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CNBC > SEC Filings for CNBC > Form 10-K on 5-Mar-2014All Recent SEC Filings

Show all filings for CENTER BANCORP INC

Form 10-K for CENTER BANCORP INC


5-Mar-2014

Annual Report


Item 7. Management's Discussion and Analysis ("MD&A") of Financial Condition and Results of Operations

The purpose of this analysis is to provide the reader with information relevant to understanding and assessing the Corporation's results of operations for each of the past three years and financial condition for each of the past two years. In order to fully appreciate this analysis, the reader is encouraged to review the consolidated financial statements and accompanying notes thereto appearing under Item 8 of this report, and statistical data presented in this document.

Cautionary Statement Concerning Forward-Looking Statements

See Item 1 of this Annual Report on Form 10-K for information regarding forward-looking statements.

Critical Accounting Policies and Estimates

The accounting and reporting policies followed by the Corporation conform, in all material respects, to U.S. GAAP. In preparing the consolidated financial statements, management has made estimates, judgments and assumptions that affect the reported amounts of assets and liabilities as of the dates of the consolidated statements of condition and results of operations for the periods indicated. Actual results could differ significantly from those estimates.

The Corporation's accounting policies are fundamental to understanding this MD&A. The most significant accounting policies followed by the Corporation are presented in Note 1 of the Notes to Consolidated Financial Statements. The Corporation has identified its policies on the allowance for loan losses, other-than-temporary impairment of securities, income tax liabilities and goodwill and other identifiable intangible assets to be critical because management must make subjective and/or complex judgments about matters that are inherently uncertain and could be most subject to revision as new information becomes available. Additional information on these policies can be found in Note 1 of the Notes to Consolidated Financial Statements.

Allowance for Loan Losses and Related Provision

The allowance for loan losses represents management's estimate of probable loan losses inherent in the loan portfolio. Determining the amount of the allowance for loan losses is considered a critical accounting estimate because it requires significant judgment and the use of estimates related to the amount and timing of expected future cash flows on impaired loans, estimated losses on pools of homogeneous loans based on historical loss experience, and consideration of current economic trends and conditions, all of which may be susceptible to significant change. The loan portfolio also represents the largest asset type on the Corporation's Consolidated Statements of Condition.

The evaluation of the adequacy of the allowance for loan losses includes, among other factors, an analysis of historical loss rates by loan category applied to current loan totals. However, actual loan losses may be higher or lower than historical trends, which vary. Actual losses on specified problem loans, which also are provided for in the evaluation, may vary from estimated loss percentages, which are established based upon a limited number of potential loss classifications.

The allowance for loan losses is established through a provision for loan losses charged to expense. Management believes that the current allowance for loan losses will be adequate to absorb loan losses on existing loans that may become uncollectible based on the evaluation of known and inherent risks in the loan portfolio. The evaluation takes into consideration such factors as changes in the nature and size of the portfolio, overall portfolio quality, and specific problem loans and current economic conditions which may affect the borrowers' ability to pay. The evaluation also details historical losses by loan category and the resulting loan loss rates which are projected for current loan total amounts. Loss estimates for specified problem loans are also detailed. All of the factors considered in the analysis of the adequacy of the allowance for loan losses may be subject to change. To the extent actual outcomes differ from management estimates, additional provisions for loan losses may be required that could materially adversely impact earnings in future periods. Additional information can be found in Note 1 of the Notes to Consolidated Financial Statements.

Other-Than-Temporary Impairment of Securities

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. FASB ASC 320-10-65, clarifies the interaction of the factors that should be considered when determining whether a debt security is other-than-temporarily impaired. For debt securities, management must assess 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. Previously, this assessment required management to assert that it had both the intent and the ability to hold a security for a period of time sufficient to allow for anticipated recovery in fair value to avoid recognizing an other-than-temporary impairment. This change does not affect the need to forecast recovery of the value of the security through either cash flows or market price.

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, FASB ASC 320-10-65 changes the presentation and amount of the other-than-temporary impairment recognized in the income statement. 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 through earnings. The amount of the total other-than-temporary impairment related to all other factors is recognized in other comprehensive income. Impairment charges on certain investment securities of approximately $652,000 were recognized in earnings during the year ended December 31, 2013. Of this amount, $628,000 related to a pooled trust preferred security (or "TRUP"), and $24,000 related to principal losses on a variable rate private label collateralized mortgage obligation ("CMO"). The Corporation's approach to determining whether or not other-than-temporary impairment exists for any of these investments was consistent with the accounting guidance in effect at that time. For the year ended December 31, 2013, the Corporation primarily relied upon the guidance in FASB ASC 320-10-65, FASB ASC 820-10-65 and FASB ASC 310-10-35. Additional information can be found in Note 5 of the Notes to Consolidated Financial Statements.

Impairment charges on certain investment securities of approximately $870,000 were recognized in earnings during the year ended December 31, 2012. Of this amount, $68,000 related to a TRUP, $484,000 related to a variable rate private label CMO and $318,000 related to principal losses on a variable rate private label CMO. The Corporation's approach to determining whether or not other-than-temporary impairment exists for any of these investments was consistent with the accounting guidance in effect at that time. For the years ended December 31, 2012 and 2011, the Corporation primarily relied upon the guidance in FASB ASC 320-10-65, FASB ASC 820-10-65 and FASB ASC 325-10-35.

Income Taxes

The objectives of accounting for income taxes are to recognize the amount of taxes payable or refundable for the current year and deferred tax liabilities and assets for the future tax consequences of events that have been recognized in an entity's financial statements or tax returns. Judgment is required in assessing the future tax consequences of events that have been recognized in the Corporation's consolidated financial statements or tax returns.

Fluctuations in the actual outcome of these future tax consequences could impact the Corporation's consolidated financial condition or results of operations. Notes 1 (under the caption "Use of Estimates") and 12 of the Notes to Consolidated Financial Statements include additional discussion on the accounting for income taxes.

Goodwill

The Corporation has adopted the provisions of FASB ASC 350-10-05, which requires that goodwill be reported separate from other intangible assets in the Consolidated Statements of Condition and not be amortized but tested for impairment annually or more frequently if impairment indicators arise for impairment. No impairment charge was deemed necessary for the years ended December 31, 2013, 2012 and 2011.

Fair Value of Investment Securities

In October 2008, the FASB issued FASB ASC 820-10-35, to clarify the application of the provisions of FASB ASC 820-10-05 in an inactive market and how an entity would determine fair value in an inactive market. Changes in the Corporation's methodology occurred for the quarter ended June 30, 2009 as new accounting guidance was released in April of 2009 with mandatory adoption required in the second quarter. The Corporation relied upon the guidance in FASB ASC 820-10-65 when determining fair value for the Corporation's pooled trust preferred securities and private issue corporate bond. See Note 19 of the Notes to Consolidated Financial Statements, Fair Value Measurements and Fair Value of Financial Instruments, for further discussion.

Introduction

The following introduction to Management's Discussion and Analysis highlights the principal factors that contributed to the Corporation's earnings performance in 2013.

The year 2013 was challenging not only for the banking industry in general but also for the Corporation in particular. The current domestic economic issues, ongoing global financial uncertainty and continued headwinds from new regulatory requirements created challenges to financial institutions both domestically and abroad. Interest rates in 2013 and 2012 were reflective of significantly lower short-term interest rates, as the Federal Reserve maintained its policy stance and continued to expand monetary policy with Quantitative Easing 3, or QE3, to further stimulate the economy and employment. As a result, the Federal Reserve kept overnight borrowing rates at zero to 25 basis points throughout 2013. Short-term interest rates remained lower than longer term rates, resulting in a somewhat improved steepening of the yield curve. Historically, such an improvement in yield curve has benefitted the Corporation's net interest income, which is the Corporation's primary source of income.

The Corporation was proactive with its balance sheet strategies throughout 2013 in order to reduce further exposure to interest rates through a reduction in higher cost funding and non-core balances in the deposit mix coupled with an improvement in the earning asset mix. The Corporation's progress in growing and improving its balance sheet earning asset mix has helped to expand its spread and margin.

The Corporation's net income in 2013 was $19.9 million or $1.21 per fully diluted common share, compared with net income of $17.5 million or $1.05 per fully diluted common share in 2012. The growth in earnings performance in 2013 (as well as in 2012) was primarily attributable to earnings from core operations. Earnings for 2013 and associated operating performance was characterized by solid revenue growth, strong organic loan generation and a continuation of our stable and favorable asset quality profile. Earnings were positively impacted by growth in net interest income, primarily from an increase in the average balance of earning assets of $108.8 million, which was partially offset by a decline of 13 basis points in yield. The decline in yield on earning assets was somewhat offset by a decline of 8 basis points from a lower cost of funds as compared to 2012.

For the year ended December 31, 2013, net interest income on a fully taxable equivalent basis amounted to $48.7 million, compared to $45.4 million for the same period in 2012. For 2013, interest income increased by $2.6 million while interest expense decreased by $694,000 from last year. Compared to 2012, for 2013, as noted above average interest earning assets increased $108.8 million while net interest spread and margin decreased on a tax-equivalent basis by 5 basis points and 2 basis points, respectively. For 2013, the Corporation's net interest margin decreased to 3.30 percent as compared to 3.32 percent for 2012.

Net interest margins reflected improvement in the fourth quarter of 2012, as prior action on reducing the cost of funds coupled with offsetting compression primarily as result of a continued high liquidity pool carried during the periods took root and started to abate further compression..

Total non-interest income declined as a percentage of total revenue, which is the sum of interest income and non-interest income, in 2013 largely due to a reduction in net securities gains; $1.7 million in 2013 as compared to $2.0 million in net securities gains in 2012. For the twelve months ended December 31, 2013, total other income decreased $359,000 as compared with the twelve months ended December 31, 2012, from $7.2 million to $6.9 million. Excluding net securities gains and losses and the bargain gain on acquisition of $899,000 in the respective periods, the Corporation recorded total other income of $5.1 million and $4.3 million in the twelve months ended December 31, 2013 and 2012, respectively.

For the twelve months ended December 31, 2013, total other expense increased $81,000, or 0.03 percent, compared to the year ended December 31, 2012. Excluding a repurchase agreement termination fee and acquisition cost incurred in 2012, the increase was $1.6 million and 6.6 percent. Increases primarily included salaries and employee benefits of $894,000, $531,000 in occupancy and equipment, $118,000 in marketing and advertising and $34,000 in professional and consulting, and $80,000 in all other expense. These increases were partially offset by decreases of $56,000 in FDIC insurance expense, $16,000 in stationery and printing expense, and $13,000 in OREO expense. The Corporation' s efficiency ratio for the twelve months ended December 31, 2013 was 46.9 percent as compared to 47.7 percent in 2012.

Our continued performance put the Corporation at a competitive advantage while the competition for deposits in the Corporation's marketplace remained intense. The Corporation expanded its client base and market share, as customers seek safety through high quality organizations to satisfy liquidity and safety and soundness, which became paramount in light of the protracted financial crisis. With that competitive advantage, the Corporation continues to move forward with momentum in expanding our presence in key markets. With the acquisition of Saddle River Valley Bank in 2012 and the opening of our Englewood office, we are working to solidify and expand the service relationship with our new customers. We remain excited by the potential to create incremental shareholder value from our strategic growth. We believe that this type of sequential earnings performance demonstrates the Corporation's commitment to achieving meaningful growth in earnings performance, an essential component of providing consistent and favorable long-term returns to our shareholders. However, while we continue to see an improvement in balance sheet strength and core earnings performance, we still remain cautious about the credit stability of the broader markets.

Total assets at December 31, 2013 were $1.673 billion, an increase of 2.7 percent from assets of $1.630 billion at December 31, 2012. The increase in assets reflects the growth of $71.3 million in our loan portfolio as the Corporation continued to expand its client base and loan production, deploying cash from increased deposit production into a more efficient earning asset mix. The growth in the earning asset portfolio was funded in part through deposit growth of $35.1 million, which also resulted in increases in loans net of the allowance for loan losses and loans available for sale of $71.2 million. The Corporation has made a concerted effort to reduce non-core balances and, as mentioned in the preceding sentence, its un-invested cash position decreased by $23.4 million in 2013. Additionally, there has been a concerted effort to reduce higher costing retail deposits.

Loan demand continued to expand in 2013. Overall, the portfolio increased year over year by approximately $71.3 million or 8.0 percent from 2012. Demand for both commercial loans and real estate loans prevailed throughout the year in the Corporation's market in New Jersey, despite the economic climate at both the state and national levels. The Corporation is encouraged by loan demand and positive momentum is expected to continue in growing that segment of earning assets in 2014. However, the Corporation continues to remain concerned with the credit stability of the broader markets due to the weakened economic climate and continues to maintain a conservative credit culture. At December 31, 2013, the Corporation had $202.3 million in overall undisbursed loan commitments, which includes largely unused commercial lines of credit, home equity lines of credit and available usage from active construction facilities. Included in the overall undisbursed commitments are the Corporation's "Approved, Accepted but Unfunded" pipeline, which includes approximately $35.7 million in commercial and commercial real estate loans and $2.3 million in residential mortgages expected to fund over the next 90 days.

Asset quality remains high and a primary focus of the Corporation. Even so, the stability of the economy and credit markets remains uncertain and as such, has had an impact on certain credits within our portfolio. Despite that, the Corporation's asset quality continues to improve and our actions in 2013 related to asset quality have placed us near the top of all publicly traded banks and thrifts headquartered in the state of New Jersey. At December 31, 2013, non-performing assets totaled $3.4 million or 0.20 percent of total assets, a decline from $5.0 million or 0.31 percent at December 31, 2012. The decrease in non-performing assets from December 31, 2012 was achieved notwithstanding the addition of several new residential loans (totaling approximately $0.3 million) and commercial loans (totaling approximately $1.7 million) into non-performing status. This was more than offset by decreases from pay-downs and pay offs of $2.9 million, total charge-offs of $272,000, and the return to performing status of $0.4 million, while $220,000 was moved within the non-performing asset category from non-accrual to OREO.

At December 31, 2013, the total allowance for loan losses amounted to approximately $10.3 million, or 1.08 percent of total loans. The allowance for loan losses as a percent of total non-performing loans amounted to 329.4 percent at December 31, 2013 and 278.9 percent at December 31, 2012. This increase in the ratio from December 31, 2012 to December 31, 2013 was due to the decrease in the level of non-performing assets, along with an increase in the allowance for loan loss from $10.2 million at December 31, 2012.

Deposit grew strongly during 2013, with total deposits of $1.342 billion at December 31, 2013, increasing $35.1 million, or 2.7 percent, since December 31, 2012. Total Demand, Savings, Money Market, and certificates of deposit less than $100,000 increased $45.5 million or 3.9 percent from December 31, 2012, underscoring the strength of core growth. These increases were attributable to continued core deposit growth in overall segments of the deposit base, as well as in niche areas, such as municipal government, private schools and universities, together with the Saddle River Valley Bank transaction. Time certificates of deposit of $100,000 or more at December 31, 2013, decreased by $11.4 million or 10.3 percent from December 31, 2012.

Total stockholders' equity increased 4.9 percent in 2013 to $168.6 million, and represented 10.08 percent of total assets at year-end. Book value per common share (total common stockholders' equity divided by the number of shares outstanding) increased to $9.61 as compared with $9.14 a year ago, primarily as a result of earnings of $19.9 million in 2013. Tangible book value per common share (which excludes goodwill and other intangibles from common stockholders' equity) increased to $8.58 from $8.11 a year ago; see Item 6 of this Annual Report on Form 10-K for a reconciliation of tangible book value (which is a non-GAAP financial measure) to book value. Return on average tangible stockholders' equity for the year ended December 31, 2013 was 13.45 percent compared to 13.18 percent for 2012. This increase was attributable to higher earnings in 2013 compared with 2012 partially offset by higher average equity due primarily to benefit from the capital received under the SBLF program. The Tier I Leverage capital ratio increased to 9.69 percent of total assets at December 31, 2013, as compared with 9.02 percent at December 31, 2012, as an increase in retained earnings was offset only in part by the increased asset base in 2013.

The Corporation's capital base includes the $11.25 million of capital received from the U.S. Treasury under the Small Business Lending Fund Program in 2011 and simultaneously, using the proceeds from the issuance of SBLF preferred stock to redeem the $10 million of capital received from the U.S. Treasury under TARP. It also includes $5.2 million in subordinated debentures at December 31, 2013 and December 31, 2012. This issuance of $5.0 million in floating rate MMCapS(SM) Securities occurred on December 19, 2003. These securities presently are included as a component of Tier I capital for regulatory capital purposes. In accordance with FASB ASC 810, these securities are classified as subordinated debentures on the Corporation's Consolidated Statements of Condition.

The Corporation's risk-based capital ratios at December 31, 2013 were 12.10 percent for Tier I capital and 12.91 percent for total risk-based capital. Total Tier I capital increased to approximately $159.4 million at December 31, 2013 from $143.8 million at December 31, 2012. The increase in Tier I capital primarily reflects earnings.

At December 31, 2013, the Corporation's capital ratios continued to exceed the minimum Federal requirements for a bank holding company, and Union Center National Bank's capital ratios continued to exceed each of the minimum levels required for classification as a "well capitalized institution" under the Federal Deposit Insurance Corporation Improvement Act ("FDICIA").

The following sections discuss the Corporation's Results of Operations, Asset and Liability Management, Liquidity and Capital Resources.

Results of Operations

Net income for the year ended December 31, 2013 was $19,925,000 as compared to $17,507,000 earned in 2012 and $13,926,000 earned in 2011, an increase of 13.8 percent from 2012 to 2013. For 2013, the basic and fully diluted earnings per common share was $1.21 per share as compared with $1.05 per share in 2012 and $0.80 per share in 2011.

For the year ended December 31, 2013, the Corporation's return on average stockholders' equity ("ROE") was 12.07 percent and its return on average assets ("ROA") was 1.22 percent. The Corporation's return on average tangible stockholders' equity ("ROATE") was 13.45 percent for 2013. The comparable ratios for the year ended December 31, 2012, were ROE of 11.69 percent, ROA of 1.14 percent, and ROATE of 13.18 percent. See the discussion and reconciliation of ROATE, which is a non-GAAP financial measure, under Item 6 of this Annual Report on Form 10-K.

Earnings for 2013 benefitted from increases in net interest income and increases to non interest income, primarily service charge and fees on deposit accounts, annuity and insurance fees, loan related fees and bank owned life insurance. The increase in non-interest expenses was due to increases in salaries and benefits, occupancy expenses, marketing and advertising expenses and other expenses, primarily due to the operation of Saddle River Valley Bank branches for a full year in 2013, and the opening of the Princeton and Englewood branches. These increases were partially offset by reductions in FDIC insurance, OREO expenses, stationery and printing expenses.

Net Interest Income

The following table presents the components of net interest income on a
tax-equivalent basis for the past three years

                                                       2013                                        2012                                      2011
                                                     Increase                                Increase                                      Increase
                                                    (Decrease)                              (Decrease)                                    (Decrease)
                                                       from        Percent                     from                                          from        Percent
                                        Amount      Prior Year      Change      Amount      Prior Year     Percent Change     Amount      Prior Year      Change
                                                                                         (Dollars in Thousands)
Interest income:
Investment  available-for-sale         $  13,833   $    (1,234)       (8.19)   $  15,067   $      1,018               7.25   $  14,049   $      2,990        27.04
Investment held-to-maturity                5,275          2,562        94.43       2,713            743              37.72       1,970          1,970       100.00
Loans, including fees                     40,281          1,360         3.49      38,921          2,601               7.16      36,320          (880)       (2.37)
Other interest-bearing  deposits               2            (6)      (75.00)           8              8                  -           -              -            -
Restricted investment in bank stocks         407           (45)       (9.96)         452           (12)             (2.59)         464          (104)      (18.31)
Total interest income                     59,798          2,637         4.61      57,161          4,358               8.25      52,803          3,976         8.14
Interest expense:
Deposits                                   5,219          (189)       (3.49)       5,408          (112)             (2.03)       5,520          (486)       (8.09)
Borrowings                                 5,863          (505)       (7.93)       6,368          (289)             (4.34)       6,657        (2,122)      (24.17)
Total interest expense                    11,082          (694)       (5.89)      11,776          (401)             (3.29)      12,177        (2,608)      (17.64)
Net interest income on a
  tax-equivalent basis                    48,716          3,331         7.34      45,385          4,759              11.71      40,626          6,584        19.34
Tax-equivalent adjustment                (2,530)          (641)        33.93     (1,889)        (1,013)           (115.64)       (876)          (763)       675.22
Net interest income                    $  46,186   $      2,690         6.18   $  43,496   $      3,746               9.42   $  39,750   $      5,821        17.16

Note: The tax-equivalent adjustment was computed based on an assumed statutory Federal income tax rate of 35 percent for 2013 and 2012 and 34 percent for 2011. Adjustments were made for interest earned on tax-advantaged instruments.

Historically, the most significant component of the Corporation's earnings has been net interest income, which is the difference between the interest earned on the portfolio of earning assets (principally loans and investments) and the interest paid for deposits and borrowings, which support these assets. There were several factors that affected net interest income during 2013, including the volume, pricing, mix and maturity of interest-earning assets and interest-bearing liabilities and interest rate fluctuations.

Net interest income is directly affected by changes in the volume and mix of . . .

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