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SUBK > SEC Filings for SUBK > Form 10-Q on 8-Nov-2012All Recent SEC Filings

Show all filings for SUFFOLK BANCORP



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 comply with our written agreement with the OCC (the "Agreement") or the individual minimum capital ratios for the Bank established by the OCC; the cost of compliance with the Agreement; any failure by the Company to maintain effective internal controls 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 SEC.

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 generally accepted accounting principles in the United States (GAAP). The Company believes that these non-GAAP financial measures provide 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
Suffolk Bancorp (the "Company") is a one-bank holding company engaged in the commercial banking business through the Suffolk County National Bank (the "Bank"), a full service commercial bank headquartered in Riverhead, New York and the Company's wholly owned subsidiary. Organized in 1890, the Bank has 30 offices in Suffolk County, New York.

As of September 30, 2012, the Company, on a consolidated basis, had total assets of $1.6 billion, total deposits of $1.4 billion and stockholders' equity of $155 million. The Company recorded a net loss of $9.2 million, or ($0.94) per diluted common share, for the third quarter of 2012, compared to net income of $3.1 million, or $0.32 per diluted common share, for the third quarter of 2011. The decline in third quarter 2012 earnings was principally due to the impact of an $11.1 million increase in the provision for loan losses resulting from the Company's successful execution of a previously announced bulk sale of non-performing loans in September 2012. The Company sold $51 million of loans at an aggregate price of 61% of book value resulting in a $19.6 million charge to the allowance for loan losses. Also contributing to the third quarter loss was an increase in total operating expenses of $3.0 million, largely the result of $2.5 million in non-recurring costs, and a reduction in net interest income of $2.9 million (16.7%). Partially offsetting these factors was a 6.7% improvement in non-interest income in 2012.

The Company's return on average assets and return on average common stockholders' equity were (2.34%) and (25.40%), respectively, for the third quarter of 2012 and 0.77% and 8.96%, respectively, for the third quarter of 2011. The Company's net interest margin decreased by 58 basis points to 4.09% for the third quarter of 2012 from 4.67% for the third quarter of 2011. The decrease in the net interest margin was due to the continued low level of interest rates, a shift in the Company's balance sheet mix from loans into lower-yielding overnight interest-bearing deposits, due principally to ongoing loan workout activity, and the elevated level of non-accrual loans present throughout 2012. 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.

                                     Financial Performance Summary
                             (dollars in thousands, except per share data)
              As of or for the quarters and nine months ended September 30, 2012 and 2011

                               Quarters ended September 30,         Nine Months ended September 30,
                                                         Over/                                 Over/
                                                       (under)                               (under)
                                   2012       2011        2011           2012        2011       2011
Revenue (1)                    $ 16,748  $  19,415     (13.7%)       $ 50,490   $  62,034    (18.6%)
Operating expenses             $ 17,884  $  14,927       19.8%       $ 46,628   $  43,730       6.6%
Provision for loan losses      $ 12,000  $     900     1233.3%       $  9,600   $  24,088    (60.1%)
Net (loss) income             $ (9,161)  $   3,072         N/M (2)  $ (3,793)  $  (1,232)     207.9%
Net (loss) income per         $  (0.94)  $    0.32         N/M (2)  $  (0.39)  $   (0.13)     198.8%
common share - diluted
Return on average assets        (2.34%)      0.77%       (311) bp     (0.33%)     (0.10%)       (23) bp
Return on average              (25.40%)      8.96%     (3,436) bp     (3.65%)     (1.22%)      (243) bp
stockholders' equity
Tier 1 leverage ratio             9.74%      8.57%         117 bp       9.74%       8.57%        117 bp
Tier 1 risk-based capital        16.90%     12.60%         430 bp      16.90%      12.60%        430 bp
Total risk-based capital         18.17%     13.88%         429 bp      18.17%      13.88%        429 bp
Tangible common equity            9.75%      9.06%          69 bp       9.75%       9.06%         69 bp
ratio (non-GAAP)

bp - denotes basis points;
100 bp equals 1%.

(1) Represents net interest income plus total non-interest income.
(2) N/M - denotes % variance not meaningful for statistical purposes.

The Company's Tier 1 leverage ratio was 9.74% at September 30, 2012 versus 8.85% at December 31, 2011 and 8.57% at September 30, 2011. The Company's total risk-based capital ratio was 18.17% at September 30, 2012 versus 14.26% at December 31, 2011 and 13.88% at September 30, 2011. The Company's tangible common equity ratio (non-GAAP financial measure) was 9.75% at September 30, 2012 versus 9.05% at December 31, 2011 and 9.06% at September 30, 2011. The Company completed a successful $25 million private placement of its common stock with several institutional investors and certain of the Company's directors and officers in September 2012. The institutional investors purchased 1,783,000 shares of common stock at a price of $13.50 per share. Certain of the Company's directors and officers purchased approximately $930,000 of stock at $16.44 per share.

Total non-accrual loans, excluding loans categorized as held-for-sale, decreased to $14 million or 1.87% of loans outstanding at September 30, 2012 versus $81 million or 8.33% of loans outstanding at December 31, 2011 and $92 million or 9.09% of loans outstanding at September 30, 2011. The Company was able to make significant progress this quarter in reducing levels of non-accrual loans with the completion of the $51 million bulk loan sale.

Total accruing loans delinquent 30 days or more amounted to 2.06% of loans outstanding at September 30, 2012 versus 3.56% of loans outstanding at December 31, 2011 and 2.32% of loans outstanding at September 30, 2011. Net loan charge-offs of $20.2 million, including $19.6 million related to loans transferred to held-for-sale and then sold during the quarter, were recorded in the third quarter of 2012 versus $8.4 million in the second quarter of 2012 (including $7.0 million related to loans transferred to held-for-sale and then sold during the quarter) and $7.1 million in the third quarter of 2011. The allowance for loan losses totaled $21.0 million at September 30, 2012, $40.0 million at December 31, 2011 and $43.7 million at September 30, 2011, representing 2.74%, 4.12% and 4.31% of total loans, respectively, at such dates. The allowance for loan losses as a percentage of non-accrual loans, excluding non-accrual loans categorized as held-for-sale, was 146%, 49% and 47% at September 30, 2012, December 31, 2011 and September 30, 2011, respectively. The Company held OREO of $1.6 million at September 30, 2012 and $1.8 million at December 31, 2011 and September 30, 2011.

The Company's core deposit franchise continues to be among the best in the region and performed very well in the third quarter of 2012. Core deposits, consisting of demand, N.O.W., savings and money market accounts, totaled $1.1 billion at September 30, 2012, December 31, 2011 and September 30, 2011. Core deposits represented 82%, 81% and 80% of total deposits at September 30, 2012, December 31, 2011 and September 30, 2011, respectively. Demand deposits increased by 9.2% to $574 million at September 30, 2012 versus $525 million at December 31, 2011 and by 10.5% from $520 million at September 30, 2011. Demand deposits represented 42% of total deposits at September 30, 2012, 40% at December 31, 2011 and 38% at September 30, 2011. The deposit product mix continues to be a primary strength of the Company, and resulted in a total cost of funds of approximately 26 basis points during the third quarter of 2012 versus 34 basis points in the comparable 2011 quarter.

With completion of the $51 million bulk loan sale and $25 million capital raise, the Company has strengthened its overall financial position. The management team has been working hard to put the people, systems and processes in place to position the Company for future growth. As we diversify our lending focus into a more balanced mix of products and begin moving west from the eastern end of Long Island, we believe there are many opportunities for us in attractive markets. By gradually redeploying our current cash position into higher-yielding, high quality loans and other interest-earning assets, and focusing our efforts on expense reductions going forward, management of the Company believes we can achieve improved financial results 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 ("ALLL"). The Company considers the determination of the ALLL to involve a higher degree of judgment and complexity than its other significant accounting policies. The ALLL is determined by continuous analysis of the loan portfolio. That analysis includes changes in the size and composition of the portfolio, 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 factors. The Company maintains an ALLL at a level management believes will be adequate to absorb probable losses on existing loans that may become uncollectible, based on an evaluation of their collectibility. However, the determination of the ALLL is inherently subjective, as it requires estimates, all of which may be subject to significant change. When a loan, in full or in part, is deemed uncollectible, it is charged against the ALLL. This happens when it is past due and the borrower has not shown the ability or intent to make the loan current, or the borrower does not have enough assets to pay the debt, or the value of the collateral is less than the balance of the loan and not likely to improve soon. To the extent actual performance differs from management's estimates, additional provisions for loan losses may be required that would reduce or may substantially reduce earnings in future periods, and no assurances can be given that the Company will not sustain loan losses, in any particular period, that are sizable in relation to the ALLL. Residential real estate and consumer loans are analyzed as a group and not individually because of the large number of loans, small balances, and historically low losses. In the future, the provision for loan losses may change as a percentage of total loans.

The Company's underwriting standards generally require a loan-to-value ratio of 75 percent or less, and when applicable, a debt coverage ratio of at least 120 percent, at the time a loan is originated. The Company has not been directly affected by the increase in defaults of sub-prime mortgages as the Company does not originate, or hold in portfolio, sub-prime mortgages. The ALLL analysis also considers the loan loss history of the Company's peers with similar characteristics. In assessing the adequacy of the ALLL, the Company reviews its loan portfolio by separate classes which have similar risk and collateral

characteristics; e.g. commercial loans, commercial real estate, construction loans, residential mortgages, home equity loans, and consumer loans. Management conducts a monthly analysis of the loan portfolio which evaluates any loan designated as having a high risk profile including but not limited to, loans classified as "Substandard" or "Doubtful" as defined by regulation, loans criticized internally or designated as "Special Mention," delinquencies, expirations, overdrafts, loans to customers having experienced recent operating losses and loans identified by management as impaired. The analysis is performed to determine the amount of the ALLL which would be adequate to absorb probable losses contained in the loan portfolio. The analytical process is regularly reviewed and adjustments may be made based on the assessments of internal and external influences on credit quality.

The Company's market area experienced unprecedented damage due to Hurricane Sandy. Although the extent of the damage and its impact on the Company cannot be determined at this time, the storm is expected to impair the ability of some borrowers to repay their loans and also adversely impact collateral values. As a result, the Company may experience increased levels of non-performing loans and loan losses which may negatively impact earnings.

Deferred Tax Assets and Liabilities - The Company recognizes deferred tax assets and liabilities. Deferred income taxes occur when income taxes are allocated over time and result from differences in the timing of a transaction under generally accepted accounting principles, and the computation for income tax return purposes. Examples include the future tax effects of temporary differences for such items as deferred compensation and the provision for loan losses. Estimates of net deferred tax assets are based upon evidence available to management that future realization is more likely than not. If management determines that the Company may be unable to realize all or part of its 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 amount that management expects to realize. During 2012, the Bank set up a state valuation allowance of $835 thousand to reflect management's estimates of projected income and inability to utilize the state net operating loss carryforward.

Other-Than-Temporary Impairment ("OTTI") of Investment Securities - Current guidance requires an entity to assess 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 these criteria is met, the entire difference between amortized cost and fair value is recognized as impairment through earnings. For securities that do not meet the aforementioned criteria, the amount of impairment is split into two components as follows: 1) OTTI related to other factors, which is recognized in other comprehensive income and 2) OTTI related to credit loss, which must be recognized in the statement of income. 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. The Company has not recorded any OTTI-related charges during the first nine months of 2012.

Material Changes in Financial Condition
Total assets of the Company were $1.6 billion at September 30, 2012. When compared to December 31, 2011, total assets increased by $85 million. This change primarily reflects increases in cash and cash equivalents and investment securities of $232 million and $28 million, respectively, partially offset by a decrease in net loans of $184 million. These movements largely reflect the shift in the Company's balance sheet mix from loans into lower-yielding overnight interest-bearing deposits, primarily the result of loan workout activity. Net loans were $746 million at September 30, 2012 as compared to $930 million at December 31, 2011.

Total investment securities were $337 million at September 30, 2012 as compared to $309 million at December 31, 2011. The increase in the investment portfolio largely reflects purchases of U.S. Government agency, corporate and mortgage-backed securities of $12 million, $13 million and $36 million, respectively. These were partially offset by sales and prepayments of CMOs totaling $30 million.

At September 30, 2012, total deposits were $1.4 billion, an increase of $61 million when compared to December 31, 2011, primarily due to growth in core deposit balances which consist of demand, N.O.W., savings and money market accounts. Core deposit balances increased by $68 million including an increase of $49 million in demand deposits. Core deposit balances represented approximately 82% and 81% of total deposits at September 30, 2012 and December 31, 2011, respectively. The Company had no short-term borrowed funds outstanding at either September 30, 2012 or at year end 2011.

Liquidity and Capital Resources
Liquidity is measured by the ability to raise funds through deposits, borrowed funds, capital or cash flow from the repayment of loans and securities. These funds are used to fund loans, meet deposit withdrawals, maintain reserve requirements and operate the Company. Liquidity is primarily achieved through deposits and liquid assets such as securities available for sale, matured and called securities, federal funds sold and interest-bearing balances.

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.

Stockholders' equity is a noninterest-bearing source of funds that can provide support for asset growth. Stockholders' equity was $155 million at September 30, 2012 compared to $137 million at December 31, 2011. The $18 million increase for the first nine months of 2012 is primarily due to the $23 million in net proceeds from the Company's third quarter private placement offering partially offset by the net loss of $4 million recorded in the third quarter 2012.

The Company's tangible common equity ratio was 9.75% at September 30, 2012 compared to 9.05% at December 31, 2011 and 9.06% at September 30, 2011. The ratio of tangible common equity to tangible assets, or TCE ratio, is calculated by dividing total common stockholders' equity by total assets, after reducing both amounts by intangible assets. The TCE ratio is not required by GAAP or by applicable bank regulatory requirements, but is a metric used by management to evaluate the adequacy of our capital levels. Since there is no authoritative requirement to calculate the TCE ratio, our TCE ratio is not necessarily comparable to similar capital measures disclosed or used by other companies in the financial services industry. Tangible common equity and tangible assets are non-GAAP financial measures and should be considered in addition to, not as a substitute for or superior to, financial measures determined in accordance with GAAP or as required by bank regulatory agencies. Set forth below are the reconciliations of tangible common equity to GAAP total common stockholders' equity and tangible assets to GAAP total assets at September 30, 2012 (in thousands):

Total stockholders' equity   $155,280   Total assets             $1,569,105
Less: intangible assets       (2,537)   Less: intangible assets     (2,537)
Tangible common equity       $152,743   Tangible assets          $1,566,568

The following table details the Bank's regulatory capital amounts and ratios (dollars in thousands):

                                                                 Minimum                 Minimum to be "Well
                                                               for capital            Capitalized" under prompt
                           Actual capital ratios                adequacy             corrective action provisions
                           Amount            Ratio        Amount         Ratio          Amount            Ratio
As of September 30,
Total Capital (to
risk-weighted assets)   $     159,963          18.11 %   $  70,664          8.00 %   $     88,330           10.00 %
Tier 1 Capital (to
risk-weighted assets)         148,795          16.85 %      35,332          4.00 %         52,998            6.00 %
Tier 1 Capital (to
average assets)               148,795           9.65 %      61,656          4.00 %         77,070            5.00 %
As of December 31,
Total Capital (to
risk-weighted assets)   $     146,990          14.21 %   $  82,756          8.00 %   $    103,445           10.00 %
Tier 1 Capital (to
risk-weighted assets)         133,716          12.93 %      41,378          4.00 %         62,067            6.00 %
Tier 1 Capital (to
average assets)               133,716           8.81 %      60,726          4.00 %         75,907            5.00 %

The Bank is subject to individual minimum capital ratios ("IMCR's") established by the OCC requiring Tier 1 leverage capital equal to at least 8.00% of adjusted total assets; Tier 1 risk-based capital equal to at least 10.50% of risk-weighted assets; and total risk-based capital equal to at least 12.00% of risk-weighted assets. At September 30, 2012, management believes the Bank met all of the IMCR's.

At September 30, 2012 the Company's Tier 1 leverage ratio was 9.74%. The Company's Tier 1 risk-based capital and total risk-based capital ratios were 16.90% and 18.17%, respectively, at the same reported period. At September 30, 2012, management believes the Company's capital ratios exceed current regulatory minimum guidelines.

Off-Balance Sheet Arrangements
The Bank is a party to financial instruments with off-balance sheet risk in the normal course of business to meet the financing needs of its customers. These financial instruments include commitments to extend credit and standby and documentary letters of credit. Those instruments involve, to varying degrees, elements of credit risk in excess of the amount recognized in the consolidated financial statements. The Bank uses the same credit policies in making commitments and conditional obligations as it does for on-balance sheet instruments. Commitments to extend credit are agreements to lend to a customer as long as there is no violation of any condition established in the contract. Commitments generally have fixed expiration dates or other termination clauses and may require payment of a fee. Since many of the commitments are expected to expire without being drawn upon, the total commitment amounts do not necessarily represent future cash requirements. The Bank evaluates each customer's . . .

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