SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D. C. 20549
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FORM 10-QSB
(Mark One)
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the quarterly period ended September 30, 2005
Or
[_] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the transition period from _______________________ to _____________________
Commission file number 0-29030
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SUSSEX BANCORP.
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(Exact name of registrant as specified in its charter)
New Jersey 22-3475473
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(State of other jurisdiction of (I. R. S. Employer
incorporation or organization) Identification No.)
399 Route 23, Franklin, New Jersey 07416
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(Address of principal executive offices) (Zip Code)
Issuer's telephone number, including area code) (973) 827-2914
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(Former name, former address and former fiscal year,
if changed since last report)
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15 (d) of the Securities and Exchange Act of 1934
during the preceding 12 months (or for such shorter period that the registrant
was required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days. Yes X No
--- ---
As of November 9, 2005 there were 3,021,284 shares of common stock, no par
value, outstanding.
SUSSEX BANCORP
FORM 10-QSB
INDEX
Part I - Financial Information Page(s)
Item 1. Financial Statements (Unaudited) 3
Item 2. Management's Discussion and Analysis of 10
Results of Operations and Financial Condition
Item 3. Controls and Procedures 20
Part II - Other Information
Item 1. Legal Proceedings 21
Item 2. Unregistered Sales of Equity Securities and
Use of Proceeds 21
Item 3. Defaults upon Senior Securities 21
Item 4. Submission of Matters to a Vote of Security Holders 21
Item 5. Other Information 21
Item 6. Exhibits 21
Signatures 21
Exhibits 22
-2-
PART I - FINANCIAL INFORMATION
ITEM 1 - FINANCIAL STATEMENTS
SUSSEX BANCORP
CONSOLIDATED BALANCE SHEETS
(Dollars in thousands)
(Unaudited)
ASSETS September 30, 2005 December 31, 2004
------ ----------------------------------------
Cash and due from banks $ 9,800 $ 10,434
Federal funds sold 8,900 18,860
------------------ ------------------
Cash and cash equivalents 18,700 29,294
Interest bearing time deposits with other banks 500 3,900
Securities available for sale 66,203 74,736
Federal Home Loan Bank Stock, at cost 900 690
Loans receivable, net of unearned income 203,653 156,916
Less: allowance for loan losses 2,394 2,274
------------------ ------------------
Net loans receivable 201,259 154,642
Premises and equipment, net 5,806 5,618
Accrued interest receivable 1,523 1,330
Goodwill 2,334 2,334
Other assets 6,728 5,731
------------------ ------------------
Total Assets $ 303,953 $ 278,275
================== ==================
LIABILITIES AND STOCKHOLDERS' EQUITY
------------------------------------
Liabilities:
Deposits:
Non-interest bearing $ 37,355 $ 34,451
Interest bearing 207,767 195,376
------------------ ------------------
Total Deposits 245,122 229,827
Borrowings 18,000 10,000
Accrued interest payable and other liabilities 2,652 1,641
Junior subordinated debentures 5,155 5,155
------------------ ------------------
Total Liabilities 270,929 246,623
Stockholders' Equity:
Common stock, no par value, authorized 5,000,000 shares;
issued and outstanding 3,177,325 in 2005 and 2,994,874 in 2004 27,688 25,397
Retained earnings 5,382 6,116
Accumulated other comprehensive income (loss) (46) 139
------------------ ------------------
Total Stockholders' Equity 33,024 31,652
------------------ ------------------
Total Liabilities and Stockholders' Equity $ 303,953 $ 278,275
================== ==================
See Notes to Consolidated Financial Statements
-3-
SUSSEX BANCORP
CONSOLIDATED STATEMENTS OF INCOME
(Dollars In Thousands Except Per Share Data)
(Unaudited)
Three Months Ended September 30, Nine Months Ended September 30,
--------------------------------- ---------------------------------
2005 2004 2005 2004
--------------- --------------- --------------- ---------------
INTEREST INCOME
Loans receivable, including fees $ 3,259 $ 2,260 $ 8,748 $ 6,522
Securities:
Taxable 400 483 1,280 1,368
Tax-exempt 285 221 877 634
Federal funds sold 65 10 184 41
Interest bearing deposits 14 13 41 30
--------------- --------------- --------------- ---------------
Total Interest Income 4,023 2,987 11,130 8,595
--------------- --------------- --------------- ---------------
INTEREST EXPENSE
Deposits 877 493 2,150 1,460
Borrowings 169 130 461 395
Junior subordinated debentures 92 66 256 187
--------------- --------------- --------------- ---------------
Total Interest Expense 1,138 689 2,867 2,042
--------------- --------------- --------------- ---------------
Net Interest Income 2,885 2,298 8,263 6,553
PROVISION FOR LOAN LOSSES 206 120 547 373
--------------- --------------- --------------- ---------------
Net Interest Income after Provision for Loan Losses 2,679 2,178 7,716 6,180
--------------- --------------- --------------- ---------------
OTHER INCOME
Service fees on deposit accounts 334 175 885 557
ATM and debit card fees 90 87 259 237
Insurance commissions and fees 536 526 1,753 1,696
Mortgage banking fees 48 130 209 456
Investment brokerage fees 104 96 234 217
Net gain on sale of securities, available for sale 42 11 42 11
Other 113 84 310 252
--------------- --------------- --------------- ---------------
Total Other Income 1,267 1,109 3,692 3,426
--------------- --------------- --------------- ---------------
OTHER EXPENSES
Salaries and employee benefits 1,610 1,564 4,813 4,654
Occupancy, net 246 225 734 639
Furniture, equipment and data processing 267 247 789 659
Stationary and supplies 43 43 131 126
Professional fees 136 81 385 238
Advertising and promotion 108 96 374 279
Insurance 33 41 121 126
Postage and freight 41 39 131 130
Amortization of intangible assets 61 51 188 145
Other 311 354 1,015 1,015
--------------- --------------- --------------- ---------------
Total Other Expenses 2,856 2,741 8,681 8,011
--------------- --------------- --------------- ---------------
Income before Income Taxes 1,090 546 2,727 1,595
PROVISION FOR INCOME TAXES 338 143 789 430
--------------- --------------- --------------- ---------------
Net Income $ 752 $ 403 $ 1,938 $ 1,165
=============== =============== =============== ===============
EARNINGS PER SHARE
--------------- --------------- --------------- ---------------
Basic $ 0.24 $ 0.21 $ 0.61 $ 0.61
=============== =============== =============== ===============
--------------- --------------- --------------- ---------------
Diluted $ 0.23 $ 0.20 $ 0.61 $ 0.58
=============== =============== =============== ===============
See Notes to Consolidated Financial Statements
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SUSSEX BANCORP
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
Nine Months Ended September 30, 2005 and 2004
(Dollars in thousands, except per share amounts)
Accumulated
Number of Other Total
Shares Common Retained Comprehensive Treasur Stockholders'
Outstanding Stock Earnings Income (Loss) Stock Equity
----------- ----- -------- ------------- ----- ------
Balance December 31, 2003 1,811,460 $ 9,616 $ 5,040 $ 248 $ -- $ 14,904
Comprehensive income:
Net income -- -- 1165 -- -- 1,165
Change in unrealized gains (losses) on securities
available for sale, net of tax -- -- -- 130 -- 130
----------
Total Comprehensive Income 1,295
Treasury shares purchased (1,346) -- -- -- (23) (23)
Treasury shares retired -- (23) -- -- 23 --
Exercise of stock options 23,807 205 -- -- -- 205
Income tax benefit of stock options exercised -- 52 -- -- -- 52
Shares issued through dividend reinvestment plan 8,267 137 -- -- -- 137
Dividends on common stock ($.20 per share) -- -- (384) -- -- (384)
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Balance September 30, 2004 1,842,188 $ 9,987 $ 5,821 $ 378 $ -- $ 16,186
==========================================================================
Balance December 31, 2004 2,994,874 $ 25,397 $ 6,116 $ 139 $ -- $ 31,652
Comprehensive income:
Net income -- -- 1,938 -- -- 1,938
Change in unrealized gains (losses) on securities
available for sale, net of tax -- -- -- (185) -- (185)
----------
Total Comprehensive Income 1,753
Treasury shares purchased (13,150) -- -- -- (187) (187)
Treasury shares retired -- (187) -- -- 187 --
Exercise of stock options 36,527 278 -- -- -- 278
Income tax benefit of stock options exercised -- 77 -- -- -- 77
Shares issued through dividend reinvestment plan 7,773 109 -- -- -- 109
Additional expenses for stock offering -- (25) -- -- -- (25)
Dividends on common stock ($.20 per share) -- -- (633) -- -- (633)
5% Stock Dividend 151,301 2,039 (2,039) -- -- --
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Balance September 30, 2005 3,177,325 $ 27,688 $ 5,382 ($ 46) $ -- $ 33,024
==========================================================================
See Notes to Consolidated Financial Statements
-5-
SUSSEX BANCORP
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Dollars in Thousands)
(Unaudited)
Nine Months Ended September 30,
--------------------------------
2005 2004
-------------- --------------
Cash Flows from Operating Activities
Net income $ 1,938 $ 1,165
Adjustments to reconcile net income to net cash provided by operating activities:
Provision for loan losses 547 373
Provision for depreciation and amortization 687 567
Net amortization of securities premiums and discounts 192 456
Net realized gain on sale of securities (42) (11)
Net gain on sale of equipment (12) --
Income tax benefit of stock options exercised 77 52
Earnings on investment in life insurance (69) (81)
(Increase) decrease in assets:
Accrued interest receivable (193) (24)
Other assets (700) (933)
Increase in accrued interest payable and other liabilities 1,011 189
-------------- --------------
Net Cash Provided by Operating Activities 3,436 1,753
-------------- --------------
Cash Flows from Investing Activities
Securities available for sale:
Purchases (4,941) (24,154)
Proceeds from sale of securities 2,995 7,291
Maturities, calls and principal repayments 10,021 20,568
Net increase in loans (47,434) (14,988)
Purchases of premises and equipment (698) (1,439)
(Increase) decrease in FHLB stock (210) 70
(Increase) decrease in interest bearing time deposits with other banks 3,400 (7,400)
Purchase of investment in life insurance -- (1,500)
-------------- --------------
Net Cash Used in Investing Activities (36,867) (21,552)
-------------- --------------
Cash Flows from Financing Activities
Net increase in deposits 15,295 16,073
Increase in federal funds purchased -- 2,385
Increase (decrease) in borrowings 8,000 (1,000)
Proceeds from the exercise of stock options 278 205
Purchase of treasury stock (187) (23)
Expenses paid related to stock offering (25) --
Dividends paid, net of reinvestments (524) (247)
-------------- --------------
Net Cash Provided by Financing Activities 22,837 17,393
-------------- --------------
Net Increase (Decrease) in Cash and Cash Equivalents (10,594) (2,406)
Cash and Cash Equivalents - Beginning 29,294 15,496
-------------- --------------
Cash and Cash Equivalents - Ending $ 18,700 $ 13,090
============== ==============
Supplementary Cash Flows Information
Interest paid $2,802 $2,041
================= =================
Income taxes paid $361 $597
================= =================
Supplementary Schedule of Noncash Investing and Financing Activities
Foreclosed real estate acquired in settlement of loans $270 $291
================= =================
See Notes to Consolidated Financial Statements
-6-
Notes to Consolidated Financial Statements (Unaudited)
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1. Basis of Presentation
---------------------
The consolidated financial statements include the accounts of Sussex
Bancorp (the "Company") and its wholly-owned subsidiary Sussex Bank (the
"Bank"). The Bank's wholly-owned subsidiaries are Sussex Bancorp Mortgage
Company, Inc., SCB Investment Company, Inc., and Tri-State Insurance Agency,
Inc., ("Tri-State") a full service insurance agency located in Sussex County,
New Jersey. All inter-company transactions and balances have been eliminated in
consolidation. Sussex Bank is also a 49% partner of Sussex Settlement Services,
L.P, a title insurance agency whose registered office is located in King of
Prussia, Pennsylvania. During the second quarter of 2005, the Bank also became
the owner of 49% of the equity of SussexMortgage.com LLC, an Indiana limited
liability company and mortgage banking joint venture with National City
Mortgage, Inc. SussexMortgage.com commenced operations in the third quarter of
2005. The Bank operates eight banking offices all located in Sussex County, New
Jersey. The Company is subject to the supervision and regulation of the Board of
Governors of the Federal Reserve System (the "FRB"). The Bank's deposits are
insured by the Bank Insurance Fund ("BIF") of the Federal Deposit Insurance
Corporation ("FDIC") up to applicable limits. The operations of the Company and
the Bank are subject to the supervision and regulation of the FRB, FDIC and the
New Jersey Department of Banking and Insurance (the "Department") and the
operations of Tri-State are subject to the supervision and regulation by the
Department.
The accompanying unaudited consolidated financial statements have been
prepared in accordance with generally accepted accounting principles for interim
financial information. Accordingly, they do not include all of the information
and footnotes required by generally accepted accounting principles for full year
financial statements. In the opinion of management, all adjustments considered
necessary for a fair presentation have been included and are of a normal,
recurring nature. Operating results for the nine-month period ended September
30, 2005, are not necessarily indicative of the results that may be expected for
the year ending December 31, 2005. These consolidated financial statements
should be read in conjunction with the consolidated financial statements and the
notes thereto that are included in the Company's Annual Report on Form 10-KSB
for the fiscal period ended December 31, 2004.
2. Stockholders' Equity and Subsequent Events
------------------------------------------
On October 19, 2005, the Board of Directors declared a 5% common stock
dividend payable on November 29, 2005 to shareholders of record as of November
3, 2005. Accordingly, 151,301 shares of common stock will be issued to the
Company's stockholders and $2,039,000 will be transferred from retained earnings
to common stock. The effect of the stock dividend has been retroactively
reflected as of September 30, 2005 in the consolidated balance sheet and the
consolidated statement of stockholders' equity. The earnings per share amounts
and dividend per share amounts disclosed in the consolidated financial
statements and related footnote reflect the effect of the stock dividend on the
number of outstanding shares for all periods.
On November 8, 2005, Sussex Bancorp announced that its Sussex Bank
subsidiary had entered into an agreement to purchase the Port Jervis, New York
branch office of NBT Bank, N.A. As part of the transaction, Sussex Bank will
assume approximately $6.0 million in deposits and acquire approximately $3.7
million in loans. The transaction is subject to regulatory approval and is
expected to close in the first quarter of 2006.
3. Earnings per Share
------------------
Basic earnings per share is calculated by dividing net income by the
weighted average number of shares of common stock outstanding during the period,
as adjusted for the stock dividend discussed in note 2. Diluted earnings per
share reflects additional common shares that would have been outstanding if
dilutive potential common shares had been issued, as well as any adjustment to
income that would result from the assumed issuance of potential common shares
that may be issued by the Company relating to outstanding stock options and, for
the 2004 period, guaranteed and contingently issuable shares from the
acquisition of Tri-State. As of the fourth quarter of 2004, the Company had no
additional obligation to issue further shares in connection with the acquisition
of Tri-State Potential common shares related to stock options are determined
using the treasury stock method.
The following table sets forth the computations of basic and diluted
earnings per share as retroactively adjusted for the 5% stock dividend declared
October 19, 2005.
-7-
Three Months Ended September 30, 2005 Three Months Ended September 30, 2004
------------------------------------- ---------------------------------------
Per Per
Income Shares Share Income Shares Share
(In thousands, except per share data) (Numerator) (Denominator) Amount (Numerator) (Denominator) Amount
---------------------------------------------------------------------------------- ---------------------------------------
Basic earnings per share:
Net income applicable to common
stockholders $ 752 3,170 $ 0.24 $ 403 1,931 $ 0.21
============ ===========
Effect of dilutive securities:
Stock options -- 31 -- 58
Deferred common stock payments for
purchase of insurance agency -- -- -- 18
-------------------------------------------------------------------- -------------------------
Diluted earnings per share:
Net income applicable to common stock-
holders and assumed conversions $ 752 3,201 $0.23 $ 403 2,007 $ 0.20
================================================================================== =======================================
Nine Months Ended September 30, 2005 Nine Months Ended September 30, 2004
------------------------------------- ---------------------------------------
Per Per
Income Shares Share Income Shares Share
(In thousands, except per share data) (Numerator) (Denominator) Amount (Numerator) (Denominator) Amount
---------------------------------------------------------------------------------- ---------------------------------------
Basic earnings per share:
Net income applicable to common
stockholders $ 1,938 3,163 $ 0.61 $ 1,165 1,922 $ 0.61
============ ===========
Effect of dilutive securities:
Stock options -- 38 -- 76
Deferred common stock payments for
purchase of insurance agency -- -- 2 16
-------------------------------------------------------------------- -------------------------
Diluted earnings per share:
Net income applicable to common stock-
holders and assumed conversions $ 1,938 3,201 $ 0.61 $ 1,167 2,014 $ 0.58
================================================================================== =======================================
4. Comprehensive Income
--------------------
The components of other comprehensive income (loss) and related tax
effects are as follows:
Three Months Ended September 30, Nine Months Ended September 30,
(Dollars in thousands) 2005 2004 2005 2004
------------------------------------------------------------------------ ------------- -------------- -------------
Unrealized holding gains (losses) on available
for sale securities ($256) $ 1,340 ($266) $ 228
Reclassification adjustments for gains included in net income (42) (11) (42) (11)
------------------------------------------------------------------------ ------------- -------------- -------------
Net unrealized gains (losses) (298) 1,329 (308) 217
Tax effect 119 (532) 123 (87)
------------------------------------------------------------------------ ------------- -------------- -------------
Other comprehensive income (loss), net of tax ($179) $ 797 ($185) $ 130
======================================================================== ============= ============== =============
5. Segment Information
-------------------
The Company's insurance agency operations are managed separately from the
traditional banking and related financial services that the Company also offers.
The insurance agency operation provides commercial, individual, and group
benefit plans and personal coverage.
(Dollars in thousands) Three Months Ended September 30, 2005 Three Months Ended September 30, 2004
-------------------------------------------------------------------------------------- --------------------------------------------
Banking and Insurance Banking and Insurance
Financial Services Services Total Financial Services Services Total
-------------------------------------------------------------------------------------- --------------------------------------------
Net interest income from external sources $ 2,885 $ -- $ 2,885 $ 2,298 $ -- $ 2,298
Other income from external sources 731 536 1,267 583 526 1,109
Depreciation and amortization 178 40 218 186 30 216
Income (loss) before income taxes 1,072 18 1,090 567 (21) 546
Income tax expense (benefit) 331 7 338 151 (8) 143
Total assets 300,604 3,349 303,953 256,415 3,286 259,701
-------------------------------------------------------------------------------------- --------------------------------------------
-8-
(Dollars in thousands) Nine Months Ended September 30, 2005 Nine Months Ended September 30, 2004
-------------------------------------------------------------------------------------- --------------------------------------------
Banking and Insurance Banking and Insurance
Financial Services Services Total Financial Services Services Total
-------------------------------------------------------------------------------------- --------------------------------------------
Net interest income from external sources $ 8,263 $ -- $ 8,263 $ 6,553 $ -- $ 6,553
Other income from external sources 1,939 1,753 3,692 1,730 1,696 3,426
Depreciation and amortization 562 125 687 485 82 567
Income before income taxes 2,646 81 2,727 1,480 115 1,595
Income tax expense 757 32 789 384 46 430
Total assets 300,604 3,349 303,953 256,415 3,286 259,701
-------------------------------------------------------------------------------------- --------------------------------------------
6. Stock Option Plans
------------------
The Company accounts for stock option plans under the recognition and
measurement principles of APB Opinion No. 25. "Accounting for Stock Issued to
Employees," and related interpretations. No stock-based employee compensation
cost is reflected in net income, as all options granted under the Company's
plans had an exercise price equal to the market value of the underlying common
stock on the date of grant. The following table illustrates the effect on net
income and earnings per share if the Company had applied the fair value
recognition provisions of FASB Statement No. 123, "Accounting for Stock-Based
Compensation," to stock-based compensation for the periods presented:
Three Months Ended September 30, Nine Months Ended September 30,
(Dollars in thousands) 2005 2004 2005 2004
--------------------------------------------------------------------------------- ------------ ------------ ------------
Net income, as reported $ 752 $ 403 $ 1,938 $ 1,165
Total stock-based compensation expense determined under fair value
based method for all awards, net of related tax effects (26) (39) (231) (103)
--------------------------------------------------------------------------------- ------------ ------------ ------------
Pro forma net income $ 726 $ 364 $ 1,707 $ 1,062
================================================================================= ============ ============ ============
Basic earnings per share:
As reported $ 0.24 $ 0.21 $ 0.61 $ 0.61
Pro forma $ 0.23 $ 0.19 $ 0.54 $ 0.55
Diluted earnings per share:
As reported $ 0.23 $ 0.20 $ 0.61 $ 0.58
Pro forma $ 0.23 $ 0.18 $ 0.53 $ 0.53
--------------------------------------------------------------------------------- ------------ ------------ ------------
7. Guarantees
----------
The Company does not issue any guarantees that would require liability
recognition or disclosure, other than its standby letters of credit. Standby
letters of credit are conditional commitments issued by the Company to guarantee
the performance of a customer to a third party. Generally, all letters of
credit, when issued have expiration dates within one year. The credit risk
involved in issuing letters of credit is essentially the same as those that are
involved in extending loan facilities to customers. The Company, generally,
holds collateral and/or personal guarantees supporting these commitments. The
Company had $1,108,000 of standby letters of credit as of September 30, 2005.
Management believes that the proceeds obtained through a liquidation of
collateral and the enforcement of guarantees would be sufficient to cover the
potential amount of future payment required under the corresponding guarantees.
The current amount of the liability as of September 30, 2005 for guarantees
under standby letters of credit issued is not material.
8. New Accounting Standards
------------------------
In December 2004, the Financial Accounting Standards Board (FASB) issued
Statement No. 123(R), "Share-Based Payment." Statement No. 123(R) replaces
Statement No. 123, "Accounting for Stock-Based Compensation," and
supersedes APB
Opinion No. 25, "Accounting for Stock Issued to Employees." Statement No. 123(R)
requires compensation costs related to share-based payment transactions to be
recognized in the financial statements over the period that an employee provides
service in exchange for the award. Public companies are required to adopt the
new standard using a modified prospective method and may elect to restate prior
periods using the modified retrospective method. Under the modified prospective
method, companies are required to record compensation cost
-9-
for new and modified awards over the related vesting period of such awards
prospectively and record compensation cost prospectively for the unvested
portion, at the date of adoption, of previously issued and outstanding awards
over the remaining vesting period of such awards. No change to prior periods
presented is permitted under the modified prospective method. Under the modified
retrospective method, companies record compensation costs for prior periods
retroactively through restatement of such period using the exact pro forma
amounts disclosed in the companies' footnotes. Also, in the period of adoption
and after, companies record compensation cost based on the modified prospective
method. Statement No. 123(R) is effective for periods beginning after December
15, 2005 (i.e. first quarter 2006 for the Company). Early application of
Statement No. 123(R) is encouraged, but not required.
The Company will adopt the modified prospective method. Using the modified
prospective method, the Company estimates that total stock-based compensation
expense, based on awards currently outstanding that will vest in 2006, net of
related tax effects, will be $94,000 for the year ending December 31, 2006.
In March 2005, the SEC issued Staff Accounting Bulletin No. 107 ("SAB No.
107"), "Share-Based Payment", providing guidance on option valuation methods,
the accounting for income tax effects of share-based payment arrangements upon
adoption of SFAS No. 123(R), and the disclosures in MD&A subsequent to the
adoption. The Company will provide SAB No. 107 required disclosures upon
adoption of SFAS No. 123(R) on January 1, 2006.
In January 2003, the FASB's Emerging Issues Task Force (EITF) issued EITF
Issue No. 03-1, "The Meaning of Other-Than-Temporary Impairment and Its
Application to Certain Investors" ("EITF 03-1"), and in March 2004, the EITF
issued an update. EITF 03-1 addresses the meaning of other-than-temporary
impairment and its application to certain debt and equity securities. EITF 03-1
aids in the determination of impairment of an investment and gives guidance as
to the measurement of impairment loss and the recognition and disclosures of
other-than-temporary investments. EITF 03-1 also provides a model to determine
other-than-temporary impairment using evidence-based judgment about the recovery
of the fair value up to the cost of the investment by considering the severity
and duration of the impairment in relation to the forecasted recovery of the
fair value. In July 2005, FASB adopted the recommendation of its staff to
nullify key parts of EITF 03-1. The staff's recommendations were to nullify the
guidance on the determination of whether an investment is impaired as set forth
in paragraphs 10-18 of Issue 03-1 and not to provide additional guidance on the
meaning of other-than-temporary impairment. Instead, the staff recommends
entities recognize other-than-temporary impairments by applying existing
accounting literature such as paragraph 16 of SFAS 115.
In July 2005, the FASB issued a proposed interpretation of FAS 109,
"Accounting for Income Taxes", to clarify certain aspects of accounting for
uncertain tax positions, including issues related to the recognition and
measurement of those tax positions. If adopted as proposed, the interpretation
would be effective in the fourth quarter of 2005, and any adjustments required
to be recorded as a result of adopting the interpretation would be reflected as
a cumulative effect from a change in accounting principle. We are currently in
the process of determining the impact of adoption of the interpretation as
proposed on our financial position or results of operations.
In June 2005, the FASB's Emerging Issues Task Force (EITF) reached a
consensus on Issue No. 05-6, "Determining the Amortization Period for Leasehold
Improvements Purchased after Lease Inception or Acquired in a Business
Combination" ("EITF 05-6"). This guidance requires that leasehold improvements
acquired in a business combination or purchased subsequent to the inception of a
lease be amortized over the shorter of the useful life of the assets or a term
that includes required lease periods and renewals that are reasonably assured at
the date of the business combination or purchase. This guidance is applicable
only to leasehold improvements that are purchased or acquired in reporting
periods beginning after June 29, 2005. The Company is evaluating the impact, if
any, of EITF 05-6 on its financial statements.
In October 2005, the FASB issued FASB Staff Position FAS 13-1 ("FSP FAS
13-1"), which requires companies to expense rental costs associated with ground
or building operating leases that are incurred during a construction period. As
a result, companies that are currently capitalizing these rental costs are
required to expense them beginning in its first reporting period beginning after
December 15, 2005. FSP FAS 13-1 is effective for our Company as of the first
quarter of fiscal 2006. We evaluated the provisions of FSP FAS 13-1 and do not
believe that its adoption will have a material impact on our Company's financial
condition or results of operations.
Item 2. Management's Discussion and Analysis of Financial Condition and Results
-----------------------------------------------------------------------
of Operations
-------------
MANAGEMENT STRATEGY
-------------------
The Company's goal is to serve as a community-oriented financial
institution serving the Northwestern New Jersey, Northeastern Pennsylvania and
New York tri-state marketplace. Our market presence has been expanded by opening
loan production offices in early 2005 in Milford, Pennsylvania and Warwick, New
York with added availability of all of our financial services in those counties
contiguous to our existing New Jersey market. While offering traditional
community bank loan and deposit products and services such as residential
mortgages originated for the Company's portfolio, the Company obtains
significant non-interest income through its Tri-State Insurance Agency, Inc.
("Tri-State") insurance brokerage operations and the sale of non-deposit
products. In the second quarter of 2005, the Company acquired a 49% equity
interest in SussexMortgage.com LLC; a mortgage banking joint venture with
National City Mortgage Inc. SussexMortgage.com LLC commenced operations in the
third quarter of 2005. Loans originated by SussexMortgage.com LLC are funded by
third parties and will generate fee income net of origination costs.
On November 8, 2005, Sussex Bancorp announced that its Sussex Bank
subsidiary had entered into an agreement to purchase the Port Jervis, New York
branch office of NBT Bank, N.A. As part of the transaction, Sussex Bank will
assume approximately $6.0 million in deposits and acquire approximately $3.7
million in loans. The transaction is subject to regulatory approval and is
expected to close in the first quarter of 2006.
CRITICAL ACCOUNTING POLICIES
----------------------------
Disclosure of the Company's significant accounting policies is included in
Note 1 to the consolidated financial statements of the Company's Annual Report
on Form 10-KSB for the year ended December 31, 2004. Some of these
-10-
policies are particularly sensitive, requiring significant judgments, estimates
and assumptions to be made by management, most particularly in connection with
determining the provision for loan losses and the appropriate level of the
allowance for loan losses. Additional information is contained on pages 13, 15
and 17 of this Form 10-QSB for the provision and allowance for loan losses.
FORWARD LOOKING STATEMENTS
--------------------------
When used in this discussion the words: "believes", "anticipates",
"contemplated", "expects" or similar expressions are intended to identify
forward looking statements. Such statements are subject to certain risks and
uncertainties that could cause actual results to differ materially from those
projected. Those risks and uncertainties include changes to interest rates, the
ability to control costs and expenses, general economic conditions and economic
conditions in the Company's Sussex, New Jersey marketplace, and the success of
the Company's efforts to diversify its revenue base by developing additional
sources of non-interest income while continuing to manage its existing fee based
business. The Company undertakes no obligation to publicly release the results
of any revisions to those forward looking statements that may be made to reflect
events or circumstances after this date or to reflect the occurrence of
unanticipated events.
RESULTS OF OPERATIONS
---------------------
Three Months ended September 30, 2005 and September 30, 2004
------------------------------------------------------------
Overview
--------
The Company realized net income of $752 thousand for the third quarter of
2005, an increase of $349 thousand, or 86.6%, from the $403 thousand reported
for the same period in 2004. Basic earnings per share, as retroactively adjusted
for the 5% stock dividend declared October 19, 2005, increased from $0.21 in the
third quarter of 2004 to $0.24 for the third quarter of 2005 and diluted
earnings per share increased from $0.20 in the third quarter of 2004 to $0.23
for the quarter ended September 30, 2005. During the third quarter of 2005, we
had 3,169,592 average shares outstanding, compared to 1,930,731 average shares
outstanding in the prior year period, reflecting the impact of our capital
offering which closed in December, 2004.
The results reflect an increase in net interest income, primarily due to
increased loan interest income, coupled with increases in non-interest income
associated with an increase in service fees on deposit accounts, partially
offset by increases in non-interest expenses due to salary and employee benefits
and professional fees.
Comparative Average Balances and Average Interest Rates
-------------------------------------------------------
The following table presents, on a fully taxable equivalent basis, a
summary of the Company's interest-earning assets and their average yields, and
interest-bearing liabilities and their average costs for the three month period
ended September 30, 2005 and 2004.
Three Months Ended September 30,
(dollars in thousands) 2005 2004
---------------------------------------------------------------------------------------------------------------------
Average Average Average Average
Earning Assets: Balance Interest (1) Rate (2) Balance Interest(1) Rate (2)
---------------------------------------------------------------------------------------------------------------------
Securities:
Tax exempt (3) $ 26,495 $ 399 5.98% $ 21,984 $ 316 5.72%
Taxable 43,719 400 3.63% 53,367 483 3.60%
---------------------------------------------------------------------------------------------------------------------
Total securities 70,214 799 4.52% 75,351 799 4.22%
Total loans receivable (4) 194,053 3,259 6.66% 145,451 2,260 6.18%
Other interest-earning assets 9,107 80 3.47% 5,648 23 1.59%
---------------------------------------------------------------------------------------------------------------------
Total earning assets 273,374 $ 4,138 6.01% 226,450 3,082 5.41%
Non-interest earning assets 24,314 25,831
Allowance for loan losses (2,250) (2,011)
------------------------------------------------------ --------
Total Assets $295,438 $250,270
====================================================== ========
Sources of Funds:
Interest bearing deposits:
NOW $ 43,922 $76 0.69% $42,910 $ 46 0.42%
Money market 19,965 127 2.52% 16,551 50 1.21%
-11-
Savings 61,937 118 0.76% 67,314 109 0.64%
Time 75,036 556 2.94% 55,290 288 2.07%
---------------------------------------------------------------------------------------------------------------------
Total interest bearing deposits 200,860 877 1.73% 182,066 493 1.08%
Borrowed funds 14,576 169 4.54% 10,499 130 4.83%
Junior subordinated debentures 5,155 92 7.00% 5,155 66 5.05%
---------------------------------------------------------------------------------------------------------------------
Total interest bearing liabilities 220,591 $ 1,138 2.05% 197,719 $689 1.39%
Non-interest bearing liabilities:
Demand deposits 40,005 35,093
Other liabilities 2,135 1,982
------------------------------------------------------ --------
Total non-interest bearing liabilities 42,140 37,075
Stockholders' equity 32,707 15,476
------------------------------------------------------ --------
Total Liabilities and Stockholders' Equity $295,438 $250,270
====================================================== ========
------------------------------------------- ------------------- --------------------
Net Interest Income and Margin (5) $ 3,000 4.35% $2,393 4.20%
=========================================== =================== ====================
(1) Includes loan fee income
(2) Average rates on securities are calculated on amortized costs
(3) Full taxable equivalent basis, using a 39% effective tax rate and adjusted
for TEFRA (Tax and Equity Fiscal Responsibility Act) disallowance
(4) Loans outstanding include non-accrual loans
(5) Represents the difference between interest earned and interest paid, divided
by average total interest-earning assets
Net Interest Income
-------------------
Net interest income is the difference between interest and fees on loans
and other interest-earning assets and interest paid on interest-bearing
liabilities. Net interest income is directly affected by changes in volume and
mix of interest-earning assets and interest-bearing liabilities that support
those assets, as well as changing interest rates when differences exist in
repricing dates of assets and liabilities.
Net interest income, on a fully taxable equivalent basis (a 39% tax rate),
increased $607 thousand, or 25.4%, to $3.0 million for the three months ended
September 30, 2005 compared to $2.4 million for the same three month period in
2004. The net interest margin increased, on a fully taxable equivalent basis, by
15 basis points to 4.35% for the three months ended September 30, 2005 compared
to 4.20% for the same period in 2004.
Interest Income
---------------
Total interest income, on a fully taxable equivalent basis, increased by
$1.1 million to $4.1 million for the three months ended September 30, 2005
compared to $3.1 million in the same period in 2004. Total average earning
assets increased by $46.9 million to $273.4 million from $226.5 million for the
three months ended September 30, 2004. The repositioning of average balances in
higher yielding loans and the increase in market rates of interest have
increased the average rate earned 60 basis points from 5.41% for the third
quarter of 2004 to 6.01% in the same period in 2005.
Total interest income on securities, on a fully taxable equivalent basis,
was unchanged at $799 thousand for the three month periods ended September 30,
2005 and 2004. As the average balance of total securities decreased $5.1
million, the average rate earned increased 30 basis points, from 4.22% in the
third quarter of 2004 to 4.52% for the third quarter of 2005. The decrease in
the average balances of the securities portfolio reflects a $9.6 million
reduction in taxable securities and a $4.5 million increase in tax-exempt
securities. The increase in yield was accomplished through the repositioning of
these securities and the tax equivalent effect on the interest earned in an
increasing market rate environment.
Comparing the average balance in the loan portfolio for the three months
ended September 30, 2004 to same period in 2005, the average balance in loans
increased $48.6 million, or 33.4%, while the interest earned on total loans
increased $999 thousand, or 44.2%. The average rate earned on loans increased 48
basis points from 6.18% for the three months ended September 30, 2004 to 6.66%
for the same period in 2005. The increase in our loan portfolio reflects our
continuing efforts to enhance our loan origination capacity and continue to grow
our commercial portfolio.
Interest Expense
----------------
The Company's interest expense for the three months ended September 30,
2005 increased $449 thousand, or 65.2%, to $1.1 million from $689 thousand for
the same period in 2004, as the balance in average interest-bearing liabilities
increased $22.9 million, or 11.6% to $220.6 million from $197.7 million between
the same two periods. The
-12-
average rate paid on total interest-bearing liabilities has increased by 66
basis points from 1.39% for the three months ended September 30, 2004 to 2.05%
for the same period in 2005, largely due to increased market rates of interest.
The average balance in time deposits increased $19.7 million from $55.3
million in the third quarter of 2004 to $75.0 million during the same period in
2005 due to the Company actively promoting competitive market rates of interest.
To attract municipal accounts, a higher incentive rate was offered on the public
fund money market account. The average balance in money market accounts
increased $3.4 million in the third quarter of 2005 compared to three month
period ended September 30, 2004, as the rate of interest paid increased 131
basis points to 2.52% for the three months ended September 31, 2005 from 1.21%
for the same period in 2004.
For the quarter ended September 30, 2005, the Company's average borrowed
funds increased $4.1 million to $14.6 million compared to average borrowed funds
of $10.5 million during the third quarter of 2004. The balance at September 30,
2005 consisted of four convertible notes totaling $12.0 million, one ninety day
note for $5.0 million and $1.0 million in a repurchase agreement from the
Federal Home Loan Bank. The average rate paid on total borrowed funds has
decreased 29 basis points from the third quarter of 2004 to the same period in
2005, as the rates paid on the newer borrowings were at lower market rates of
interest. In the third quarter of 2002, the Company issued $5.2 million in
junior subordinated debentures. The debentures bear a floating rate of interest,
which averaged 7.00% for the three months ended September 30, 2005, up 195 basis
points from 5.05% in the same period of 2004.
Provision for Loan Losses
-------------------------
The provision for loan losses for the third quarter of 2005 was $206
thousand compared to a provision of $120 thousand in the third quarter of 2004,
an increase of $86 thousand. The increase in the provision from the third
quarter of 2004 to the same quarter in 2005 was due to substantial loan growth,
mainly in commercial and non-residential real estate. The provision for loan
losses reflects management's judgment concerning the risks inherent in the
Company's existing loan portfolio and the size of the allowance necessary to
absorb the risks, as well as the average balance of the portfolio over both
periods. Management reviews the adequacy of its allowance on an ongoing basis
and will provide additional provisions, as management may deem necessary.
Non-Interest Income
-------------------
The Company's non-interest income is primarily generated through insurance
commissions earned through the operation of Tri-State, service charges on
deposit accounts and investment brokerage fees.
The Company's non-interest income increased by $158 thousand, or 14.2%, to
$1.3 million for the three months ended September 30, 2005 from $1.1 million for
the same period in 2004. In February of 2005 the Company began a new "no-return"
overdraft privilege program. Service fees on deposit accounts have consequently
accounted for the increase in non-interest income as they increased $159
thousand, or 90.9%, to $334 thousand in the third quarter of 2005 from $175
thousand during the same period in 2004. Insurance commission income from
Tri-State and investment brokerage fee income have marginally increased in the
third quarter of 2005 over the same period in 2004. This was offset by a
decrease in mortgage banking fee income between the same two periods, as the
Company's newly formed mortgage banking joint venture with National City
Mortgage Inc., SussexMortgage.com LLC, commenced operations in the third quarter
of 2005.
Non-Interest Expense
--------------------
Total non-interest expense increased $115 thousand, or 4.2%, from $2.7
million in the third quarter of 2004 to $2.9 million in the third quarter of
2005. Salaries and employee benefits, the largest component of non-interest
expense, increased $46 thousand, or 2.9%. Professional fees have increased $55
thousand, or 67.9%, in the third quarter of 2005 to $136 thousand, due to the
preparation for implementation of Sarbanes Oxley Act Section 404 and the
retention of consultants to assist with the documentation and review of the
Company's internal controls. Occupancy expense increased $21 thousand to $246
thousand for the third quarter of 2005 from $225 for the same period in 2004, as
the rental expense for Tri-State increased $11 thousand due to the expansion of
their office space in August of 2005.
Income Taxes
------------
The Company's income tax provision, which includes both federal and state
taxes, was $338 thousand and $143 thousand for the three months ended September
30, 2005 and 2004, respectively. This increase in income taxes resulted from an
increase in income before taxes of $544 thousand, or 99.6% for the three months
ended September 30, 2005 as compared to the same period in 2004. The Company's
effective tax rate of 31% and 26% for the three months ended
-13-
September 30, 2005 and 2004, respectively, is below the statutory tax rate due
to tax-exempt interest on securities and earnings on the investment in life
insurance.
Nine Months ended September 30, 2005 and September 30, 2004
-----------------------------------------------------------
Overview
--------
For the nine months ended September 30, 2005, net income was $1.9 million,
an increase of $773 thousand, or 66.4%, from the $1.2 million reported for the
same period in 2004. Basic earnings per share, as retroactively adjusted for the
5% stock dividend declared October 19, 2005, were $0.61 for each of the nine
month periods ended September 30, 2005 and 2004. The weighted number of basic
shares increased by 1,241,364 shares, or 64.6%, between the nine months ended
September 30, 2004 and the nine months ended September 30, 2005 as a result of a
capital offering in December 2004. Diluted earnings per share were $0.61 for the
nine months ended September 30, 2005, an increase from $0.58 from the first nine
months of 2004, as the weighted number of diluted shares increased by 1,187,026
shares, or 58.9%, in the current nine month period.
Comparative Average Balances and Average Interest Rates
-------------------------------------------------------
The following table presents, on a fully taxable equivalent basis, a
summary of the Company's interest-earning assets and their average yields, and
interest-bearing liabilities and their average costs for the nine month period
ended September 30, 2005 and 2004.
Nine Months Ended September 30,
(dollars in thousands) 2005 2004
----------------------------------------------------------------------------------------------------------
Average Average Average Average
Earning Assets: Balance Interest (1) Rate (2) Balance Interest (1) Rate (2)
---------------------------------------------------------------------------------------------------------
Securities:
Tax exempt (3) $ 27,326 $ 1,245 6.09% $ 22,109 $ 905 5.47%
Taxable 46,527 1,280 3.68% 52,691 1,368 3.47%
---------------------------------------------------------------------------------------------------------
Total securities 73,853 2,525 4.57% 74,800 2,273 4.06%
Total loans receivable (4) 177,891 8,748 6.57% 140,980 6,522 6.18%
Other interest-earning assets 10,427 225 2.89% 8,044 71 1.17%
---------------------------------------------------------------------------------------------------------
Total earning assets 262,171 $11,498 5.86% 223,824 $8,866 5.29%
Non-interest earning assets 23,982 25,012
Allowance for loan losses (2,118) (1,899)
------------------------------------------------- ---------
Total Assets $284,035 $ 246,937
================================================= =========
Sources of Funds:
Interest bearing deposits:
NOW $ 43,028 $ 200 0.62% $45,671 $ 152 0.45%
Money market 20,746 326 2.10% 11,392 93 1.09%
Savings 64,110 345 0.72% 66,505 324 0.65%
Time 66,419 1,279 2.57% 57,051 891 2.09%
---------------------------------------------------------------------------------------------------------
Total interest bearing deposits 194,303 2,150 1.48% 180,619 1,460 1.08%
Borrowed funds 13,189 461 4.61% 10,832 395 4.79%
Junior subordinated debentures 5,155 256 6.55% 5,155 187 4.78%
---------------------------------------------------------------------------------------------------------
Total interest bearing liabilities 212,647 $2,867 1.80% 196,606 $2,042 1.39%
Non-interest bearing liabilities:
Demand deposits 37,545 32,923
Other liabilities 1,682 2,100
------------------------------------------------- ---------
Total non-interest bearing liabilities 39,227 35,023
Stockholders' equity 32,161 15,308
------------------------------------------------- ---------
Total Liabilities and Stockholders'
Equity $284,035 $ 246,937
================================================= =========
--------------------------------------- ---------------- ------------------
Net Interest Income and Margin (5) $ 8,631 4.40% $6,824 4.07%
======================================= ================ ==================
(1) Includes loan fee income
(2) Average rates on securities are calculated on amortized costs
(3) Full taxable equivalent basis, using a 39% effective tax rate and adjusted
for TEFRA (Tax and Equity Fiscal Responsibility Act) interest expense
disallowance
(4) Loans outstanding include non-accrual loans
(5) Represents the difference between interest earned and interest paid, divided
by average total interest-earning assets
-14-
Net Interest Income
-------------------
Net interest income, on a fully taxable equivalent basis (a 39% tax rate),
increased $1.8 million, or 26.5%, to $8.6 million for the nine months ended
September 30, 2005 compared to $6.8 million for the same nine month period in
2004. The net interest margin increased, on a fully taxable equivalent basis, by
34 basis points to 4.40% for the nine months ended September 30, 2005 compared
to 4.07% for the same period in 2004.
Interest Income
---------------
Total interest income, on a fully taxable equivalent basis, increased by
$2.6 million, or 29.7%, to $11.5 million for the nine months ended September 30,
2005 compared to $8.9 million in the first nine months of 2004. Total average
earning assets increased by $38.3 million to $262.2 million in the current nine
month period from $223.8 million for the nine months ended September 30, 2004.
The growth in higher yielding loan average balances in an increasing interest
rate environment have increased the average rate earned on earning assets 57
basis points from 5.29% for the first nine months of 2004 to 5.86% in the same
period in 2005.
Total interest income on securities, on a fully taxable equivalent basis,
increased $252 thousand, or 11.1%, from the nine months ended September 30, 2004
to the same period in 2005. As the average balance of total securities decreased
$947 thousand, the average rate earned increased 51 basis points, from 4.06% in
the first nine months of 2004 to 4.57% for the same period in 2005. The increase
in yield was accomplished by replacing taxable securities in the portfolio with
tax-exempt securities and the tax equivalent effect on the interest earned in an
increasing market rate environment.
The average balance in the loan portfolio for the nine months ended
September 30, 2005 increased $36.9 million, or 26.2%, from the first nine months
of 2004. The interest earned on total loans increased $2.2 million, or 34.1% as
the average rate earned on loans increased 39 basis points from 6.18% for the
nine months ended September 30, 2004 to 6.57% for the same period in 2005. The
growth in our loan portfolio is a result of the reorganization of our loan
department and success in marketing our loan products.
Interest Expense
----------------
Interest expense increased $825 thousand to $2.9 million for the nine
months ended September 30, 2005 from $2.0 million for the nine months ended
September 30, 2004 as the average balance in interest bearing liabilities
increased $16.0 million, to $212.6 million for the first nine months of 2005
from $196.7 million in the same period in 2004. These increases were due to
increases in market rates of interest and time deposit promotions. The average
rate paid on interest bearing liabilities increased 41 basis points to 1.80% for
the first nine months of 2005 from 1.39% for the nine months ended September 30,
2004.
The Company's interest expense on deposit liabilities for the nine months
ended September 30, 2005 increased $690 thousand, or 47.3%, to $2.2 million from
$1.5 million for the same period in 2004, as the average balance in interest
bearing deposits increased 7.6% to $194.3 million during the first nine months
of 2005 from $180.6 million for the same period a year earlier. The increase
reflects the growth in time deposits through promotional rate incentives and
money market deposits, largely through the increase in municipal deposits.
The average rate paid on total interest-bearing deposits has increased by
40 basis points from 1.08% for the nine months ended September 30, 2004 to 1.48%
for the same period in 2005. A higher incentive rate paid on money market
accounts has increased money market balances $9.4 million, or 82.1%, to $20.7
million for the first nine months of 2005 compared to $11.4 million for the nine
month period ended September 30, 2004. Time deposit average balances increased
by $9.4 million, or 16.4%, to $66.4 million for the first nine months of 2005
from $57.1 million for the nine month period ended 2004.
For the nine months ended September 30, 2005, the Company's average
borrowed funds increased $2.4 million to $13.2 million from $10.8 million for
the first nine months of 2004. The Company's $5.2 million in junior subordinated
debentures bear a floating rate of interest, which averaged 6.55% for the nine
months ended September 30, 2005, up 177 basis points from 4.78% in the same
period of 2004.
Provision for Loan Losses
-------------------------
The provision for loan losses for the first nine months of 2005 was $547
thousand compared to a provision of $373 thousand in the first nine months of
2004, an increase of $174 thousand. The increase in the provision between
periods was due to substantial loan growth, mainly in commercial and
non-residential real estate.
-15-
Non-Interest Income
-------------------
The Company's non-interest income is primarily generated through insurance
commissions earned through the operation of Tri-State and service charges on
deposit accounts.
The Company's non-interest income increased by $266 thousand, or 7.8%, to
$3.7 million for the nine months ended September 30, 2005 from $3.4 million for
the same period in 2004. Insurance commissions and fees increased 3.4% for the
nine month period ended September 30, 2005 to $1.8 million from $1.7 million in
the same period of 2004. Service fees on deposit accounts increased $328
thousand to $885 thousand in the first nine months of 2005 from $557 thousand
during the same period in 2004. Fees from the Company's new "no-return"
overdraft privilege program have increased overdraft fee income 58.9% in the
first nine months of 2005 from the same period last year. Mortgage banking fees
have decreased 54.2% to $209 thousand for the first nine months of 2005 from
$456 thousand during the same period in 2004 due to a decline in originations
during the organization of the Company's 49% joint venture with National City
Mortgage, Inc. The Company recorded a $12 thousand gain on the sale of assets
and $42 thousand gain on the sale of securities, available for sale during the
first nine months of 2005 compared to an $11 thousand gain on the sale of
securities, available for sale in the same period in 2004.
Non-Interest Expense
--------------------
Total non-interest expense increased from $8.0 million in the first nine
months of 2004 to $8.7 million in the first nine months of 2005, an increase of
$670 thousand, or 8.4%. The largest percent increases were in professional fees,
advertising and promotion and amortization of intangible assets. Professional
fees have increased $147 thousand, or 61.8%, in the first nine months of 2005 to
$385 thousand due to higher costs associated with the implementation of Sarbanes
Oxley Act Section 404. Advertising and promotion expenses have increased $95
thousand, or 34.1%, in the first nine months of 2005 over the same period in
2004 due to increased advertisements for deposit product rate promotions and the
fees associated with a new cross-selling initiative program.
Income Taxes
------------
The Company's federal and state income tax provision was $789 thousand for
the nine months ended September 30, 2005 compared to $430 thousand recorded for
the first nine months of 2004. This increase in income taxes resulted from an
increase in income before taxes of $1.1 million, or 71.0% for the nine months
ended September 30, 2005 as compared to the same period in 2004. The Company's
effective tax rate of 29% for the nine month period ended September 30, 2005 and
27% for the same period in 2004 are below the statutory tax rate due to
tax-exempt interest on securities and earnings on the investment in life
insurance.
FINANCIAL CONDITION
-------------------
September 30, 2005 as compared to December 31, 2004
---------------------------------------------------
At September 30, 2005 the Company had total assets of $304.0 million
compared to total assets of $278.3 million at December 31, 2004, an increase of
$25.7 million. Loans receivable increased $46.7 million, or 29.8%, to $203.7
million, as cash and cash equivalents, interest bearing time deposits and
securities available for sale, cumulatively decreased $22.5 million at September
30, 2005 from $156.9 million at December 31, 2004. Total deposits increased to
$245.1 million at September 30, 2005 from $229.8 million at December 31, 2004
and borrowings increased $8.0 million to $18.0 million at September 30, 2005.
Cash and Cash Equivalents
-------------------------
The Company's cash and cash equivalents decreased by $10.6 million at
September 30, 2005 to $18.7 million from $29.3 million at December 31, 2004.
This decrease reflects the Company's decrease in federal funds sold of $10.0
million to $8.9 million at September 30, 2005 from $18.9 million at year-end
2004. This decrease in federal funds sold helped to fund the growth in the
Company's loan portfolio.
Securities Portfolio
--------------------
The Company's securities, available for sale, at fair value, decreased
$8.5 million from $74.7 million at December 31, 2004 to $66.2 million at
September 30, 2005. The Company purchased $4.9 million in new securities during
the first nine months of 2005, $9.0 million in available for sale securities
matured or were repaid, $1.0 million in available for sale securities were
called and there were $3.0 million in sales. Balances in state and municipal
tax-exempt
-16-
securities decreased, at fair value, by $1.3 million to $24.6 million as
paydowns exceeded purchases in taxable securities, at fair value, for a net
decrease of $7.2 million to $41.6 million. The securities portfolio contained no
high-risk securities or derivatives as of September 30, 2005. There were no held
to maturity securities at September 30, 2005 or at December 31, 2004.
Loans
-----
Total loans at September 30, 2005 increased $46.7 million, or 29.8% to
$203.7 million from $156.9 million at year-end 2004. The Company is emphasizing
the origination of commercial, industrial, and non-residential real estate loans
to increase the yield in its loan portfolio. The Company has also increased its
activity in the loan participation market, both bought and sold. The majority of
the originated and sold participations are commercial real estate related loans
which exceed the Company's legal lending limit. The balances in all major loan
categories have increased from December 31, 2004 to September 30, 2005. The
largest increase was a $31.1 million, or 44.6%, increase in non-residential real
estate loans from $69.8 million at December 31, 2004 to $100.9 million at
September 30, 2005.
The increase in loans was funded during the first nine months of 2005 by a
decrease in the Company's federal funds sold, cash flows from repayments and
maturities on securities as well as increased deposits and borrowings from the
Federal Home Loan Bank. The loan to deposit ratios at September 30, 2005 and
December 31, 2004 were 83.1% and 68.3%, respectively.
Loan and Asset Quality
----------------------
Non-performing assets consist of non-accrual loans and all loans over
ninety days delinquent and foreclosed real estate owned ("OREO"). The Company's
non-accrual loans decreased to $1.2 million at September 30, 2005 from $1.3
million at December 31, 2004. There were $290 thousand in past due loans over 90
days and still accruing and $49 thousand in renegotiated loans at September 30,
2005. The Company had one OREO property valued at $270 thousand at September 30,
2005 and none at December 31, 2004.
The Company seeks to actively manage its non-performing assets. In
addition to active monitoring and collecting on delinquent loans, management has
an active loan review process for customers with aggregate relationships of
$250,000 or more if the credit(s) are unsecured or secured, in whole or
substantial part, by collateral other than real estate and $1,000,000 or more if
the credit(s) are secured in whole or substantial part by real estate.
Management continues to monitor the Company's asset quality and believes
that the non-accrual loans are adequately collateralized and anticipated
material losses have been adequately reserved for in the allowance for loan
losses.
The following table provides information regarding risk elements in the
loan portfolio at each of the periods presented:
(Dollars in thousands) September 30, 2005 December 31, 2004
-----------------------------------------------------------------------------------------------------
Non-accrual loans $ 1,163 $ 1,304
Non-accrual loans to total loans 0.57% 0.83%
Non-performing assets to total assets 0.59% 0.48%
Allowance for loan losses as a % of non-performing loans 159.39% 169.96%
Allowance for loan losses to total loans 1.18% 1.45%
-----------------------------------------------------------------------------------------------------
Allowance for Loan Losses
-------------------------
The allowance is allocated to specific loan categories based upon
management's classification of problem loans under the bank's internal loan
grading system and to pools of other loans that are not individually analyzed.
Management makes allocations to specific loans based on the present value of
expected future cash flows or the fair value of the underlying collateral for
impaired loans and to other classified loans based on various credit risk
factors. These factors include collateral values, the financial condition of the
borrower and industry and current economic trends.
Allocations to commercial loan pools are categorized by commercial loan
type and are based on management's judgment concerning historical loss trends
and other relevant factors. Installment and residential mortgage loan
allocations are made at a total portfolio level based on historical loss
experience adjusted for portfolio activity and current conditions. Additionally,
all other delinquent loans are grouped by the number of days delinquent with
this amount assigned a general reserve amount.
-17-
In April of 2005 the Company began an allowance for overdraft losses,
providing for losses in conjunction with the new no-return overdraft privilege
program. The provisions, charge-offs and recoveries for this new program are
included the Company's total allowance for loan losses. At September 30, 2005,
the total allowance for loan losses was $2.4 million, an increase of $120
thousand from the $2.3 million at December 31, 2004. The total provision for
loan losses was $547 thousand and there were $632 thousand in charge-offs and
$203 thousand in recoveries for the first nine months of 2005. The allowance for
loan losses as a percentage of total loans was 1.18% at September 30, 2005
compared to 1.45% on December 31, 2004. At December 31, 2004 the allowance held
specific reserves for the potential charge off of several loans in the loan
portfolio. During the first nine months of 2005, $421 thousand was charged off
relating to delinquent loans and $180 thousand was charged off on the write down
of a property the Company foreclosed on.
Management regularly assesses the appropriateness and adequacy of the loan
loss reserve in relation to credit exposure associated with individual
borrowers, overall trends in the loan portfolio and other relevant factors, and
believes the reserve is reasonable and adequate for each of the periods
presented.
Deposits
--------
Total deposits increased $15.3 million, or 6.7%, from $229.8 million at
December 31, 2004 to $245.1 million at September 30, 2005. Non-interest bearing
deposits increased $2.9 million, or 8.4% to $37.4 million at September 30, 2005
from $34.5 million at December 31, 2004 and interest-bearing deposits increased
$12.4 million, or 6.3%, to $207.8 million at September 30, 2005 from $195.4
million at December 31, 2004. Total time deposits balances increased $13.8
million, or 21.8%, from $63.2 million at December 31, 2004 to $77.0 million at
September 30, 2005 while other interest bearing deposit account balances
decreased $1.4 million, or 1.1%, to $130.8 million at September 30, 2005 from
$132.2 million at December 31, 2004. The shift from other interest-bearing
deposits, mainly from a select savings account product for senior citizens, to
time deposits, is market driven as the Company has increased interest rates paid
on short term time deposits. Management continues to monitor the shift in
deposits through its Asset/Liability Committee.
Borrowings
----------
Borrowings consist of advances and repurchase agreements from the Federal
Home Loan Bank ("FHLB"). The advances are secured under terms of a blanket
collateral agreement by a pledge of qualifying investment securities and certain
mortgage loans. As of September 30, 2005 the Company had $17.0 million in notes
outstanding at an average interest rate of 4.60% compared to $10.0 million in
notes outstanding at an average rate of 4.85% for the year ended December 31,
2004. The borrowings consist of three long-term notes totaling $10.0 million
that mature on December 21, 2010 and one $2.0 million long-term note that
matures on March 29, 2015, all four with a convertible quarterly option which
allows the FHLB to change the note to then current market rates. In September of
2005 the Bank took an additional $5.0 million ninety day advance from the FHLB
that matures on December 20, 2005. In March of 2005 the Company purchased $2.0
million in securities sold under agreements to repurchase at an average rate of
3.63%; $1.0 million matured September 29, 2005 and the second $1.0 million
matures in March of 2006.
Junior Subordinated Debentures
------------------------------
On July 11, 2002, the Company raised an additional $4.8 million, net of
offering costs, in capital through the issuance of junior subordinated
debentures to a statutory trust subsidiary. The subsidiary in turn issued $5.0
million in variable rate capital trust pass through securities to investors in a
private placement. The interest rate is based on the three-month LIBOR plus 365
basis points and adjusts quarterly. The rate at September 30, 2005 was 7.25%.
The rate is capped at 12.5% through the first five years, and the securities may
be called at par anytime after October 7, 2007 or if the regulatory capital or
tax treatment of the securities is substantially changed. These trust preferred
securities are included in the Company's and the Bank's capital ratio
calculations.
As a result of the adoption of FASB Interpretation No. 46, "Consolidation
of Variable Interest Entities, and Interpretation of ARB No. 51", we
deconsolidated our wholly-owned subsidiary Sussex Capital Trust I, referred to
as the "Trust", from our consolidated financial statements as of March 31, 2004.
For regulatory reporting purposes, the Federal Reserve is allowing trust
preferred securities to continue to qualify as Tier 1 Capital subject to
specified limitations. The adoption of FIN 46 did not have an impact on our
results of operations or liquidity.
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Interest Rate Sensitivity
-------------------------
An interest rate sensitive asset or liability is one that, within a
defined time period, either matures or experiences an interest rate change in
line with general market interest rates. Interest rate sensitivity is the
volatility of a Company's earnings from a movement in market interest rates.
Interest rate "gap" analysis is a common, though imperfect, measure of interest
rate risk. We do not employ gap analysis as a rate risk management tool, but
rather we rely upon earnings at risk analysis to forecast the impact on our net
interest income of instantaneous 100 and 200 basis point increases and decreases
in market rates. In assessing the impact on earnings, the rate shock analysis
assumes that no change occurs in our funding sources or types of assets in
response to the rate change.
Our board of directors has established limits for interest rate risk based
on the percentage change in interest income we would incur in differing interest
rate scenarios. Through the first nine months of 2005, we sought to remain
relatively balanced, and our policies provide for a variance of no more than 25%
of net interest income, at a 100 and 200 basis point increase or decrease. At
September 30, 2005 the percentages of change were within policy limits.
Our financial modeling simulates our cash flows, interest income and
interest expense from earning assets and interest bearing liabilities for a
twelve month period in each of the different interest rate environments, using
actual individual deposit, loan and investment maturities and rates in the model
calculations. Assumptions regarding the likelihood of prepayments on residential
mortgage loans and investments are made based on historical relationships
between interest rates and prepayments. Commercial loans with prepayment
penalties are assumed to pay on schedule to maturity. In actual practice,
commercial borrowers may request and be granted interest rate reductions during
the life of a commercial loan due to competition from financial institutions and
declining interest rates.
The following table sets forth our interest rate risk profile at September
30, 2005 and 2004. The interest rate sensitivity of our assets and liabilities,
and the impact on net interest income, illustrated in the following table would
vary substantially if different assumptions were used or if actual experience
differs from that indicated by the assumptions.
September 30, 2005 September 30, 2004
------------------------------------------------------------------------------------
Change in Percent Gap as a Change in Percent Gap as a
Net Interest Change in Net % of Net Interest Change in Net % of
(Dollars in thousands) Margin Interest Margin Total Assets Margin Interest Margin Total Assets
-----------------------------------------------------------------------------------------------------------------
Down 200 basis points ($682) -0.23% 11.39% ($681) -0.26% 13.13%
Down 100 basis points (134) -0.04% 4.47% (193) -0.07% 7.45%
Up 100 basis points (110) -0.04% -3.67% (52) -0.02% -2.01%
Up 200 basis points (279) -0.09% -4.66% (165) -0.06% -3.19%
-----------------------------------------------------------------------------------------------------------------
Liquidity
---------
It is management's intent to fund future loan demand with deposits and
maturities and pay downs on investments. In addition, the bank is a member of
the Federal Home Loan Bank of New York and as of September 30, 2005, had the
ability to borrow up to $23.9 million against its one to four family mortgages
and selected investment securities as collateral for borrowings, of which the
Company had outstanding borrowings totaling $17.0 million and $1.0 million in
securities sold under an agreement to repurchase. The bank also has available an
overnight line of credit and a one-month overnight repricing line of credit,
each in an amount of $27.7 million at the Federal Home Loan Bank and an
overnight line of credit in the amount of $4.0 million at the Atlantic Central
Bankers Bank.
At September 30, 2005, the amount of liquid assets remained at a level
management deemed adequate to ensure that contractual liabilities, depositors'
withdrawal requirements, and other operational customer credit needs could be
satisfied. At September 30, 2005, liquid investments totaled $18.7 million, and
all mature within 30 days.
At September 30, 2005, the Company had $66.2 million of securities
classified as available for sale. Of these securities, $37.9 million had $588
thousand of unrealized losses and therefore are not available for liquidity
purposes because management's intent to hold them until market recovery.
The Company has no investment in or financial relationship with any
unconsolidated entities that are reasonably likely to have a material effect on
liquidity or the availability of capital resources.
The Company is not aware of any known trends or any known demands,
commitments, events or uncertainties, which would result in any material
increase or decrease in liquidity.
-19-
Off-Balance Sheet Arrangements
------------------------------
The Company's financial statements do not reflect off-balance sheet
arrangements that are made in the normal course of business. These off-balance
sheet arrangements consist of unfunded loans and letters of credit made under
the same standards as on-balance sheet instruments. These unused commitments, at
September 30, 2005 totaled $67.9 million and consisted of $36.9 million in
commitments to grant commercial real estate, construction and land development
loans, $12.2 million in home equity lines of credit, and $18.9 million in other
unused commitments. These instruments have fixed maturity dates, and because
many of them will expire without being drawn upon, they do not generally present
any significant liquidity risk to the Company.
Management believes that any amounts actually drawn upon can be funded in
the normal course of operations.
Capital Resources
-----------------
Stockholders' equity inclusive of accumulated other comprehensive income
(loss), net of income taxes, was $33.0 million at September 30, 2005, an
increase of $1.4 million from the $31.6 million at year-end 2004. Activity in
stockholders' equity consisted of net proceeds from common stock issuances of
$252 thousand, a net increase in retained earnings of $1.3 million derived from
$1.9 million in net income earned in the first nine months of 2005, offset by
$633 thousand for the payment of cash dividends and a $185 thousand unrealized
loss on securities available for sale, net of income tax of $123 thousand. The
five percent stock dividend, as retroactively adjusted to stockholders' equity,
reclassified $2.0 million to common stock from retained earnings.
At September 30, 2005 the Company and the Bank both meet the
well-capitalized regulatory standards applicable to them. The table below
presents the capital ratios at September 30, 2005, for the Company and the Bank,
as well as the minimum regulatory requirements.
Minimum Minimum
(Dollars in thousands) Amount Ratio Amount Ratio
---------------------------------------------------------------------------------------------
The Company:
Leverage Capital $35,450 12.11% $>11,714 4%
-
Tier 1 - Risk Based 35,450 15.71.% > 9,027 4%
-
Total Risk-Based 37,844 16.77% >18,054 8%
-
The Bank:
Leverage Capital 27,746 9.58% >11,587 4%
-
Tier 1 Risk-Based 27,746 12.42% > 8,933 4%
-
Total Risk-Based 30,140 13.50% >17,866 8%
-
---------------------------------------------------------------------------------------------
Effect of Inflation
-------------------
Unlike most industrial companies, virtually all of the assets and
liabilities of a financial institution are monetary in nature. As a result, the
level of interest rates has a more significant impact on a financial
institution's performance than effects of general levels of inflation. Interest
rates do not necessarily move in the same direction or change with the same
magnitude as the price of goods and services, which prices are affected by
inflation. Accordingly, the liquidity, interest rate sensitivity and maturity
characteristics of the Company's assets and liabilities are more indicative of
its ability to maintain acceptable performance levels. Management of the Company
monitors and seeks to mitigate the impact of interest rate changes by attempting
to match the maturities of assets and liabilities to gap, thus seeking to
minimize the potential effect of inflation.
Item 3. Controls and Procedures
-----------------------
(a) Evaluation of disclosure controls and procedures
The Company carried out an evaluation, under the supervision and with the
participation of the Company's management, including the Company's Chief
Executive Officer and Chief Financial Officer, of the effectiveness of the
design and operation of the Company's disclosure controls and procedures
pursuant to Exchange Act Rule 13a-15. Based upon that evaluation, the
Chief Executive Officer and Chief Financial Officer concluded that the
Company's disclosure controls and procedures are, as of the end of the
period covered by this report, effective in timely alerting them to
material information relating to the Company (including its consolidated
subsidiaries) required to be included in the Company's periodic SEC
filings.
-20-
(b) Changes in internal controls.
Not applicable
PART II - OTHER INFORMATION
Item 1. Legal Proceedings
-----------------
The Company and the Bank are periodically involved in various legal
proceedings as a normal incident to their businesses. In the opinion of
management, no material loss is expected from any such pending lawsuit.
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds
-----------------------------------------------------------
On April 16, 1999 the Company announced a stock repurchase plan whereby
the Company may purchase up to 50,000 shares of outstanding stock. There is no
expiration date to this plan. On April 27, 2005, the Company's Board increased
this plan to 100,000 shares of the Company's common stock.
Maximum
Total Number Number of
of Shares Shares that
Purchased as May Yet Be
Total Number Part of Publicly Purchased
of Shares Average Price Announced Plans Under the Plans
Period Purchased Paid per Share or Programs or Programs
------ --------- -------------- ----------- -----------
July 1, 2005 through
July 31, 2005 -- -- -- --
August 1, 2005 through
August 31, 2005 11,045 $14.31 45,053 54,947
September 1, 2005 through
September 30, 2005 105 $14.30 45,158 54,842
--------------------------------------------------------------------------------------------------------
Total 11,150 $14.31 45,158 54,842
========================================================================================================
Item 3. Defaults upon Senior Securities
-------------------------------
Not applicable
Item 4. Submission of Matters to a Vote of Security Holders
---------------------------------------------------
Not applicable
Item 5. Other Information
-----------------
Not applicable
Item 6. Exhibits
--------
Number Description
------ -----------
31.1 Certification of Donald L. Kovach pursuant to Section
302 of the Sarbanes-Oxley Act of 2002
31.2 Certification of Candace A. Leatham pursuant to Section
302 of the Sarbanes-Oxley Act of 2002
32 Certification pursuant to Section 906 of the
Sarbanes-Oxley Act of 2002.
In accordance with the requirements of the Exchange Act, the registrant
caused this report to be signed on its behalf by the undersigned, thereunto duly
authorized.
SUSSEX BANCORP
By: /s/ Candace A. Leatham
----------------------
CANDACE A. LEATHAM
Executive Vice President and
Chief Financial Officer
Date: November 14, 2005
-21-