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SUBK > SEC Filings for SUBK > Form 10-Q on 31-Oct-2013All Recent SEC Filings

Show all filings for SUFFOLK BANCORP

Form 10-Q for SUFFOLK BANCORP


31-Oct-2013

Quarterly Report


ITEM 2. - MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

Safe Harbor Statement Pursuant to the Private Securities Litigation Reform Act of 1995 - Certain statements contained in this discussion are "forward-looking statements" within the meaning of the Private Securities Litigation Reform Act of 1995. These can include remarks about the Company, the banking industry, the economy in general, expectations of the business environment in which the Company operates, projections of future performance, and potential future credit experience. These remarks are based upon current management expectations, and may, therefore, involve risks and uncertainties that cannot be predicted or quantified and are beyond the Company's control and are subject to a variety of uncertainties that could cause future results to vary materially from the Company's historical performance, or from current expectations. These remarks may be identified by such forward-looking statements as "should," "expect," "believe," "view," "opportunity," "allow," "continues," "reflects," "typically," "usually," "anticipate," or similar statements or variations of such terms. Factors that could affect the Company include particularly, but are not limited to: a failure by the Company to meet the deadlines under SEC rules for filing its periodic reports (or any permitted extension thereof); increased capital requirements mandated by the Company's regulators; the Company's ability to raise capital; changes in interest rates; increases or decreases in retail and commercial economic activity in the Company's market area; variations in the ability and propensity of consumers and businesses to borrow, repay, or deposit money, or to use other banking and financial services; results of regulatory examinations; any failure by the Company to maintain effective internal control over financial reporting; larger-than-expected losses from the sale of assets; potential litigation or regulatory action relating to the matters resulting in the Company's failure to file on time its Quarterly Report on Form 10-Q for the quarters ended March 31, 2011, June 30, 2011, and September 30, 2011 or resulting from the revisions to earnings previously announced on April 12, 2011 or the restatement of its financial statements for the quarterly period ended September 30, 2010 and year ended December 31, 2010; and the potential that net charge-offs are higher than expected or for further increases in our provision for loan losses. Further, it could take the Company longer than anticipated to implement its strategic plans to increase revenue and manage non-interest expense, or it may not be possible to implement those plans at all. Finally, new and unanticipated legislation, regulation, or accounting standards may require the Company to change its practices in ways that materially change the results of operations. We have no obligation to update any forward-looking statements to reflect events or circumstances after the date of this document. For more information, see the risk factors described in the Company's Annual Report on Form 10-K and other filings with the Securities and Exchange Commission.


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Non-GAAP Disclosure - This discussion includes a non-GAAP financial measure of the Company's tangible common equity ratio. A non-GAAP financial measure is a numerical measure of historical or future financial performance, financial position or cash flows that excludes or includes amounts that are required to be disclosed in the most directly comparable measure calculated and presented in accordance with GAAP. The Company believes that this non-GAAP financial measure provides both management and investors a more complete understanding of the underlying operational results and trends and the Company's marketplace performance. The presentation of this additional information is not meant to be considered in isolation or as a substitute for the numbers prepared in accordance with GAAP.

Executive Summary - The Company is a one-bank holding company engaged in the commercial banking business through the Bank, a full-service commercial bank headquartered in Riverhead, New York. Organized in 1890, the Bank has 28 branch offices in Suffolk County, New York, and is a wholly owned subsidiary of the Company. The Bank offers a full line of domestic commercial and retail banking services and wealth management services. The Bank's primary lending area includes all of Suffolk County and to a limited degree the adjacent markets of Nassau County and New York City. The Bank makes commercial real estate floating and fixed rate loans, commercial and industrial loans to manufacturers, wholesalers, distributors, developers/contractors and retailers, and agricultural loans. The Bank also makes loans secured by residential mortgages, and both fixed and floating rate second mortgage loans with a variety of plans for repayment. Real estate construction loans are also offered. In order to expand the Company geographically into western Suffolk and Nassau Counties and to diversify the lending business of the Company, a new loan production office was opened in Melville in 2012. As part of our strategy to move westward, an additional loan production office will open in early November in Garden City to serve the major business markets in central and western Long Island. Seasoned banking professionals have joined the Company to augment both interest and fee income through the origination of commercial and industrial loans, the generation of high quality multifamily and jumbo mortgages to be retained in the portfolio and conforming mortgages for sale in secondary markets. The Bank finances most of its activities with deposits, including demand, saving, N.O.W. and money market deposits, as well as time deposits. It may also rely on other sources of funds, including inter-bank overnight loans.

At September 30, 2013, the Company, on a consolidated basis, had total assets of $1.7 billion, total deposits of $1.5 billion and stockholders' equity of $162 million. The Company recorded net income of $3.9 million, or $0.34 per diluted common share, for the third quarter of 2013, compared to a net loss of $9.2 million, or $0.94 per diluted common share, for the third quarter of 2012. The improvement in third quarter 2013 earnings versus 2012 resulted from several factors, most notably a $12.0 million reduction in the provision for loan losses in 2013, a $4.7 million increase in non-interest income and a $2.1 million reduction in total operating expenses. Third quarter 2013 earnings included the previously disclosed $3.4 million pre-tax net gain on the sale of Visa Class B shares executed in July and one-time costs of $596 thousand incurred in closing two branch offices in 2013. Partially offsetting these positive factors was a $182 thousand reduction in net interest income in the third quarter of 2013 due to a 27 basis point narrowing of the Company's net interest margin to 3.82% in 2013 from 4.09% a year ago. Generally, the Company's net interest margin is impacted not only by the average balance and mix of the Company's interest-earning assets and interest-bearing liabilities, but also by the level of market interest rates. These rates are significantly influenced by the actions of the Federal Open Market Committee of the Board of Governors of the Federal Reserve System (the "FOMC") policy makers.

The Company's return on average assets and return on average common stockholders' equity were 0.92% and 9.72%, respectively, in the third quarter of 2013 versus (2.34%) and (25.40%), respectively, in the third quarter of 2012.


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Financial Performance Summary As of or for the quarters and nine months ended September 30, 2013 and 2012
(dollars in thousands, except per share data)

                                                                             Over/                                                        Over/
                                     Quarters ended September 30,          (under)             Nine months ended September 30,          (under)
                                        2013                 2012             2012                  2013                  2012             2012
Revenue (1)                   $       20,559       $       16,035             28.2 %     $        53,829       $        49,777              8.1 %
Operating expenses (2)        $       15,090       $       17,171            (12.1 %)    $        41,583       $        45,915             (9.4 %)
Provision for loan losses     $            -       $       12,000           (100.0 %)    $             -       $         9,600           (100.0 %)
Net income (loss)             $        3,912       $       (9,161 )            N/M (3)   $         9,390       $        (3,793 )            N/M (3)
Net income (loss) per
common share - diluted        $         0.34       $        (0.94 )            N/M (3)   $          0.81       $         (0.39 )            N/M (3)
Return on average assets                0.92 %              (2.34 %)           325 bp               0.76 %               (0.33 %)           109 bp
Return on average
stockholders' equity                    9.72 %             (25.40 %)         3,512 bp               7.70 %               (3.65 %)         1,135 bp
Tier 1 leverage ratio                   9.66 %               9.74 %             (8 )bp              9.66 %                9.74 %             (8 )bp
Tier 1 risk-based capital
ratio                                  13.94 %              16.90 %           (296 )bp             13.94 %               16.90 %           (296 )bp
Total risk-based capital
ratio                                  15.19 %              18.17 %           (298 )bp             15.19 %               18.17 %           (298 )bp
Tangible common equity
ratio (non-GAAP)                        9.21 %               9.75 %            (54 )bp              9.21 %                9.75 %            (54 )bp

bp - denotes basis points; 100 bp equals 1%.
(1) Represents net interest income plus total non-interest income.
(2) Results for the 2013 nine-month period are net of a $1,659 non-recurring gain arising from the termination of post-retirement life insurance benefits during the second quarter of 2013.
(3) N/M - denotes % variance not meaningful for statistical purposes.

The Company's core deposit franchise continues to be among the best in the region. Core deposits, consisting of demand, N.O.W., saving and money market deposits, totaled $1.3 billion at September 30, 2013, representing 85% of total deposits at that date. Demand deposits totaled $650 million at September 30, 2013 and represented 42% of total deposits at that date. The deposit product mix continues to be a primary strength of the Company and resulted in a total cost of funds of 19 basis points during the third quarter of 2013.

The Company experienced sequential quarter increase in the total loan portfolio of $104 million, from $895 million at June 30, 2013 to $999 million at September 30, 2013, an 11.6% quarterly growth rate. The geographic and product diversification strategies implemented in our lending businesses are working well. Each of our lending businesses, commercial, multifamily and residential, are contributing to this accelerating momentum. The Company is increasing market share by protecting our eastern Suffolk lending franchise while simultaneously expanding west.

As part of the Bank's desire to diversify its portfolio on both a product and geographic basis, its initiative aimed at the development of a multifamily mortgage portfolio has meant that the Bank now has exposure to a favorable geographic area that had previously been a minimal segment of the portfolio. This effort is primarily concentrated in the five boroughs of New York City and targets buildings with stabilized rent flows. It has been well-established that the incidence of loss in multifamily loan transactions is lower than almost all other loan categories as their performance over time has shown limited defaults, even during the worst period of the recent recession. The property value for these buildings is directly attributable to the cash flow from rents and the rate of return investors need on their invested capital. Rental rates are a function of demand for apartments and the vacancy rates in New York City (where the majority of the Bank's assets are located) are at historical lows. Average rental rates for an apartment are above $3,000/month for the first time ever. New apartments are coming to market but are being absorbed rapidly.

The Bank has dedicated credit analysts/underwriters and a portfolio manager for the multifamily product line that have extensive experience in this type of lending. The portfolio of multifamily loans continues to perform satisfactorily with no delinquencies reported and risk ratings solidly in the pass range.

On the expense side, we are working diligently to balance the increased investments needed to grow our lending businesses with offsetting operating expense reductions in other areas, and believe we will see continued improvement as we move forward. We are currently studying our existing branch network for cost saving opportunities. As a result of this effort, the previously announced closings of our branches in Middle Island and Water Mill became effective on October 4. While third quarter results reflect total one-time charges of $596 thousand to close these two branches, the aggregate permanent operating expense savings resulting from these actions will be over $800 thousand per year. Further, after carefully implementing a detailed customer retention plan, we are very pleased to report that preliminary deposit retention rates for these two closed branches is in excess of 95%. We continue to analyze our branch network and each of our lines of business to identify further opportunities for cost savings, which will be an ongoing focus of our management team across our entire Company.


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Notwithstanding the strong loan growth described above, we still maintained a relatively large cash position at the end of the third quarter of $157 million in interest-bearing deposits with correspondent banks, or 9% of total assets. Even with this cash position, our net interest margin during the quarter was 3.82%, as we maintained an extraordinarily low cost of funds of 19 basis points. As we continue to redeploy our cash into high quality loans and other interest-earning assets, we believe we have a unique opportunity to improve both our margin and our non-interest income in future periods.

Critical Accounting Policies, Judgments and Estimates - The Company's accounting and reporting policies conform to U.S. GAAP and general practices within the financial services industry. The preparation of the financial statements in conformity with U.S. GAAP requires management to make estimates and assumptions that affect the amounts reported in the financial statements and the accompanying notes. Actual results could differ from those estimates.

Allowance for Loan Losses - In management's opinion, one of the most critical accounting policies impacting the Company's financial statements is the evaluation of the allowance for loan losses. The allowance for loan losses is a valuation allowance for probable incurred losses, increased by the provision for loan losses and recoveries, and decreased by loan charge-offs. For all classes of loans, when a loan, in full or in part, is deemed uncollectible, it is charged against the allowance for loan losses. This happens when the loan is past due and the borrower has not shown the ability or intent to make the loan current, or the borrower does not have sufficient assets to pay the debt, or the value of the collateral is less than the balance of the loan and is not considered likely to improve soon. The allowance for loan losses is determined by a continuous analysis of the loan portfolio. Such analysis includes changes in the size and composition of the portfolio, the Company's own historical loan losses, industry-wide losses, current and anticipated economic trends, and details about individual loans. It also includes estimates of the actual value of collateral, other possible sources of repayment and estimates that are susceptible to significant changes due to changes in appraisal values of collateral, national and regional economic conditions and other relevant factors. All non-accrual loans over $250 thousand in the commercial and industrial, commercial real estate and real estate construction loan classes and all TDRs are evaluated individually for impairment. Management will use judgment to determine if there are other loans outside of these two categories that fit the definition of impaired. All other loans are generally evaluated as homogeneous pools with similar risk characteristics. In assessing the adequacy of the allowance for loan losses, management reviews the loan portfolio by separate classes that have similar risk and collateral characteristics; e.g., commercial and industrial, commercial real estate, multifamily, real estate construction, residential mortgages, home equity and consumer loans.

The allowance for loan losses consists of specific and general components. The specific component relates to loans that are individually classified as impaired. Specific reserves are established based on an analysis of the most probable sources of repayment and liquidation of collateral. Impaired loans that are collateral dependent are reviewed based on their collateral and the estimated time required to recover the Company's investment in the loans, as well as the cost of doing so, and the estimate of the recovery. Non-collateral dependent impaired loans are reviewed based on the present value of estimated future cash flows, including balloon payments, if any, using the loan's effective interest rate. While every impaired loan is evaluated individually, not every loan requires a specific reserve. Specific reserves fluctuate based on changes in the underlying loans, anticipated sources of repayment, and charge-offs. The general component covers non-impaired loans and is based on historical loss experience for each loan class from a rolling twelve quarter period and modifying those percentages, if necessary, after adjusting for current qualitative and environmental factors that reflect changes in the collectability of the loan class not captured by historical loss data. These factors augment actual loss experience and help estimate the probability of loss within the loan portfolio based on emerging or inherent risk trends. These qualitative factors are applied as an adjustment to historical loss rates and require judgments that cannot be subjected to exact mathematical calculation. There are no formulas for translating them into a specific basis point adjustment of the Company's historical loss rate for a pool of loans having similar risk characteristics. These adjustments reflect management's overall estimate of the extent to which current losses on a pool of loans will differ from historical loss experience. These adjustments are subjective estimates and management reviews them on a quarterly basis. TDRs are also considered impaired with impairment generally measured at the present value of estimated future cash flows using the loan's effective interest rate at inception or using the fair value of collateral, less estimated costs to sell, if repayment is expected solely from the collateral.

Deferred Tax Assets and Liabilities - Deferred tax assets and liabilities are the expected future tax consequences of temporary differences between the carrying amounts and the tax bases of assets and liabilities, computed using enacted tax rates. Deferred tax assets are recognized if it is more likely than not that a future benefit will be realized. A valuation allowance, if needed, reduces deferred tax assets to the amount expected to be realized. The realization of deferred tax assets (net of a recorded valuation allowance) is largely dependent upon future taxable income, future reversals of existing taxable temporary differences and the ability to carryback losses to available tax years. In assessing the need for a valuation allowance, the Company considers all relevant positive and negative evidence, including taxable income in carryback years, scheduled reversals of deferred tax liabilities, expected future taxable income and available tax planning strategies.


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OTTI of Investment Securities - Management evaluates securities for OTTI on at least a quarterly basis, and more frequently when economic or market conditions warrant such an evaluation. For securities in an unrealized loss position, management considers the extent and duration of the unrealized loss, and the financial condition and near-term prospects of the issuer. Management also assesses whether it intends to sell, or it is more likely than not that it will be required to sell, a security in an unrealized loss position before recovery of its amortized cost basis. If either of the criteria regarding intent or requirement to sell is met, the entire difference between amortized cost and fair value is recognized as impairment through earnings. For debt securities that do not meet the aforementioned criteria, the amount of impairment is split into two components as follows: 1) OTTI related to credit loss, which must be recognized in the statement of operations and 2) OTTI related to other factors, which is recognized in other comprehensive income (loss). The credit loss is defined as the difference between the present value of the cash flows expected to be collected and the amortized cost basis. For equity securities, the entire amount of impairment is recognized through earnings.

Material Changes in Financial Condition - Total assets of the Company were $1.7 billion at September 30, 2013. When compared to December 31, 2012, total assets increased by $103 million. This change largely reflects increases in loans, bank owned life insurance, investment securities and interest-bearing time deposits in other banks of $218 million, $38 million, $11 million and $10 million, respectively, partially offset by a decline in cash and cash equivalents of $175 million as we continue our redeployment of lower-yielding overnight interest-bearing deposits into higher yielding assets. Total loans were $999 million at September 30, 2013 as compared to $781 million at December 31, 2012. Total investment securities increased to $421 million at September 30, 2013 from $410 million at December 31, 2012.

The increase in the loan portfolio largely reflects growth of multifamily and commercial real estate loans of $128 million and $89 million, respectively, during the first nine months of 2013. The increase in the investment portfolio largely reflects purchases of U.S. Government agency securities and mortgage-backed securities of U.S. Government-sponsored enterprises of $62 million and $44 million, respectively, during the first nine months of 2013. These were partially offset by sales and principal paydowns of CMOs totaling $55 million and calls of U.S. Government agency securities of $18 million during the same 2013 period. Higher interest rates in 2013 negatively impacted the market value of the Company's available for sale investment portfolio by approximately $19 million at September 30, 2013 when compared to December 31, 2012.

At September 30, 2013, total deposits were $1.5 billion, an increase of $106 million when compared to December 31, 2012. This increase was primarily due to growth in saving, N.O.W. and money market deposits of $79 million coupled with higher demand deposit balances of $34 million. Core deposit balances, which consist of demand, saving, N.O.W. and money market deposits, represented 85% and 83% of total deposits at September 30, 2013 and December 31, 2012, respectively. Demand deposit balances represented 42% of total deposits at September 30, 2013 versus 43% at December 31, 2012. The Company had no borrowed funds outstanding at either September 30, 2013 or December 31, 2012.

Liquidity and Capital Resources - Liquidity management is defined as both the Company's and the Bank's ability to meet their financial obligations on a continuous basis without material loss or disruption of normal operations. These obligations include the withdrawal of deposits on demand or at their contractual maturity, the repayment of borrowings as they mature, funding new and existing loan commitments and the ability to take advantage of business opportunities as they arise. Asset liquidity is provided by short-term investments and the marketability of securities available for sale. The Company may also leave excess reserve balances at the Federal Reserve Bank ("FRB") if the rate being paid is higher than would be available from other short-term investments. Liquid assets, consisting of federal funds sold, securities available for sale and balances at the FRB, were $561 million at September 30, 2013 compared to $706 million at December 31, 2012. These liquid assets may include assets that have been pledged against municipal deposits or other short-term borrowings. Liquidity is also provided by the maintenance of a base of core deposits, maturing short-term assets including cash and due from banks, the ability to sell or pledge marketable assets and access to lines of credit.

Liquidity is continuously monitored, thereby allowing management to better understand and react to emerging balance sheet trends, including temporary mismatches with regard to sources and uses of funds. After assessing actual and projected cash flow needs, management seeks to obtain funding at the most economical cost. These funds can be obtained by converting liquid assets to cash or by attracting new deposits or other sources of funding. Many factors affect the Company's ability to meet liquidity needs, including variations in the markets served, loan demand, its asset/liability mix, its reputation and credit standing in its markets and general economic conditions. Borrowings and the scheduled amortization of investment securities and loans are more predictable funding sources. Deposit flows and securities prepayments are somewhat less predictable as they are often subject to external factors. Among these are changes in the local and national economies, competition from other financial institutions and changes in market interest rates.


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The Company's primary sources of funds are cash provided by deposits and borrowings, proceeds from maturities and sales of securities available for sale, and cash provided by operating activities. At September 30, 2013, total deposits were $1.5 billion, an increase of $106 million when compared to December 31, 2012. Of the total time deposits at September 30, 2013, $194 million are scheduled to mature within the next 12 months. Based on historical experience, the Company expects to be able to replace a substantial portion of those maturing deposits with comparable deposit products. At September 30, 2013 and December 31, 2012, there were no borrowings outstanding. For the nine months ended September 30, 2013 and 2012, proceeds from sales and maturities of securities available for sale totaled $35 million and $36 million, respectively.

The Company's primary uses of funds are for the origination of loans and the purchase of investment securities. For the nine months ended September 30, 2013, the Company had net loan originations for portfolio of $223 million compared to net loan repayments of $120 million for the same period in 2012. The Company purchased investment securities totaling $116 million and $94 million during the nine months ended September 30, 2013 and 2012, respectively.

The Company strives to maintain an efficient level of capital, commensurate with its risk profile, on which a competitive rate of return to stockholders will be realized over both the short and long term. Capital is managed to enhance stockholder value while providing flexibility for management to act opportunistically in a changing marketplace. Management continually evaluates . . .

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