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TRCB > SEC Filings for TRCB > Form 10-Q on 14-Nov-2013All Recent SEC Filings

Show all filings for TWO RIVER BANCORP

Form 10-Q for TWO RIVER BANCORP


14-Nov-2013

Quarterly Report


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

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. Such statements are not historical facts and include expressions about management's confidence and strategies and management's expectations about new and existing programs and products, relationships, opportunities, taxation, technology and market conditions. When used in this and in our future filings with the SEC in our press releases and in oral statements made with the approval of an authorized executive officer, 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 one of our authorized executive officers of any such expressions made by a third party with respect to us) are intended to identify forward-looking statements. We wish to caution readers not to place undue reliance on any such forward-looking statements, each of which speaks only as of the date made, even if subsequently made available on our website or otherwise. 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 discussed under "Business", "Risk Factors" and "Management's Discussion and Analysis of Financial Condition and Results of Operations" in the 2012 Form 10-K, under this Item 2, and in our other filings with the SEC.

Although management has taken certain steps to mitigate any negative effect of these factors, significant unfavorable changes could severely impact the assumptions used and 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.

This Report contains certain financial information determined by methods other than in accordance with generally accepted accounting policies in the United States (GAAP). These non-GAAP financial measures are "tangible book value per common share," "return on average tangible assets," "return on average tangible equity," and "average tangible equity to average tangible assets." This non-GAAP disclosure has limitations as an analytical tool and should not be considered in isolation or as a substitute for analysis of the Company's results as reported under GAAP, nor is it necessarily comparable to non-GAAP performance measures that may be presented by other companies. Our management uses these non-GAAP measures in its analysis of our performance because it believes these measures are material and will be used as a measure of our performance by investors.

The following information should be read in conjunction with the consolidated financial statements and the related notes thereto included in the 2012 Form 10-K and in this Form 10-Q.

Critical Accounting Policies and Estimates

The following discussion is based upon our financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States of America ("GAAP"). The preparation of these financial statements requires the Company to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses.

Note 1 to our audited consolidated financial statements included in the 2012
Form 10-K contains a summary of the Company's significant accounting policies. Management believes the following critical accounting policies encompass the more significant judgments and estimates used in the preparation of our consolidated financial statements.

Allowance for Loan Losses. Management believes our policy with respect to the methodology for the determination of the allowance for loan losses ("ALLL") involves a high degree of complexity and requires management to make difficult and subjective judgments which often require assumptions or estimates about highly uncertain matters. Changes in these judgments, assumptions or estimates could materially impact the results of operations. This critical policy and its application are reviewed quarterly with our audit committee and Board of Directors.

Management is responsible for preparing and evaluating the ALLL on a quarterly basis in accordance with Bank policy, and the Interagency Policy Statement on the ALLL released by the Board of Governors of the Federal Reserve System on December 13, 2006 as well as GAAP. We believe that our allowance for loan losses is adequate to cover specifically identifiable loan losses, as well as estimated losses inherent in our portfolio for which certain losses are probable but not specifically identifiable. The allowance for loan losses is based upon management's evaluation of the adequacy of the allowance account, including an assessment of known and inherent risks in the portfolio, giving consideration to the size and composition of the loan portfolio, actual loan loss experience, level of delinquencies, detailed analysis of individual loans for which full collectability may not be assured, the existence and estimated net realizable value of any underlying collateral and guarantees securing the loans, and current economic and market conditions. Although management utilizes the best information available, the level of the allowance for loan losses remains an estimate that is subject to significant judgment and short term change. Various regulatory agencies may require us and our banking subsidiaries to make additional provisions for loan losses based upon information available to them at the time of their examination. The majority of our loans are secured by real estate in New Jersey, primarily in Monmouth and Union counties. The Company has also expanded its lending efforts into Middlesex County. Accordingly, the collectability of a substantial portion of the carrying value of our loan portfolio is susceptible to changes in local market conditions and may be adversely affected should real estate values decline or the New Jersey and/or our local market areas experience economic shock.


Stock Based Compensation. Stock based compensation cost has been measured using the fair value of an award on the grant date and is recognized over the service period, which is usually the vesting period. The fair value of each option is amortized into compensation expense on a straight-line basis between the grant date for the option and each vesting date. The Company estimates the fair value of stock options on the date of grant using the Black-Scholes option pricing model. The model requires the use of numerous assumptions, many of which are highly subjective in nature.

Goodwill Impairment. Although goodwill is not subject to amortization, the Company must test the carrying value for impairment at least annually or more frequently if events or changes in circumstances indicate that the asset might be impaired. Impairment testing requires that the fair value of our reporting unit be compared to the carrying amount of its net assets, including goodwill. Our reporting unit was identified as our community bank operations. If the fair value of the reporting unit exceeds the book value, no write-down of recorded goodwill is necessary. If the fair value of a reporting unit is less than book value, an expense may be required on the Company's books to write-down the related goodwill to the proper carrying value.

Investment Securities Impairment Valuation. Securities are evaluated on at least a quarterly basis, and more frequently when market conditions warrant such an evaluation, to determine whether a decline in their value is other-than-temporary. The analysis of other-than-temporary impairment requires the use of various assumptions including, but not limited to, the length of time the investment's book value has been greater than fair value, the severity of the investment's decline and the credit deterioration of the issuer. For debt securities, management assesses whether (a) it has the intent to sell the security and (b) it is more likely than not that it will be required to sell the security prior to its anticipated recovery. These steps are done before assessing whether the entity will recover the cost basis of the investment.

In instances when a determination is made that an other-than-temporary impairment exists but the investor does not intend to sell the debt security and it is not more likely than not that it will be required to sell the debt security prior to its anticipated recovery, the other-than-temporary impairment is separated into (a) the amount of the total other-than-temporary impairment related to a decrease in cash flows expected to be collected from the debt security (the credit loss) and (b) the amount of the total other-than-temporary impairment related to all other factors. The amount of the total other-than-temporary impairment related to the credit loss is recognized in earnings. The amount of the total other-than-temporary impairment related to all other factors is recognized in other comprehensive income.

Other Real Estate Owned ("OREO"). OREO includes real estate acquired through foreclosure. Real estate owned is initially recorded at fair value less cost to sell at the date of foreclosure, establishing a new cost basis. Subsequent to foreclosure, valuations are periodically performed by management and the assets are carried at the lower of carrying amount or fair value less cost to sell. When a property is acquired, the excess of the loan balance over fair value is charged to the allowance for loan losses. Operating results from real estate owned including rental income, operating expenses, and gains and losses realized from the sales of real estate owned are recorded as incurred. OREO is periodically reviewed to ensure that the fair value of the property supports the carrying value.

Deferred Tax Assets and Liabilities. We recognize deferred tax assets and liabilities for future tax effects of temporary differences, net operating loss carry forwards and tax credits. Deferred tax assets are subject to management's judgment based upon available evidence that future realization is more likely than not. If management determines that we may be unable to realize all or part of net deferred tax assets in the future, a direct charge to income tax expense may be required to reduce the recorded value of the net deferred tax asset to the expected realizable amount.


Overview

The Company reported net income to common shareholders of $1.3 million for the three months ended September 30, 2013, compared to $1.2 million, for the same period in 2012, an increase of $111,000, or 9.2%. Basic and diluted earnings per common share after preferred stock dividends were both $0.16 for the quarter ended September 30, 2013 compared to $0.15 for the same period in 2012. The annualized return on average assets was 0.73% for the three months ended September 30, 2013 as compared to 0.71% for the same period in 2012. The annualized return on average shareholders' equity was 5.81% for the three month period ended September 30, 2013 as compared to 5.47% for the three month period ended September 30, 2012.

The Company reported net income to common shareholders of $3.5 million for the nine months ended September 30, 2013, compared to $3.3 million, for the same period in 2012, an increase of $257,000, or 7.9%. Basic and diluted earnings per common share after preferred stock dividends were $0.44 and $0.43, respectively, for the nine months ended September 30, 2013 compared to $0.41 and $0.40, respectively, for the same periods in 2012. The annualized return on average assets was 0.68% for the nine month period ended September 30, 2013 as compared to 0.69% for the nine month period ended September 30, 2012. The annualized return on average shareholders' equity was 5.35% for both the nine month periods ended September 30, 2013 and 2012. Tangible book value per common share rose to $7.97 at September 30, 2013 as compared to $7.58 at September 30, 2012, as disclosed in the Non-GAAP Financial Measures table.

Net interest income for the quarter ended September 30, 2013 decreased by $49,000, or 0.7%, for the quarter ended September 30, 2013 from the same period in 2012. On a linked quarter basis, net interest income decreased by $151,000, or 2.3%, from the second quarter of 2013. Average earning assets totaled $690.2 million, an increase of $47.3 million, or 7.4%, from the quarter ended September 30, 2012, primarily due to increases in the investment and loan portfolios as well as a higher cash liquidity position, which resulted primarily from a higher level of core checking deposits. The Company reported a net interest margin of 3.77% for the quarter ended September 30, 2013, a decrease of 17 basis points when compared to the 3.94% reported for the quarter ended June 30, 2013 and a decrease of 32 basis points when compared to the 4.09% for the quarter ended September 30, 2012. The decline from last year was primarily the result of the current historically low interest rate environment, which has continued to exert pressure on net interest margins as longer term assets repriced to lower interest rate levels while funding costs near their implied floors. Additionally, the timing of a portion of our loan growth occurred in the latter part of the quarter, which will provide for incremental earnings in the fourth quarter and beyond.

Net interest income increased by $187,000, or 1.0%, for the nine months ended September 30, 2013 from the same period in 2012, primarily as a result of increases in both the investment and loan portfolios and a higher level of core checking deposits. The Company reported a net interest margin of 3.86% for the nine months ended September 30, 2013 a decrease of 26 basis points when compared to the 4.12% reported for the nine months ended September 30, 2012. The Company's net interest income increased despite margin compression resulting from the maturity, prepayment or contractual repricing of loans and securities in this prolonged low interest rate environment.

The provision for loan losses for the three months ended September 30, 2013 was $250,000, as compared to a provision for loan losses of $330,000 for the corresponding 2012 period. The provision for loan losses for the nine months ended September 30, 2013 was $710,000, as compared to a provision for loan losses of $950,000, for the corresponding 2012 period. The Company's provision considers a number of factors, including our assessment of the current state of the economy, prolonged high levels of unemployment in our market, allowances related to impaired loans and loan growth. The provision for the comparable 2012 period considered the same factors.

Non-interest income for the quarter ended September 30, 2013 totaled $681,000, an increase of $75,000, or 12.4%, compared to the same period in 2012. The increase was primarily due to a $24,000 gain on sale of SBA loans during the three months ended September 30, 2013 as compared to no gains recorded for the same period in 2012, no credit loss recorded during the quarter on our one pooled trust preferred security compared to a $32,000 loss in 2012 and a $14,000 increase in service fees on deposit accounts. Non-interest income for the nine months ended September 30, 2013 totaled $2.1 million, an increase of $145,000, or 7.5%, compared to the same period in 2012. The increase was primarily due to an increase of $153,000 in net gains from the sale of securities as compared to no net gains for the same period last year, an increase of $25,000 in service fees on deposit accounts and no credit loss recorded on our one pooled trust investment security as compared to an $80,000 loss in 2012. These increases were partially offset by a $78,000 decrease in gains on the sale of SBA loans and a $36,000 decrease in bank owned life insurance income.

Non-interest expense for the quarter ended September 30, 2013 totaled $4.8 million, a decrease of $122,000, or 2.5%, compared to the same period in 2012. This decrease was primarily due to a decrease of $74,000 in data processing expenses, a decrease of $69,000 in OREO expenses, OREO impairment and sales, net, and loan workout expenses and a decrease of $45,000 in outside service fees. These decreases were partially offset by an increase of $37,000 in professional fees and a $23,000 increase in occupancy and equipment expenses primarily resulting from costs relating to our new corporate headquarters. Non-interest expense for the nine months ended September 30, 2013 totaled $15.2 million, an increase of $322,000, or 2.2%, over the same period in 2012. The increase was due primarily to an increase of $78,000 in salary and benefit expenses as well as an increase of $345,000 in occupancy costs primarily relating to our new corporate headquarters as well as accelerated depreciation expenses relating to our Cliffwood branch closure, and an increase of $122,000 in professional fees due primarily to higher recruitment expenses. These increases were partially offset by lower data processing fees of $116,000 and a decrease of $103,000 in OREO expenses, OREO impairment and sales, net, and loan workout expenses. As previously reported, the Company filed the requisite applications to close its existing smaller branch in Red Bank, as well as its Cliffwood branch. The closures were finalized in June 2013. To date, there has been minimal loss of customer relationships due to these closures and we anticipate annual pre-tax expense savings of approximately $290,000.


Total assets at September 30, 2013 were $757.2 million, up 3.2% from total assets of $733.9 million at December 31, 2012. Total loans at September 30, 2013 were $587.9 million, an increase of 2.9% compared to $571.4 million at December 31, 2012. Total deposits were $625.7 million at September 30, 2013, an increase of 3.1% from total deposits of $606.8 million at December 31, 2012. Core checking deposits at September 30, 2013 increased $16.2 million, or 7.8%, when compared to year-end 2012, while savings accounts, inclusive of money market deposits, increased $20.0 million, or 6.7%. Conversely, higher cost time deposits decreased $17.3 million, or 17.3% over this same period.

The Company's allowance for loan losses was $8.3 million at September 30, 2013, compared with $8.0 million at December 31, 2012. The allowance for loan losses as a percentage of total loans at September 30, 2013 was 1.42%, compared with 1.40% at December 31, 2012. Non-performing assets at September 30, 2013, as a percentage of total assets were 1.43%, an increase from 1.26% at December 31, 2012. Non-performing assets increased to $10.9 million at September 30, 2013 as compared to $9.2 million at December 31, 2012.

RESULTS OF OPERATIONS

The Company's principal source of revenue is net interest income, which is the difference between interest income on earning assets and interest expense on deposits and borrowings. Interest earning assets consist primarily of loans, investment securities and Federal funds sold. Sources to fund interest-earning assets consist primarily of deposits and borrowed funds. The Company's net income is also affected by its provision for loan losses, other income and other expenses. Other income consists primarily of service charges, commissions and fees, earnings from investment in life insurance and gains on security sales, while other expenses are primarily comprised of salaries and employee benefits, occupancy costs and other operating expenses.

The following table provides information on our performance ratios for the dates indicated:

                                                       As of and for the                   As of and for the
                                               Three months ended September 30,     Nine months ended September 30,
                                                    2013               2012             2013               2012
Return on average assets                            0.73 %             0.71 %           0.68 %             0.69 %
Return on average tangible assets (1)               0.75 %             0.73 %           0.70 %             0.71 %
Return on average shareholders' equity              5.81 %             5.47 %           5.35 %             5.35 %
Return on average tangible shareholders'
equity (1)                                          7.21 %             6.87 %           6.66 %             6.75 %
Net interest margin                                 3.77 %             4.09 %           3.86 %             4.12 %
Average equity to average assets                   12.64 %            12.93 %          12.66 %            12.90 %
Average tangible equity to average tangible
assets (1)                                         10.45 %            10.57 %          10.44 %            10.50 %

(1) The following table provides the reconciliation of non-GAAP financial measures for the dates indicated:


                                                          As of and for the                         As of and for the
                                                  Three months ended September 30,           Nine months ended September 30,
                                                      2013                 2012                 2013                 2012

Book value per common share                    $       10.24         $        9.89       $       10.24         $        9.89
Effect of intangible assets                            (2.27 )               (2.31 )             (2.27 )               (2.31 )
Tangible book value per common share           $        7.97         $        7.58       $        7.97         $        7.58

Return on average assets                                0.73 %                0.71 %              0.68 %                0.69 %
Effect of intangible assets                             0.02 %                0.02 %              0.02 %                0.02 %
Return on average tangible assets                       0.75 %                0.73 %              0.70 %                0.71 %

Return on average equity                                5.81 %                5.47 %              5.35 %                5.35 %
Effect of average intangible assets                     1.40 %                1.40 %              1.31 %                1.40 %
Return on average tangible equity                       7.21 %                6.87 %              6.66 %                6.75 %

Average equity to average assets                       12.64 %               12.93 %             12.66 %               12.90 %
Effect of intangible assets                            (2.19 %)              (2.36 %)            (2.22 %)              (2.40 %)
Average tangible equity to average tangible
assets                                                 10.45 %               10.57 %             10.44 %               10.50 %

This Report contains certain financial information determined by methods other than in accordance with generally accepted accounting policies in the United States (GAAP). These non-GAAP financial measures are "tangible book value per common share," "return on average tangible assets," "return on average tangible equity," and "average tangible equity to average tangible assets." This non-GAAP disclosure has limitations as an analytical tool and should not be considered in isolation or as a substitute for analysis of the Company's results as reported under GAAP, nor is it necessarily comparable to non-GAAP performance measures that may be presented by other companies. Our management uses these non-GAAP measures in its analysis of our performance because it believes these measures are material and will be used as a measure of our performance by investors.

While the overall economy has been restrictive and somewhat constrained by the fragile economic environment, our local economy seems to reflect some strengthening in certain sectors. As such, we remain optimistic in our growth prospects for lending in 2014, recognizing that we will continue to be challenged due in part to both the competitive landscape and pricing pressures in this low rate environment. In addition, should another general decline in economic conditions in New Jersey occur, the Company may suffer higher default rates on its loans, decreased value of assets it holds as collateral, and potentially lower loan originations due to heightened competition for lending relationships coupled with our higher credit standards and requirements.

Three months ended September 30, 2013 compared to September 30, 2012

Net Interest Income

Net interest income decreased by $49,000, or 0.7%, for the three months ended September 30, 2013 compared to the corresponding period in 2012. Average interest earning assets totaled $690.2 million for the third quarter of 2013, an increase of $47.3 million, or 7.4%, from $642.9 million for the same period in 2012. The net interest spread and net interest margin decreased to 3.61% and 3.77%, respectively, for the three months ended September 30, 2013, from 3.89% and 4.09%, respectively, for the three months ended September 30, 2012. This decrease primarily resulted from the current historically low interest rate environment, which has continued to exert pressure on net interest margins as longer assets repriced to lower interest rate levels while funding costs approach their implied floors. In addition, an aggregate of $55,000 of interest income and late fee reversals were recorded on loans that were transferred into non-accrual status during the third quarter of 2013 as compared to $30,000 for the same period in 2012.

Total interest income for the three months ended September 30, 2013 decreased by $257,000, or 3.3%. The decrease in interest income was primarily due to a rate related decrease in interest income of $686,000, partially offset by a volume related increase in interest income of $429,000 for the third quarter of 2013 as compared to the same prior year period.


Interest and fees on loans decreased $248,000, or 3.4%, to $7.1 million for the three months ended September 30, 2013 compared to $7.3 million for the corresponding period in 2012. Rate related decreases equaled $600,000, partially offset by a volume related increase of $352,000. The average balance of the loan portfolio for the three months ended September 30, 2013 increased by $26.4 million, or 4.8%, to $577.4 million from $551.0 million for the corresponding period in 2012. The average annualized yield on the loan portfolio was 4.86% for the quarter ended September 30, 2013 compared to 5.29% for the quarter ended September 30, 2012. Additionally, the average balance of non-accrual loans during the three month periods ended September 30, 2013 and 2012 of $9.2 million and $4.9 million, respectively, impacted the Company's loan yield for both periods presented.

Interest income on investment securities totaled $378,000 for the three months ended September 30, 2013 compared to $391,000 for the three months ended September 30, 2012, a decrease of $13,000, or 3.3%. This decrease was primarily attributable to a decrease in rate related activity offset in part by an increase in volume related activity. New purchases made in 2013 continue to be made at lower rates resulting from the lower rate environment. For the three . . .

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