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FCCY > SEC Filings for FCCY > Form 10-Q on 12-Nov-2013All Recent SEC Filings

Show all filings for 1ST CONSTITUTION BANCORP

Form 10-Q for 1ST CONSTITUTION BANCORP


12-Nov-2013

Quarterly Report


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

The purpose of this discussion and analysis of the operating results and financial condition at September 30, 2013 is intended to help readers analyze the accompanying financial statements, notes and other supplemental information contained in this document. Results of operations for the three month and nine month periods ended September 30, 2013 are not necessarily indicative of results to be attained for any other period.

This discussion and analysis should be read in conjunction with the Consolidated Financial Statements, notes and tables included elsewhere in this report and Part II, Item 7 of the Company's Form 10-K (Management's Discussion and Analysis of Financial Condition and Results of Operations) for the year ended December 31, 2012, as filed with the Securities and Exchange Commission (the "SEC") on March 22, 2013.

General

Throughout the following sections, the "Company" refers to 1st Constitution Bancorp and, as the context requires, its wholly-owned subsidiary, 1st Constitution Bank (the "Bank"), and the Bank's wholly-owned subsidiaries, 1st Constitution Investment Company of New Jersey, Inc., FCB Assets Holdings, Inc., 1st Constitution Title Agency, LLC, 204 South Newman Street Corp. and 249 New York Avenue, LLC. 1st Constitution Capital Trust II ("Trust II"), a subsidiary of the Company, is not included in the Company's consolidated financial statements as it is a variable interest entity and the Company is not the primary beneficiary.

The Company is a bank holding company registered under the Bank Holding Company Act of 1956, as amended. The Company was organized under the laws of the State of New Jersey in February 1999 for the purpose of acquiring all of the issued and outstanding stock of the Bank, a full service commercial bank which began operations in August 1989, thereby enabling the Bank to operate within a bank holding company structure. The Company became an active bank holding company on July 1, 1999. The Bank is a wholly-owned subsidiary of the Company. Other than its ownership interest in the Bank, the Company currently conducts no other significant business activities.

The Bank operates fourteen branches, and manages an investment portfolio through its subsidiary, 1st Constitution Investment Company of New Jersey, Inc. FCB Assets Holdings, Inc., a subsidiary of the Bank, is used by the Bank to manage and dispose of repossessed real estate.

Trust II, a subsidiary of the Company, was created in May 2006 to issue trust preferred securities to assist the Company to raise additional regulatory capital.


Table of Contents

Forward-Looking Statements

This report contains forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended (the "Exchange Act"). The Private Securities Litigation Reform Act of 1995 provides a "safe harbor" for forward looking statements. When used in this and in future filings by the Company with the SEC, in the Company's press releases and in oral statements made with the approval of an authorized executive officer of the Company, the words or phrases "will," "will likely result," "could," "anticipates," "believes," "continues," "expects," "plans," "will continue," "is anticipated," "estimated," "project" or "outlook" or similar expressions (including confirmations by an authorized executive officer of the Company of any such expressions made by a third party with respect to the Company) are intended to identify forward-looking statements. The Company wishes to caution readers not to place undue reliance on any such forward-looking statements, each of which speak only as of the date made. Such statements are subject to certain risks and uncertainties that could cause actual results to differ materially from historical earnings and those presently anticipated or projected.

Factors that may cause actual results to differ from those results, expressed or implied, include, but are not limited to, those listed under "Business", "Risk Factors" and "Management's Discussion and Analysis of Financial Condition and Results of Operations" in the Company's Annual Report on Form 10-K filed with the SEC on March 22, 2013, such as the overall economy and the interest rate environment; the ability of customers to repay their obligations; the adequacy of the allowance for loan losses; competition; significant changes in accounting, tax or regulatory practices and requirements; certain interest rate risks; risks associated with investments in mortgage-backed securities; and risks associated with speculative construction lending. Although management has taken certain steps to mitigate any negative effect of the aforementioned items, significant unfavorable changes could severely impact the assumptions used and could have an adverse effect on profitability. The Company undertakes no obligation to publicly revise any forward-looking statements to reflect anticipated or unanticipated events or circumstances occurring after the date of such statements, except as required by law.


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RESULTS OF OPERATIONS

Three Months Ended September 30, 2013 Compared to the Three Months Ended September 30, 2012

Summary

The Company realized net income of $1,523,238 for the three months ended September 30, 2013, an increase of $168,319, or 12.4%, from the $1,354,919 reported for the three months ended September 30, 2012. The increase was due primarily to an increase in non-interest income and a lower level of non-interest expenses which, in total, offset the decrease in net interest income and a higher loan loss provision. Net income per diluted common share was $0.25 for the three months ended September 30, 2013, which was unchanged when compared to the three months ended September 30, 2012. All prior year share information has been adjusted for the effect of a 5% stock dividend declared on December 20, 2012 and paid on January 31, 2013 to shareholders of record on January 14, 2013.

During the third quarter of 2012, the Company launched a shareholders' common stock rights offering, which expired on October 5, 2012. The Company received gross proceeds of $5.0 million from holders of subscription rights who exercised their basic subscription rights and from holders who exercised the over-subscription privilege. The rights offering was fully subscribed. Accordingly, the Company issued a total of 555,555 shares of common stock to the holders of subscription rights who validly exercised their subscription rights, including pursuant to the exercise of the over-subscription privilege.

Key performance ratios improved for the three months ended September 30, 2013 due to higher net income for that period compared to the three months ended September 30, 2012. Return on average assets and return on average equity were 0.76% and 9.25%, respectively, for the three months ended September 30, 2013 compared to 0.69% and 9.24%, respectively, for the three months ended September 30, 2012.

The Bank's results of operations depend primarily on net interest income, which is primarily affected by the market interest rate environment, the shape of the U.S. Treasury yield curve, and the difference between the yield on interest-earning assets and the rate paid on interest-bearing liabilities. Other factors that may affect the Bank's operating results are general and local economic and competitive conditions, government policies and actions of regulatory authorities. The net interest margin on a tax-equivalent basis for the three months ended September 30, 2013 was 3.52% as compared to the 4.09% net interest margin recorded for the three months ended September 30, 2012, a decrease of 57 basis points. This decrease in the Company's net interest margin for the three months ended September 30, 2013 compared with the corresponding 2012 period was primarily due to two factors: (1) the decline in the balance of outstanding borrowings under mortgage warehouse lines and (2) the allocation of excess liquidity to much lower yielding overnight fund balances. The decline in borrowings under mortgage warehouse lines was due to the increase in long-term interest rates during the third quarter of 2013, which led to lower levels of mortgage refinancings, and the shift from borrowings for mortgage refinancings to borrowings for new mortgages to purchase real property, which typically require more time to document and close. The Company will continue to closely monitor the mix of earning assets and funding sources to maximize net interest income during this challenging interest rate environment.

Earnings Analysis

Net Interest Income

Net interest income, the Company's largest and most significant component of operating income, is the difference between interest and fees earned on loans and other earning assets and interest paid on deposits and borrowed funds. This component represented 79.6% of the Company's net revenues for the three-month period ended September 30, 2013 and 84.6% of net revenues for the three-month period ended September 30, 2012. Net interest income also depends upon the relative amount of average interest-earning assets, average interest-bearing liabilities, and the interest rate earned or paid on them, respectively.

The Company's net interest income decreased by $939,380, or 13.0 %, to $6,305,022 for the three months ended September 30, 2013 from the $7,244,402 reported for the three months ended September 30, 2012. The decrease in net interest income was primarily attributable to a lower level of higher yielding mortgage warehouse portfolio loans during the current period. The average rate paid on interest-bearing liabilities for the three months ended September 30, 2013 was 0.70%, a reduction of 14 basis points compared to 0.84% paid for the three months ended September 30, 2012. The average yield on assets decreased to 4.07% for the three months ended September 30, 2013 from 4.77% for the three months ended September 30, 2012 due to a shift in average assets away from loans which typically have higher yields than securities.

Average interest earning assets increased by $17,843,175, or 2.5%, to $743,290,714 for the three-month period ended September 30, 2013 from $725,447,539 for the three-month period ended September 30, 2012. The overall yield on interest earning assets, on a tax-equivalent basis, decreased 70 basis points to 4.07% for the three-month period ended September 30, 2013 when compared to 4.77% for the three-month period ended September 30, 2012.


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Average interest bearing liabilities decreased by $1,138,771 to $585,200,612 for the three-month period ended September 30, 2013 from $586,339,383 for the three-month period ended September 30, 2012. Overall, the cost of total interest bearing liabilities decreased 14 basis points to 0.70% for the three months ended September 30, 2013 compared to 0.84% for the three months ended September 30, 2012.

The net interest margin, which is net interest income on a tax equivalent basis divided by average interest earning assets, was 3.52% for the three months ended September 30, 2013 compared to 4.09% for the three months ended September 30, 2012.

Provision for Loan Losses

Management considers a complete review of the following specific factors in determining the provisions for loan losses: historical losses by loan category, non-accrual loans, problem loans as identified through internal classifications, collateral values, and the growth and size of the loan portfolio.

At September 30, 2013, the loan portfolio balance was $362,549,473, which represented a decrease of $159,264,637, or 30.5%, compared to the December 31, 2012 balance of $521,814,110. In addition to these factors, management takes into consideration current economic conditions and local real estate market conditions. Using this evaluation process, the Company's provision for loan losses was $539,998 for the three months ended September 30, 2013 compared to $499,998 for the three months ended September 30, 2012.

Non-Interest Income

Total non-interest income for the three months ended September 30, 2013 was $1,616,548, an increase of $299,821, or 22.8%, over non-interest income of $1,316,727 for the three months ended September 30, 2012. This component represented 20.4% of the Company's net revenues for the three months ended September 30, 2013 and 15.4% of net revenues for the three-month period ended September 30, 2012.

Service charges on deposit accounts represent a consistent source of non-interest income. Service charge revenues decreased modestly to $231,169 for the three months ended September 30, 2013 from $243,443 for the three months ended September 30, 2012. This decrease was the result of a lower volume of uncollected funds and overdraft fees collected on deposit accounts during the three months ended September 30, 2013 compared to the three months ended September 30, 2012.

Gain on sales of loans held for sale increased to $641,966 for the three months ended September 30, 2013 compared to $509,138 for the three months ended September 30, 2012. The Bank sells both residential mortgage loans and Small Business Administration loans in the secondary market. The volume of mortgage loan sales increased for the three months ended September 30, 2013 compared to the three months ended September 30, 2012.

Non-interest income also includes income from bank-owned life insurance ("BOLI"), which amounted to $115,840 for the three months ended September 30, 2013 compared to $112,276 for the three months ended September 30, 2012. The Bank purchased tax-free BOLI assets to partially offset the cost of employee benefit plans and reduce the Company's overall effective tax rate.

The Bank also generates non-interest income from a variety of fee-based services. These include safe deposit box rental, wire transfer service fees, cash counting fees and Automated Teller Machine fees for non-Bank customers. Increased customer demand for these services contributed $627,573 to the other income component of non-interest income for the three months ended September 30, 2013 compared to $451,870 for the three months ended September 30, 2012, an increase of $175,703 for the third quarter of 2013 as compared to the third quarter of 2012.

Non-Interest Expenses

Non-interest expenses decreased by $929,691, or 15.0%, to $5,253,483 for the three months ended September 30, 2013 from $6,183,174 for the three months ended September 30, 2012. The current period decrease in other real estate owned expenses was the primary cause for this current period decrease in total non-interest expenses when compared with the prior period's non-interest expenses. The following table presents the major components of non-interest expenses for the three months ended September 30, 2013 and 2012.


Table of Contents

 Non-Interest Expenses
                                               Three months ended September 30,
                                                 2013                    2012

 Salaries and employee benefits            $       3,060,143       $       3,061,065
 Occupancy expenses                                  629,922                 523,126
 Data processing services                            273,272                 257,991
 Marketing                                            79,656                  46,969
 Regulatory, professional and other fees             303,114                 196,870
 FDIC insurance expense                              111,563                 139,693
 Other real estate owned expenses                    176,796               1,246,221
 Amortization of intangible assets                    66,992                  66,993
 All other expenses                                  552,025                 644,246
                                           $       5,253,483       $       6,183,174

Salaries and employee benefits, which represent the largest portion of non-interest expenses, decreased marginally to $3,060,143 for the three months ended September 30, 2013 compared to $3,061,065 for the three months ended September 30, 2012.

Occupancy expenses increased by $106,796 to $629,922 for the three months ended September 30, 2013 compared to $523,126 for the three months ended September 30, 2012. The increase in expense was primarily attributable to higher maintenance costs incurred to maintain the Bank's branch operations and the timing of these repairs.

The cost of data processing services increased to $273,272 for the three months ended September 30, 2013 from $257,991 for the three months ended September 30, 2012 as additional expenses were incurred in connection with a 2013 initiative to upgrade software capabilities in branch offices in order to fully implement the Bank's expanding mobile banking systems.

Regulatory, professional and other fees increased by $106,244 to $303,114 for the three months ended September 30, 2013 compared to $196,870 for the three months ended September 30, 2012. During the three months ended September 30, 2013, the Company incurred professional fees in connection with consultants engaged to assess the Company's compliance with regulatory requirements and risk management programs and legal fees in connection with the proposed merger of Rumson-Fair Haven Bank & Trust Company with and into the Bank.

Other real estate owned expenses decreased by $1,069,425 to $176,796 for the three months ended September 30, 2013 compared to $1,246,221 for the three months ended September 30, 2012 as the Company incurred a lower level of property taxes, maintenance and other expenses on fewer repossessed properties during the third quarter of 2013 compared to the third quarter of 2012. At September 30, 2013, the Bank held four properties with an aggregate value of $2,808,554 as other real estate owned compared to nine properties with an aggregate value of $10,225,740 at September 30, 2012.

FDIC insurance expense decreased to $111,563 for the three months ended September 30, 2013 compared to $139,693 for the three months ended September 30, 2012 as a result of the changes required by the Dodd-Frank Act with respect to FDIC premium assessment rules.

All other expenses decreased to $552,025 for the three months ended September 30, 2013 from $644,246 for the three months ended September 30, 2012. Current period decreases occurred in correspondent bank fees, maintenance agreements and ATM operating expenses. All other expenses are comprised of a variety of operating expenses and fees as well as expenses associated with lending activities.


Table of Contents

An important financial services industry productivity measure is the efficiency ratio. The efficiency ratio is calculated by dividing total operating expenses by the sum of net interest income on a tax-equivalent basis and non-interest income. An increase in the efficiency ratio indicates that more resources are being utilized to generate the same or greater volume of income, while a decrease would indicate a more efficient allocation of resources. The Company's efficiency ratio decreased to 64.1% for the three months ended September 30, 2013 compared to 70.6% for the three months ended September 30, 2012 primarily as a result of the $1,069,425 decrease in other real estate owned expenses.

Income Taxes

Income tax expense increased by $81,813 to $604,851 for the three months ended September 30, 2013 from $523,038 for the three months ended September 30, 2012. The increase was primarily due to a higher level of pretax income for the third quarter of 2013 as compared to the third quarter of 2012.

Nine Months Ended September 30, 2013 Compared to the Nine Months Ended September 30, 2012

Summary

The Company realized net income of $4,405,588 for the nine months ended September 30, 2013, an increase of 15.3% from the $3,819,759 reported for the nine months ended September 30, 2012. The increase was due primarily to an increase in non-interest income, a lower level of the provision for loan losses and a decrease in noninterest expenses which, in total, offset a decrease in net interest income for the nine months ended September 30, 2013 compared to the same period in 2012.

Diluted net income per share was $0.72 for the nine months ended September 30, 2013 compared to diluted net income per share of $0.70 for the nine months ended September 30, 2012. All prior year share information has been adjusted for the effect of a 5% stock dividend declared on December 20, 2012 and paid on January 31, 2013 to shareholders of record on January 14, 2013.

During the third quarter of 2012, the Company launched a shareholders' common stock rights offering, which expired on October 5, 2012. The Company received gross proceeds of $5.0 million from holders of subscription rights who exercised their basic subscription rights and from holders who exercised the over-subscription privilege. The rights' offering was fully subscribed. Accordingly, the Company issued a total of 555,555 shares of common stock to the holders of subscription rights who validly exercised their subscription rights, including pursuant to the exercise of the over-subscription privilege.

Return on average assets and return on average equity were 0.73% and 8.96%, respectively, for the nine months ended September 30, 2013 compared to 0.67% and 9.01%, respectively, for the nine months ended September 30, 2012. Return on average assets improved for the nine months ended September 30, 2013 as compared to the nine months ended September 30, 2012 due to the higher level of net income for the 2013 period and the slight reduction in return on average equity for the nine months ended September 30, 2013 compared to the nine months ended September 30, 2012 was primarily due to the issuance of new shares in the Company's rights offering completed in October 2012.

The Bank's results of operations depend primarily on net interest income, which is primarily affected by the market interest rate environment, the shape of the U.S. Treasury yield curve, and the difference between the yield on interest-earning assets and the rate paid on interest-bearing liabilities. Other factors that may affect the Bank's operating results are general and local economic and competitive conditions, government policies and actions of regulatory authorities. The net interest margin for the nine months ended September 30, 2013 was 3.48% as compared to the 3.98% net interest margin recorded for the nine months ended September 30, 2012, a decrease of 50 basis points. This decrease in the Company's net interest margin for the nine months ended September 30, 2013 compared with the corresponding 2012 period was primarily due to two factors: (1) the decline in the balance of outstanding borrowings under mortgage warehouse lines and (2) the allocation of excess liquidity to much lower yielding overnight fund balances. The decline in borrowings under mortgage warehouse lines was due to the increase in long-term interest rates during the third quarter of 2013, which led to lower levels of mortgage refinancings, and the shift from borrowings for mortgage refinancings to borrowings for new mortgages to purchase real property, which typically require more time to document and close. The Company will continue to closely monitor the mix of earning assets and funding sources to maximize net interest income during this challenging interest rate environment.

Earnings Analysis

Net Interest Income

Net interest income, the Company's largest and most significant component of operating income, is the difference between interest and fees earned on loans and other earning assets and interest paid on deposits and borrowed funds. This component represented 80.0% of the Company's net revenues for the nine-month period ended September 30, 2013 and 84.8% of net revenues for the nine-month period ended September 30, 2012. Net interest income also depends upon the relative amount of interest-earning assets, interest-bearing liabilities, and the interest rate earned or paid on them, respectively.


Table of Contents

The following table sets forth the Company's consolidated average balances of assets, liabilities and shareholders' equity as well as interest income and expense on related items and the Company's average yield or rate for the nine month periods ended September 30, 2013 and 2012, respectively. The average rates are derived by dividing interest income and expense by the average balance of assets and liabilities, respectively.

Average Balance Sheets with Resultant Interest and Rates
(yields on a tax-equivalent basis)                 Nine months ended September 30, 2013                   Nine months ended September 30, 2012
                                                Average                               Average          Average                               Average
                                                Balance             Interest           Yield           Balance             Interest           Yield
Assets:
Federal Funds Sold/Short-Term Investments   $   112,351,662       $     221,087          0.26%     $    28,950,888       $      55,315          0.26%
Investment Securities:
Taxable                                         156,884,880           2,818,801          2.40%         171,836,158           3,430,770          2.66%
Tax-exempt                                       67,610,995           2,418,022          4.77%          50,443,281           1,837,521          4.86%
Total                                           224,495,875           5,236,823          3.11%         222,279,439           5,268,291          3.16%

Loan Portfolio:
Construction                                     42,149,774           1,926,931          6.11%          57,303,861           2,861,353          6.67%
Residential real estate                          11,057,154             430,207          5.20%          11,920,919             463,905          5.20%
Home Equity                                       9,208,816             373,778          5.43%          10,529,455             445,123          5.65%
Commercial and commercial real estate           143,067,333           7,838,953          7.33%         145,668,346           8,013,835          7.35%
Mortgage warehouse lines                        166,142,165           5,808,889          4.67%         198,007,591           7,060,451          4.76%
Installment                                         254,238              12,284          6.46%             356,875              18,221          6.82%
All Other Loans                                  41,800,648             928,216          2.97%          32,771,044             837,561          3.41%
Total                                           413,680,128          17,319,258          5.60%         456,558,091          19,700,449          5.76%

      Total Interest-Earning Assets             750,527,665          22,777,168          4.05%         707,788,418          25,024,055          4.72%

Allowance for Loan Losses                       (6,777,671)                                            (6,150,075)
Cash and Due From Bank                           18,481,914                                             10,091,843
. . .
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