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NBBC > SEC Filings for NBBC > Form 10-K on 25-Mar-2013All Recent SEC Filings

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Form 10-K for NEWBRIDGE BANCORP


25-Mar-2013

Annual Report


Item 7. Management's Discussion and Analysis of Financial Condition and
Results of Operations

The following presents management's discussion and analysis of the Company's financial condition and results of operations and should be read in conjunction with the consolidated financial statements and related notes included elsewhere in this Annual Report on Form 10-K. This discussion may contain forward-looking statements that involve risks and uncertainties. Our actual results could differ significantly from those anticipated in forward-looking statements as a result of various factors. The following discussion is intended to assist in understanding the financial condition and results of operations of the Company.

Executive Overview

In 2012 the Company accomplished two primary goals: an aggressive reduction of its adversely classified assets and the completion of a $56 million convertible preferred equity raise. These two achievements are transformative for the Company. Our strengthened balance sheet, our increased regulatory capital and the significant reduction of the expense weight of adversely classified assets will allow the Company to pursue its vision of being a high performing community bank.

Asset Quality. In mid-2012 the Company formulated an asset disposition plan to resolve the lingering impact of the recession on its asset quality. Our 2012 operating results reflect the impact of the implementation of this plan. The Company had a net loss of $25.3 million for the year. We anticipated this result.

Under the plan, the Company projected that it would dispose of $71 million in classified assets during 2012. We decided these dispositions would be handled internally, not through a broker, so that the Company could eliminate broker fees, execute efficient sales and target the assets for liquidation that had the greatest imbedded losses. We also decided that dispositions would be made through direct negotiations with customers, direct sales of notes, auctions and sales of small pools of homogeneous assets. We began to execute on the plan in the third quarter and provisioned and expensed more than $41 million of credit-related costs in that period. We also wrote down our deferred tax asset by $11 million in the third quarter. By year end, the Company had reduced total classified assets by $96 million, or $25 million more than the projected total under the plan. Total classified assets were $53 million at December 31, 2012, one-third the level of 2011 year end balance of $159 million.

We believe the asset disposition plan was highly successful. The negative impact of adversely classified assets on the Company's earnings was markedly reduced. As a result, our fourth quarter net income climbed to a record level of $4.8 million, an increase of 230% over the prior year's fourth quarter. We believe that our future earnings will also be favorably impacted by the increased quality of our assets.

Equity Raise. Following the 2007 merger of FNB Financial Services Corporation into the Company, our Board and management established a disciplined business model built on an operating vision of Quality, Profitability and Growth. Additionally, our President and Chief Executive Officer, Pressley A. Ridgill, brought together a management team united behind a simple, but powerful, principle - "Financial Success Begins With Integrity."

During this time, however, the effects of the economic recession were increasing and direct pursuit of our vision was not possible. We had to pause and deal with the challenges before us. We elected not to defer credit costs. Instead, we aggressively charged off and wrote down credits. From late 2007 through the completion of the asset disposition plan in the fourth quarter of 2012, the Company charged off over $194 million of loans and other real estate owned, or 11.94% of the Company's peak level of loan balances in September of 2008. In addition, the Company made the difficult but necessary decisions to close or sell multiple branches and reduce the number of its full-time employees by one-third. The results of our commitment to directly confront our challenges were mounting losses, declining capital, a reduction in size and decreasing valuation of our shares in the market.

By late 2008, the Company's well capitalized status was threatened. We accepted $52 million of capital through the Troubled Asset Relief Program ("TARP"). Our acceptance of TARP capital has presented challenges. It currently requires the payment of a dividend at an annual rate of 5%. Moreover, the market value of the Company's shares likely has been depressed in part because of investors' concerns over our ability to repay the TARP capital and the cost of the necessary replacement capital.

As with our asset quality difficulties, we decided to aggressively resolve our TARP capital challenges. On November 1, 2012, the Company agreed to issue approximately $56 million of convertible preferred stock to a number of selected investors at a price of $4.40 per common share equivalent. The market price of the Company's common stock on the last trading day before November 1, 2012 was $4.26. The closing of this private placement occurred on November 30, 2012. At a Special Shareholders Meeting on February 20, 2013, the shareholders of the Company overwhelmingly approved resolutions providing for the conversion of the convertible preferred stock into 9.6 million shares of voting Class A Common Stock and 3.2 million shares of nonvoting Class B Common Stock.

The Company believes that the combination of the significant enhancement of its asset quality and its ability to redeem its TARP capital, without impacting materially its well capitalized status, as a result of its equity raise, have transformed the opportunities available to it. Although the economy remains difficult and presently unknown challenges may well arise, the Company believes that it has the financial strength and management depth needed to aggressively pursue its vision of Quality, Profitability and Growth.

2012 Highlights. The Company took significant actions in 2012 in pursuit of its operating vision.

Quality

Nonperforming assets declined $44.4 million

As a percentage of assets, nonperforming assets declined from 4.10% to 1.56%

Total adversely classified assets declined from $159.1 million to $53.2 million

Other real estate owned declined 82% to $5.4 million

Profitability

The net interest margin averaged 4.06%

Core deposit costs declined to 0.16% at year end

Core deposits represented 75% of total deposits at year end

Total noninterest expense declined $1.3 million, or 2.3%, excluding $1.8 million of one-time expense

The closing of two branch locations was decided as part of our redeployment of resources in more vibrant markets

Branch locations were reduced to 30 (down from 42 in 2007)

Annual operating expenses have declined by $16 million since 2007

Growth

Loan balances increased 5%, net of classified loans

Our footprint was expanded into the Raleigh and Charlotte markets through loan production offices

Twelve senior level experienced community bankers were employed, including new market executives in the Piedmont Triad and Charlotte markets

Pursuing Our Community Banking Strategy

The Company will remain focused on opportunities to achieve our vision of Quality, Profitability and Growth. We will continue to manage our progress in achieving these goals through basic, measurable operating objectives that communicate throughout the organization the steps needed to enhance the Company's financial results. Many of these steps have been taken, others are underway and still others will be taken in coming periods.

Sustained Asset Quality. We believe we have resolved our asset quality issues and achieved the asset base necessary to achieve sustained profitability. The balance of nonperforming assets at December 31, 2012 totaled $26.7 million, or 1.56% of total assets, down from $71.1 million, or 4.11% of total assets, at December 31, 2011. Our nonperforming assets consist of nonperforming loans, loans that have been impaired and on which management no longer believes all principal and interest will be collected, loans that have been restructured to aid the financial distress of a borrower, and other real estate owned which is physical real estate that the Company has taken in settlement of troubled debt. Likewise, total classified loans declined 62.75%, or $80.6 million, for the year to $47.9 million. This total is down 71.44%, or $119.7 million, from the peak level at September 30, 2010. At December 31, 2012, other real estate owned totaled $5.4 million, down from $30.6 million at December 31, 2011. At December 31, 2012, the allowance for credit losses totaled $26.6 million, or 2.30% of loans held for investment, and 124.7% of nonperforming loans. Management believes that substantially all losses in the Company's impaired and nonperforming loans have been recognized and charged off through the allowance for credit losses.

Profitability. The Company's ability to achieve sustained profitability depends not only on the maintenance of a high level of asset quality, but on careful management of interest income, interest expense and other expense. Management has identified and implemented a number of steps to increase net interest and fee income, preserve an acceptable net interest margin and control our controllable expenses.

Expanded our presence into key North Carolina markets and redeployed resources previously dedicated to less vibrant areas. The Company has opened loan production offices in Raleigh and Charlotte, NC - the two largest and fastest growth banking markets in North Carolina. The Company also established loan production offices in smaller markets in which particular growth opportunities were identified. Our goal is to pursue opportunities to increase our portfolio of creditworthy loans with attractive interest rates. Additionally, the Company sold its Harrisonburg, Virginia operations and closed 11 branches not meeting its profitability requirements.

Reduced the Company's dependence on high cost time deposits in favor of lower cost core accounts, including DDA, NOW checking, money market and savings accounts.

Acquired a mortgage brokerage operation (2012 fee revenues increased 124% over the prior year).

Established a loan pricing committee to better evaluate risk-based and relationship pricing to include deposit and other relationships. Management has also focused on maintaining consistency on loan pricing relative to credit characteristics of loans.

Redirected portfolio investments to corporate debt and commercial mortgage backed securities.

Expanded our trust and wealth management services (assets under management increased 30% in 2012 and have increased 164% since 2010).

Maintained a disciplined and accountable budget process that includes monitoring loan, investment and deposit yields; carefully reviewing variances every month, and reviewing controllable expenses every month.

Expense management is critical to the achievement of our profitability goals. Management has implemented a disciplined cost management culture where "that which is within our control is controlled." A key element to creating this culture is our line item accountable budget process. The foundation of our budgeting process is the "CAST" philosophy:

Conservative in forecasts and expectations

Accountable on an account by account basis

Specific to each individual in the organization so goals and budgets are understood

Timely so that continued monitoring and adjustments can be made

Several major cost reduction initiatives focused on eliminating excess costs and non-core or unprofitable activities are continuing. These initiatives include an ongoing franchise validation plan, which carefully reviews each of our branch locations and targets the elimination of waste, inefficiency and duplication throughout our franchise. Each branch is evaluated for its pre-tax contribution, the age and state of the branch facility, the ease of closure, market demographics and the branch's overall fit within our strategic vision. Execution of the franchise validation plan and other expense reduction initiatives have resulted in a net reduction of 12 bank locations and 254 full time equivalent employees since the third quarter of 2007. The reduction in the number of branch locations and other expense reductions resulted in an improvement of our core efficiency from a high of 90% in 2009 to 68% in 2012.

Growth. As a community bank, we believe our opportunities to achieve exceptional returns for our shareholders depend upon consistent delivery of superior customer service to small to medium-sized business and retail clients in a manner that the large national and super regional banks are unable or unwilling to emulate. The Piedmont Triad has approximately $33 billion of deposits. The market is dominated by large national and regional banks, with 76% of the market's deposits residing in banks with more than $10 billion of assets. We believe that we have an opportunity to materially increase our deposit share of this market.

While deposit growth is available in our primary market of the Piedmont Triad, quality loan opportunities in that market and elsewhere in our footprint have been insufficient in recent quarters to offset loan portfolio pay downs. Although we will continue to aggressively compete in the Piedmont Triad and in our Coastal market, the Company has determined that to achieve its growth goals it must seek out additional opportunities. Consequently, we have opened loan production offices in Raleigh, NC and in Charlotte, NC, two of the fastest growing metropolitan statistical areas ("MSAs") in our country. These offices will be converted to branch offices in 2013. The Company now has a lending presence in each of the four largest MSAs in NC - Charlotte, Raleigh, the Piedmont Triad and Wilmington. We believe this expansion of our footprint will enhance our ability to significantly grow our deposit base and loan portfolio.

Although we intend to grow our deposit base and loan portfolio in our traditional and new markets, we will also consider other opportunities to expand our operations in these markets or in markets complementary to our existing franchise. We intend, however, to employ a disciplined approach, consistent with our management philosophy, in evaluating any such opportunities.

The Future. We cannot predict with assurance the performance of the Company in the coming years. Banks operate in an environment where factors beyond their control impact their performance. Recessions, stricter government regulations, interest rates, real property values, consumer spending, investment yields, regulatory capital requirements, and unemployment rates - to name a few - can and do adversely impact the profitability of financial institutions.

We do believe, however, that our aggressive resolution of our asset quality issues, the capital strength provided by our equity raise, our commitment to careful management of the drivers of our income and our expenses, and our focus on thoughtful growth, position our Company to move beyond the challenges of the past and seize upon opportunities available to us now and in the future.

Financial Condition at December 31, 2012 and 2011

The Company's consolidated assets of $1.71 billion at year end 2012 reflect a decrease of 1.5% from year end 2011. The decrease was primarily a result of a decline in the Company's loan portfolio. Total average assets decreased 1.4% from $1.75 billion in 2011, to $1.72 billion in 2012, while average earning assets decreased 1.6%, from $1.60 billion in 2011, to $1.58 billion in 2012. The decreases in total average assets and average earning assets were also primarily the result of a decrease in loans outstanding.

Loans (excluding loans held for sale) decreased $44.6 million during 2012, or 3.7%, compared to a decrease of 4.8% in 2011. The decline in loans was due primarily to our asset disposition plan. In our Quarterly Report on Form 10-Q for the second quarter of 2012, we disclosed that a plan was being developed to accelerate the workout and disposition of a substantial portion of remaining problem assets. During the third quarter, management initiated the asset disposition plan.

Using March 31, 2012 problem asset levels, management established the following goals:

Nonperforming Loans - Reduce by $20.0 million to $23.7 million

Performing Classified Loans - Reduce by $26.0 million to $49.3 million

Real Estate Acquired in Settlement of Loans ("OREO") - Reduce by $25.0 million to $5.0 million

Total Classified Assets - Reduce by $71.0 million to $78.0 million

Classified Assets - Reduce to 45.00% of Tier 1 capital plus allowance for credit losses

Nonperforming Assets - Reduce to 2.00% or less of total assets

By December 31, 2012, the asset disposition plan was completed. As of that date, total problem assets were reduced by approximately $95.8 million from the March 31, 2012 levels as follows:

Nonperforming Loans - Reduced by $22.4 million to $21.4 million

Performing Classified Loans - Reduced by $48.8 million to $26.5 million

OREO - Reduced by $24.7 million to $5.4 million

Total Classified Assets - Reduced by $95.8 million to $53.2 million

Classified Assets - Reduced to 30.53% of Tier 1 capital plus allowance for credit losses

Nonperforming Assets - Reduced to 1.56% of total assets

The results achieved through the asset disposition plan are reflected in the amounts reported for December 31, 2012 and for the periods then ended and are the principal reasons for changes from prior period amounts.

Loans secured by real estate totaled $1.01 billion at year end 2012 and represented 87.5% of total loans (excluding loans held for sale), compared with 86.4% at year end 2011. Within this category, residential real estate loans decreased 4.1% to $501.4 million, and construction loans decreased 15.4% to $75.7 million. Commercial loans totaled $545.3 million at year end 2012, a decrease of 0.4% from the end of 2011. Consumer loans decreased 22.6% during 2012, ending the year at $26.9 million.

Investment securities (at amortized cost) totaled $379.1million at year end 2012, a 12.5% increase from $337.0 million at year end 2011. U.S. Government agency securities totaled $67.1 million, or 17.7% of the portfolio, at year end 2012, compared to $39.0 million, or 11.6% of the portfolio one year earlier. Mortgage backed securities totaled $64.7 million, or 17.1% of the portfolio, at December 31, 2012, compared to $62.1 million, or 18.4% of the portfolio, at the previous year end. State and municipal obligations amounted to $18.0 million at year end 2012, and comprised 4.7% of the portfolio, compared to $19.4 million, or 5.7% of the portfolio, a year earlier. Corporate bonds totaled $195.5 million, or 51.6% of the portfolio at December 31, 2012, of which $44.9 million were covered bonds, compared to total corporate bonds of $180.0 million, or 53.4% of the portfolio at December 31, 2011, of which $61.4 million were covered bonds. Collateralized mortgage obligations ("CMOs") totaled $10.4 million, or 2.7% of the portfolio at year end 2012, compared to $23.6 million, or 7.0% of the portfolio, at the end of the previous year. The Company's investment strategy is to achieve acceptable total returns through investments in securities with varying maturity dates, cash flows and yield characteristics. U.S. Government agency securities are generally purchased for liquidity and collateral purposes, mortgage backed securities are purchased for yield and cash flow purposes, corporate bonds are purchased for yield, and longer maturity municipal bonds are purchased for yield and income tax advantage. The table, "Investment Securities," on page 52, presents the composition of the securities portfolio for the last three years, as well as information about cost and fair value, and the table "Investment Securities Portfolio Maturity Schedule" presents the maturities, fair values and weighted average yields.

Total deposits decreased $86.2 million to $1.33 billion at December 31, 2012, a 6.1% decrease from a total of $1.42 billion one year earlier. The decline in deposits was due primarily to lower time deposit balances, which fell $59.4 million for the year. Retail time deposits declined $75.9 million for the year as the Company has chosen not to compete for high priced time deposits. Noninterest-bearing deposits increased $33.7 million for the year to $206.0 million due in part to changes in the rate and fee structures the Company applied to certain product offerings in the fourth quarter of 2012.

In order to attract additional deposits, when necessary the Bank uses several different sources such as membership in an electronic deposit gathering network that allows it to post interest rates and attract deposits from across the U.S. (bulletin board deposits), brokered certificates of deposit secured through broker/dealer partnerships and deposits obtained through the Promontory InterFinancial Network, also known as CDARS. CDARS increased $27.2 million, from $15.2 million at year end 2011 to $42.4 million at year end 2012, while brokered deposits decreased $10.7 million, from $28.4 million at year end 2011 to $7.7 million at year end 2012.

The Bank also has a credit facility available with the FHLB of Atlanta. The Bank utilized a portion of the $342.5 million credit line with the FHLB of Atlanta to fund earning assets. FHLB borrowings totaled $113.0 million at year end 2012, and based on collateral pledged, $95.3 was available to be borrowed. In addition to the credit line at the FHLB, the Bank has borrowing capacity at the Federal Reserve Bank totaling $7.7 million, and has federal funds lines of $25.0 million, of which there were no borrowings outstanding at December 31, 2012. Management believes these credit lines are a cost effective and prudent alternative to deposit balances, since particular amounts, terms and structures may be selected to meet changing needs.

Financial Condition at December 31, 2011 and 2010

The Company's consolidated assets of $1.73 billion at year end 2011 reflected a decrease of 4.2% from year end 2010. The decrease was primarily a result of a decline in the Company's loan portfolio. Total average assets decreased 8.4% from $1.91 billion in 2010, to $1.75 billion in 2011, while average earning assets decreased 9.6%, from $1.77 billion in 2010, to $1.60 billion in 2011. The decreases in total average assets and average earning assets were also primarily the result of a decrease in loans outstanding.

Loans (excluding loans held for sale) decreased $60.5 million during 2011, or 4.8%, compared to a decrease of 13.5% in 2010. The decrease in loans in 2011 is due primarily to principal repayment on existing loans and loan chargeoffs and foreclosures, coupled with soft loan demand from qualified borrowers. The decrease in loans in 2010 is due primarily to the reclassification of $72.5 million of loans from loans held for investment to loans held for sale in connection with the sale of the Bank's Virginia operation in May 2011. Loans secured by real estate totaled $1.04 billion in 2011 and represented 86.4% of total loans (excluding loans held for sale), compared with 84.8% at year end 2010. Within this category, residential real estate loans decreased 4.0% to $522.8 million and construction loans decreased 35.7% to $89.4 million. Commercial loans totaled $547.4 million at year end 2011, an increase of 6.1% from the end of 2010. Consumer loans decreased 34.5% during 2011, ending the year at $34.7 million.

Investment securities (at amortized cost) totaled $337.0 million at year end 2011, a 4.9% increase from $321.3 million at year end 2010. U.S. Government agency securities totaled $39.0 million, or 11.6% of the portfolio, at year end 2011, compared to $109.3 million, or 34.0% of the portfolio one year earlier. Mortgage backed securities totaled $62.1 million, or 18.4% of the portfolio, at December 31, 2011, compared to $56.0 million, or 17.4% of the portfolio, at the previous year end. State and municipal obligations amounted to $19.4 million at year end 2011, and comprised 5.7% of the portfolio, compared to $17.4 million, or 5.4% of the portfolio, a year earlier. Corporate bonds totaled $180.0 million, or 53.4% of the portfolio at December 31, 2011, of which $61.4 million were covered bonds, compared to total corporate bonds of $82.8 million, or 25.8% of the portfolio at December 31, 2010, of which $46.1 million were covered bonds. Collateralized mortgage obligations ("CMOs") totaled $23.6 million, or 7.0% of the portfolio at year end 2011, compared to $39.7 million, or 12.3% of the portfolio, at the end of the previous year. The Company's investment strategy is to achieve acceptable total returns through investments in securities with varying maturity dates, cash flows and yield characteristics. U.S. Government agency securities are generally purchased for liquidity and collateral purposes, mortgage backed securities are purchased for yield and cash flow purposes, corporate bonds are purchased for yield, and longer maturity municipal bonds are purchased for yield and income tax advantage. The table, "Investment Securities," on page 52, presents the composition of the securities portfolio for the last three years, as well as information about cost and fair value, and the table "Investment Securities Portfolio Maturity Schedule" presents the maturities, fair values and weighted average yield.

Total deposits decreased $34.3 million to $1.42 billion at December 31, 2011, a 2.4% decrease from a total of $1.45 billion one year earlier. This change was primarily the result of a $102.2 million reduction in time deposits, as the interest rates offered by the Bank were reduced substantially during the year. This decrease was partially offset by a $54.2 million increase in money market account deposits. In May 2011, $54.1 million of total deposits, which included $24.9 million of core deposits, were sold as part of the sale of the Bank's Virginia operations. The Bank's "FastForward Checking" product, introduced in the third quarter of 2009, totaled $184.8 million at December 31, 2011.

Net Interest Income

Like most financial institutions, the primary component of the Company's revenue is net interest income. Net interest income is the difference between interest income, principally from loans and investments, and interest expense on customer deposits and borrowings. Changes in net interest income result from changes in volume and mix of the various interest-earning asset and interest-bearing liability components and changes in interest rates earned and paid. Volume refers to the average dollar level of interest-earning assets and interest-bearing liabilities. Spread refers to the difference between the average yield on interest-earning assets and the average cost of interest-bearing liabilities, and margin refers to net interest income divided by average interest-earning assets. Spread and margin are influenced by the levels and relative mix of interest-earning assets and interest-bearing liabilities, as well as by levels of noninterest-bearing liabilities.

Average Balances and Net Interest Income Analysis. The accompanying table sets forth, for the years 2010 through 2012, information with regard to average balances of assets and liabilities, as well as the total dollar amounts of interest income from interest-earning assets and interest expense on interest-bearing liabilities, resultant yields or rates, net interest income, net interest spread, net interest margin and ratio of average interest-earning assets to average interest-bearing liabilities. Average loans include nonaccruing loans, the effect of which is to lower the average yield.

Average Balances and Net Interest Income Analysis

Fully taxable-equivalent basis(1) (dollars in thousands)



                                                      2012                                           2011                                           2010
                                                    Interest                                       Interest                                       Interest
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