or 1.32%, to $784.6 million at December 31, 2012, from $774.4 million at December 31, 2011. The increase is attributable to a $61.9 million, or 12.88%, increase in core deposits, partially offset by a decrease of $50.5 million in certificates of deposit. NOW and money market accounts increased $42.0 million, or 13.06%, to $363.5 million at December 31, 2012 from $321.5 million at December 31, 2011. This increase was primarily attributable to increases in municipal accounts of $17.3 million, or 27.78%, commercial money market accounts of $14.3 million, or 35.04%, and increases in personal interest bearing checking accounts of $13.6 million, or 17.55%. Non-interest bearing checking accounts increased $11.7 million, or 16.48%, to $82.7 million at December 31, 2012 from $71.0 million at December 31, 2011, and savings deposits increased $8.2 million or 9.29% to $96.2 million at December 31, 2012 from $88.0 million at December 31, 2011. Certificates of deposit totaled $238.6 million at December 31, 2012, a decline of $50.5 million or 17.46%, from $289.1 million at December 31, 2011. Total borrowings decreased $46.0 million, or 31.98%, to $98.0 million at December 31, 2012 from $144.0 million at December 31, 2011. The Company extinguished $20.0 million in FHLB of NY fixed rate term borrowings which had a weighted average rate of 3.44% and maturity dates ranging from August 2013 through February 2014. The prepayment of these borrowings will be accretive to net interest income through the first quarter of 2014. In addition, in August 2012, the Company restructured an additional $54.0 million in borrowings, significantly lowering the cost of funds. As a result of both restructurings, net interest income is projected to increase by $1.3 million annually and the net interest margin will benefit by 22 basis points annually. In addition, the increase in deposits discussed previously enabled the Company to replace borrowings with lower costing funding sources such as interest bearing demand deposits and non- interest bearing deposits. At December 31, 2012, our borrowings to assets ratio decreased to 9.4% from 13.4% at December 31, 2011. Borrowings to total liabilities decreased to 11.0% at December 31, 2012 from 15.6% at December 31, 2011.

Stockholders' equity increased $5.1 million, or 3.50%, to $150.8 million at December 31, 2012, from $145.7 million at December 31, 2011. The increase in equity was primarily attributable to the net income of $4.6 million. At December 31, 2012, stockholders' equity totaled $150.8 million, or 14.49% of total assets, and tangible equity totaled $128.0 million or 12.57% of total tangible assets.

Comparison of Operating Results for the Years Ended December 31, 2012 and 2011

General. The Company recorded net income of $4.6 million, or $0.37 per common and fully diluted share for the year ended December 31, 2012 compared to net . . .

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