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EX-32 - EXHIBIT 32 - Cape Bancorp, Inc.c16221exv32.htm
EX-31.1 - EXHIBIT 31.1 - Cape Bancorp, Inc.c16221exv31w1.htm
EX-31.2 - EXHIBIT 31.2 - Cape Bancorp, Inc.c16221exv31w2.htm
Table of Contents

 
 
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
     
þ   Quarterly Report Pursuant To Section 13 or 15(d) of the Securities Exchange Act of 1934
For the quarterly period ended March 31, 2011
OR
     
o   Transition Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934
For the transition period from                      to                     
Commission File No. 001-33934
Cape Bancorp, Inc.
(Exact name of registrant as specified in its charter)
     
Maryland   26-1294270
(State or other jurisdiction of   (I.R.S. Employer
incorporation or organization)   Identification Number)
     
225 North Main Street, Cape May Court House, New Jersey   08210
(Address of Principal Executive Offices)   Zip Code
(609) 465-5600
(Registrant’s telephone number)
N/A
(Former name or former address, 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 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 requirements for the past 90 days. YES þ NO o
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes o No o
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer or a smaller reporting company. See definition of “accelerated filer,” “large accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one)
             
Large accelerated filer o   Accelerated filer þ   Non-accelerated filer o   Smaller Reporting Company o
        (Do not check if smaller reporting company)    
Indicate by check mark whether the Registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). YES o NO þ
As of May 4, 2011 there were 13,313,521 shares of the Registrant’s common stock, par value $0.01 per share, outstanding.
 
 

 

 


 

CAPE BANCORP, INC.
FORM 10-Q
Index
         
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 Exhibit 31.1
 Exhibit 31.2
 Exhibit 32

 

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Item 1.  
Financial Statements
CAPE BANCORP, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
                 
    (unaudited)        
    March 31,     December 31,  
    2011     2010  
    (in thousands)  
ASSETS
               
Cash & due from financial institutions
  $ 11,590     $ 10,181  
Interest-bearing bank balances
    14,926       4,816  
 
           
Cash and cash equivalents
    26,516       14,997  
Interest-bearing time deposits
    9,612       9,361  
Investment securities available for sale, at fair value (amortized cost of $156,296 and $165,877 respectively)
    148,546       157,407  
Loans held for sale
    947       1,224  
Loans, net of allowance of $13,032 and $12,538 respectively
    764,685       772,318  
Accrued interest receivable
    4,088       4,029  
Premises and equipment, net
    24,883       25,212  
Other real estate owned
    3,981       3,255  
Federal Home Loan Bank (FHLB) stock, at cost
    8,028       8,721  
Prepaid FDIC insurance premium
    2,902       3,195  
Deferred income taxes
    13,725       6,054  
Bank owned life insurance (BOLI)
    28,499       28,252  
Goodwill
    22,575       22,575  
Intangible assets, net
    417       445  
Assets held for sale
          479  
Other assets
    2,235       3,518  
 
           
Total assets
  $ 1,061,639     $ 1,061,042  
 
           
 
               
LIABILITIES AND STOCKHOLDERS’ EQUITY
               
Liabilities
               
Deposits
               
Noninterest-bearing deposits
  $ 70,505     $ 68,267  
Interest-bearing deposits
    690,459       684,801  
Borrowings
    154,238       169,637  
Advances from borrowers for taxes and insurance
    608       554  
Accrued interest payable
    580       714  
Other liabilities
    4,145       4,915  
 
           
Total liabilities
    920,535       928,888  
 
           
 
               
Stockholders’ Equity
               
Common stock, $.01 par value: authorized 100,000,000 shares; issued 13,324,521 shares; outstanding 13,313,521 shares
    133       133  
Additional paid-in capital
    126,989       126,864  
Treasury stock at cost — 11,000 shares
    (85 )     (85 )
Unearned ESOP shares
    (9,274 )     (9,380 )
Accumulated other comprehensive loss, net
    (5,115 )     (5,590 )
Retained earnings
    28,456       20,212  
 
           
Total stockholders’ equity
    141,104       132,154  
 
           
Total liabilities & stockholders’ equity
  $ 1,061,639     $ 1,061,042  
 
           
See accompanying notes to consolidated financial statements.

 

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CAPE BANCORP, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME
(unaudited)
                 
    For the three months ended March 31,  
    2011     2010  
    (dollars in thousands, except share data)  
Interest income:
               
Interest on loans
  $ 10,835     $ 11,606  
Interest and dividends on investments
               
Taxable
    636        
Tax-exempt
    233       314  
Interest on mortgage-backed securities
    408       645  
 
           
Total interest income
    12,112       12,565  
 
           
Interest expense:
               
Interest on deposits
    1,672       2,381  
Interest on borrowings
    1,354       1,587  
 
           
Total interest expense
    3,026       3,968  
 
           
Net interest income before provision for loan losses
    9,086       8,597  
Provision for loan losses
    2,400       244  
 
           
Net interest income after provision for loan losses
    6,686       8,353  
 
           
Non-interest income:
               
Service fees
    828       763  
Net gains on sale of loans
    42       12  
Net income from BOLI
    247       252  
Net rental income
    61       58  
Gain on sale of investment securities held for sale, net
    148        
Net gain (loss) on sale of OREO
    63       265  
Other
    78       66  
Gross other-than-temporary impairment losses
    305       (2,422 )
Less: Portion of loss recognized in other comprehensive income
    (516 )     (149 )
 
           
Net other-than-temporary impairment losses
    (211 )     (2,571 )
 
           
Total non-interest income
    1,256       (1,155 )
 
           
Non-interest expense:
               
Salaries and employee benefits
    3,721       3,559  
Occupancy and equipment
    848       1,030  
Federal insurance premiums
    313       320  
Data processing
    323       314  
Loan related expenses
    286       218  
Advertising
    99       95  
Telecommunications
    240       233  
Professional services
    200       202  
OREO expenses
    105       308  
Other operating
    983       815  
 
           
Total non-interest expense
    7,118       7,094  
 
           
Income before income taxes
    824       104  
Income tax expense (benefit)
    (7,420 )     (531 )
 
           
Net income
  $ 8,244     $ 635  
 
           
 
               
Earnings per share (see Note 10):
               
Basic
  $ 0.67     $ 0.05  
Diluted
  $ 0.67     $ 0.05  
 
               
Weighted average number of shares outstanding:
               
Basic
    12,393,888       12,338,966  
Diluted
    12,396,463       12,338,966  
See accompanying notes to unaudited consolidated financial statements.

 

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CAPE BANCORP, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS’ EQUITY
Year ended December 31, 2010 and three months ended March 31, 2011
(unaudited)
                                                         
                                    Accumulated                
                            Unearned     Other             Total  
    Common     Paid-In     Treasury     ESOP     Comprehensive     Retained     Stockholders’  
    Stock     Capital     Stock     Shares     Income (Loss)     Earnings     Equity  
    (in thousands)  
 
                                                       
Balance, December 31, 2009
  $ 133     $ 126,695     $     $ (9,806 )   $ (6,645 )   $ 16,171     $ 126,548  
 
                                                       
Net income
                                  4,041       4,041  
 
                                                       
Stock option compensation expense
          268                               268  
 
                                                       
Restricted stock compensation expense
          8                               8  
 
                                                       
Net unrealized gains, net of reclassification adjustments and taxes
                            1,055             1,055  
 
                                                     
Total comprehensive income
                                                    5,372  
 
                                                       
Common stock repurchased — 11,000 shares
                (85 )                       (85 )
 
                                                       
ESOP shares earned
          (107 )           426                   319  
 
                                         
 
                                                       
Balance, December 31, 2010
    133       126,864       (85 )     (9,380 )     (5,590 )     20,212       132,154  
 
                                                       
Net income
                                  8,244       8,244  
 
                                                       
Stock option compensation expense
          124                                 124  
 
                                                       
Restricted stock compensation expense
          4                                 4  
 
                                                       
Net unrealized gains, net of reclassification adjustments and taxes
                            475             475  
 
                                                     
Total comprehensive income
                                                    8,847  
 
                                                       
ESOP shares earned
          (3 )           106                   103  
 
                                         
 
                                                       
Balance, March 31, 2011
  $ 133     $ 126,989     $ (85 )   $ (9,274 )   $ (5,115 )   $ 28,456     $ 141,104  
 
                                         
See accompanying notes to unaudited consolidated financial statements.

 

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CAPE BANCORP, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(unaudited)
                 
    Three months ended  
    March 31,  
    2011     2010  
    (in thousands)  
Cash flows from operating activities
               
Net income
  $ 8,244     $ 635  
Adjustments to reconcile net income (loss) to net cash provided by operating activities:
               
Provision for loan losses
    2,400       244  
Net gain on the sale of loans
    (42 )     (12 )
Net gain on the sale of other real estate owned
    (63 )     (265 )
Write-down of other real estate owned
    47       184  
Loss on impairment of securities
    211       2,571  
Net gain on sale of investments
    (148 )      
Earnings on BOLI
    (247 )     (252 )
Origination of loans held for sale
    (3,154 )     (1,479 )
Proceeds from sales of loans
    3,431       818  
Depreciation and amortization
    413       502  
ESOP and stock-based compensation expense
    231       72  
Deferred income taxes
    (7,915 )     (1,173 )
Changes in assets and liabilities that (used) provided cash:
               
Accrued interest receivable
    (59 )     623  
Other assets
    2,052       15  
Accrued interest payable
    (134 )     (83 )
Other liabilities
    (770 )     377  
 
           
Net cash provided by operating activities
    4,497       2,777  
 
           
Cash flows from investing activities
               
Proceeds from sales of AFS securities
    10,166        
Proceeds from calls, maturities, and principal repayments of AFS securities
    17,812       22,069  
Purchases of AFS securities
    (18,432 )     (22,383 )
Redemption of Federal Home Loan Bank stock
    693       1,481  
Proceeds from sale of other real estate owned
    946       2,868  
Increase in interest-bearing time deposits
    (251 )     (951 )
Decrease in loans, net
    3,541       4,932  
Purchase of property and equipment, net
    (6 )     (16 )
 
           
Net cash provided by investing activities
    14,469       8,000  
 
           
Cash flows from financing activities
               
Net increase in deposits
    7,899       30,016  
Increase in advances from borrowers for taxes and insurance
    54       11  
Increase in long-term borrowings
    10,000        
Repayments of long-term borrowings
    (20,000 )     (25,000 )
Net change in short-term borrowings
    (5,400 )     (7,900 )
 
           
Net cash used in financing activities
    (7,447 )     (2,873 )
 
           
Net increase in cash and cash equivalents
    11,519       7,904  
Cash and cash equivalents at beginning of period
    14,997       13,513  
 
           
Cash and cash equivalents at end of period
  $ 26,516     $ 21,417  
 
           
Supplementary disclosure of cash flow information:
               
Cash paid during period for:
               
Interest
  $ 3,161     $ 4,051  
Income taxes, net of refunds
  $     $  
Supplementary disclosure of non-cash financing and investing activities:
               
Transfers from loans to other real estate owned
  $ 1,655     $ 484  
See accompanying notes to unaudited consolidated financial statements.

 

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Notes to Financial Statements (Unaudited)
NOTE 1 — ORGANIZATION
Cape Bancorp (“Company”) is a Maryland corporation that was incorporated on September 14, 2007 for the purpose of becoming the holding company of Cape Bank (formerly Cape Savings Bank) in connection with Cape Bank’s mutual-to-stock conversion, Cape Bancorp’s initial public offering and simultaneous acquisition of Boardwalk Bancorp, Inc. (“Boardwalk Bancorp”), Linwood, New Jersey and its wholly-owned New Jersey chartered bank subsidiary, Boardwalk Bank. As a result of these transactions, Boardwalk Bancorp was merged with, and into, Cape Bancorp and Boardwalk Bank was merged with, and into, Cape Bank. As of January 31, 2008, Cape Savings Bank changed its name to Cape Bank.
Cape Bank (“Bank”) is a New Jersey-chartered stock savings bank. The Bank provides a complete line of business and personal banking products through its sixteen full service branch offices located throughout Atlantic and Cape May counties in southern New Jersey and a loan production office in Burlington County (opened in February 2011). The Bank received regulatory approval for the closing of one branch in Cape May County which was effective as of the close of business February 4, 2011.
The Bank competes with other banking and financial institutions in its primary market areas. Commercial banks, savings banks, savings and loan associations, credit unions and money market funds actively compete for savings and time certificates of deposit and all types of loans. Such institutions, as well as consumer financial and insurance companies, may be considered competitors of the Bank with respect to one or more of the services it renders.
The Bank is subject to regulations of certain state and federal agencies, and accordingly, the Bank is periodically examined by such regulatory authorities. As a consequence of the regulation of commercial banking activities, the Bank’s business is particularly susceptible to future state and federal legislation and regulations.
NOTE 2 — SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Basis of Financial Statement Presentation: The accounting and reporting policies of the Bank conform to accounting principles generally accepted in the United States of America (US GAAP).
We have prepared the consolidated financial statements included herein pursuant to the rules and regulations of the Securities and Exchange Commission (“SEC”). We have condensed or omitted certain information and footnote disclosures normally included in consolidated financial statements prepared in accordance with U.S. generally accepted accounting principles (“GAAP”) pursuant to such rules and regulations. In the opinion of management, the statements include all adjustments (which include normal recurring adjustments) required for a fair statement of financial position, results of operations and cash flows for the interim periods presented. These financial statements should be read in conjunction with the financial statements and notes thereto included in our latest Annual Report on Form 10-K. The results of operations for the interim periods are not necessarily indicative of the results for the full year.
The consolidated financial statements include the accounts of Cape Bancorp, Inc. and its subsidiaries, all of which are wholly-owned. Significant intercompany balances and transactions have been eliminated. Certain prior period amounts have been reclassified to conform to current year presentations. The consolidated financial statements, as of and for the periods ended March 31, 2011 and 2010, have not been audited by the Company’s independent registered public accounting firm. In the opinion of management, all accounting entries and adjustments, including normal recurring accruals, necessary for a fair presentation of the financial position and the results of operations for the interim periods have been made. Events occurring subsequent to the date of the balance sheet have been evaluated for potential recognition or disclosure in the consolidated financial statements through the date of the filing of the consolidated financial statements with the SEC.
Use of Estimates: To prepare financial statements in conformity with accounting principles generally accepted in the United States of America (or with U.S. generally accepted accounting principles), management makes estimates and assumptions based on available information. These estimates and assumptions affect the amounts reported in the financial statements and the disclosures provided, and actual results could differ. The allowance for loan losses, deferred taxes, evaluation of investment securities for other-than-temporary impairment and fair values of financial instruments are particularly subject to change.
Cash and Cash Equivalents: For purposes of reporting cash flows, cash and cash equivalents include cash on hand, amounts due from banks, overnight deposits, federal funds sold and interest-bearing bank balances. The Federal Reserve Bank required reserves of $756,000 as of March 31, 2011, and $657,000 as of December 31, 2010, are included in these balances.
Interest-Bearing Time Deposits: Interest-bearing time deposits are held to maturity, are carried at cost and have original maturities greater than three months.

 

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Investment Securities: Investment securities classified as available for sale are carried at fair value with unrealized gains and losses excluded from earnings and reported in a separate component of equity, net of related income tax effects. Gains and losses on sales of investment securities are recognized upon realization utilizing the specific identification method.
When the fair value of a debt security has declined below the amortized cost at the measurement date, an entity that intends to sell a security or is more likely than not to sell the security before the recovery of the security’s cost basis, the entity must recognize the other-than-temporary impairment (OTTI) in earnings. For a debt security with a fair value below the amortized cost at the measurement date where it is more likely than not that an entity will not sell the security before the recovery of its cost basis, but an entity does not expect to recover the entire cost basis of the security, the security is considered other-than-temporarily impaired. The related other-than-temporary impairment loss on the debt security will be recognized in earnings to the extent of the credit losses with the remaining impairment loss recognized in accumulated other comprehensive income. In estimating other-than-temporary losses, management considers: the length of time and extent that fair value has been less than cost, the financial condition and near term prospects of the issuer, cash flow, stress testing analysis on securities when applicable, and the Company’s ability and intent to hold the security for a period sufficient to allow for any anticipated recovery in fair value.
Loans Held for Sale: Mortgage loans originated and intended for sale in the secondary market are carried at the lower of aggregate cost or market, as determined by outstanding commitments from investors. Net unrealized losses, if any, are recorded as a valuation allowance and charged to earnings. Gains and losses on sales of mortgage loans are based on the difference between the selling price and the carrying value of the related loan sold.
Loans and Allowance for Loan Losses: Loans that management has the intent and ability to hold for the foreseeable future or until maturity or payoff are stated at the amount of unpaid principal, net of unearned interest, deferred loan fees and costs, and reduced by an allowance for loan losses. Interest on loans is accrued and credited to operations based upon the principal amounts outstanding. The allowance for loan losses is established through a provision for loan losses charged to operations. Loans are charged against the allowance for loan losses when management believes that the collectability of the principal is unlikely.
Recognition of interest income is discontinued when, in the opinion of management, the collectability of such interest becomes doubtful. A commercial loan is classified as non-accrual when the loan is 90 days or more delinquent, or when in the opinion of management, the collectability of such loan is in doubt. Consumer and residential loans are classified as non-accrual when the loan is 90 days or more delinquent with a loan to value ratio greater than 70 percent. Loan origination fees and certain direct origination costs are deferred and amortized over the life of the related loans as an adjustment to the yield on loans receivable in a manner which approximates the interest method.
All interest accrued, but not received, for loans placed on non-accrual is reversed against interest income. Interest received on such loans is accounted for on the cash basis or cost-recovery method, until qualifying for return to accrual. Commercial loans are returned to accrual status when all the principal and interest amounts contractually due are brought current and future payments are reasonably assured. Payments are generally applied to reduce the principal balance but, in certain situations, the application of payments may vary. Consumer and residential loans are returned to accrual status when their delinquency becomes less than 90 days and/or the loan to value ratio is less than 70%.
The allowance for loan losses is maintained at an amount management deems adequate to cover probable incurred losses. In determining the level to be maintained, management evaluates many factors including current economic trends, industry experience, historical loss experience, industry loan concentrations, the borrowers’ ability to repay and repayment performance, estimated collateral values, changes in loan policies and procedures, changes in loan volume, delinquency and troubled asset trends, loan management and personnel, internal and external loan review, total credit exposure of the individual or entity, and external factors including competition, legal, regulatory and seasonal factors. In the opinion of management, the allowance is adequate to absorb probable loan losses. While management uses the best information available to make such evaluations, future adjustments to the allowance may be necessary based on changes in economic conditions or any of the other factors used in management’s determination. In addition, various regulatory agencies, as an integral part of their examination process, periodically review the Bank’s allowance for losses on loans. Such agencies may require the Bank to recognize additions to the allowance based on their judgment about information available to them at the time of their examination. Charge-offs to the allowance are made when the loan is transferred to other real estate owned or a determination of loss is made.
A loan is impaired when, based on current information and events, it is probable that a creditor will be unable to collect all amounts due according to the contractual terms of the loan agreement. Loans are individually evaluated for impairment. If a loan is impaired, a portion of the allowance is allocated so that the loan is reported net, at the present value of estimated future cash flows using the loan’s existing rate or at the fair value of collateral if repayment is expected solely from the collateral. Included in the allowance for loan losses at March 31, 2011 was an impairment reserve for troubled debt restructurings (TDRs) in the amount of $418,000.

 

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Other Real Estate Owned: Real estate acquired as a result of foreclosure or by deed in lieu of foreclosure is classified as other real estate owned and is initially recorded at the lower of cost or estimated fair market value, less the estimated cost to sell, at the date of foreclosure, thereby establishing a new cost basis. If fair value declines subsequent to foreclosure, a valuation allowance is recorded through expense. Operating costs after acquisition are expensed.
Premises and Equipment: Land is carried at cost. Premises and equipment are stated at cost less accumulated depreciation. Buildings and related components are depreciated using the straight-line method with useful lives ranging from 10 to 39 years. Furniture, fixtures and equipment are depreciated using the straight-line (or accelerated) method with useful lives ranging from 3 to 7 years.
Federal Home Loan Bank of New York (FHLB) Stock: The Bank is a member of the FHLB of New York. Members are required to own a certain amount of stock based on the level of borrowings and other factors. FHLB stock is carried at cost, classified as a restricted security, and periodically evaluated for impairment based on ultimate recovery of par value. Cash dividends are reported as income.
Goodwill and Other Intangible Assets: Goodwill results from business acquisitions and represents the excess of the purchase price over the fair value of acquired tangible assets and liabilities and identifiable intangible assets. Goodwill is assessed at least annually for impairment and any such impairment will be recognized in the period identified. The annual goodwill assessment for 2011 will be performed in the fourth quarter.
Other intangible assets consist of core deposit and acquired customer relationship intangible assets arising from whole bank acquisitions. They are initially measured at fair value and then are amortized on an accelerated method over their estimated useful lives, which range from 5 to 13 years. Other intangible assets are assessed at least annually for impairment and any such impairment will be recognized in the period identified.
Bank Owned Life Insurance (BOLI): The Bank has an investment of bank owned life insurance. BOLI involves the purchasing of life insurance by the Bank on a chosen group of employees and directors. The Bank is the owner and beneficiary of the policies and in accordance with FASB Accounting Standards Codification (ASC) Topic 325 “Investments in Insurance Contracts”, the amount recorded is the cash surrender value, which is the amount realizable.
Loan Commitments and Related Financial Instruments: Financial instruments include off-balance sheet credit instruments, such as commitments to make loans and commercial letters of credit, issued to meet customer financing needs. The face amount for these items represents the exposure to loss, before considering customer collateral or ability to repay. Such financial instruments are recorded when they are funded.
Defined Benefit Plan: The Bank participates in a multi-employer defined benefit plan. The plan was amended to freeze participation to new employees commencing January 1, 2008. Employees who became eligible to participate prior to January 1, 2008, will continue to accrue a benefit under the plan. The Bank accrues pension costs as incurred. The plan was further amended to freeze benefits as of December 31, 2008 for all employees eligible to participate prior to January 1, 2008.
401(k) Plan: The Bank maintains a tax-qualified defined contribution plan for all salaried employees of Cape Bank who have satisfied the 401(k) Plan’s eligibility requirements. The Bank’s matching contribution under the Plan is equal to 100% of the participant’s contribution on up to 3% of the participant’s salary contributed to the plan and 50% of contributions on the next 2% of salary contributed by the participant, with a maximum potential matching contribution of 4%.
Employee Stock Ownership Plan (ESOP): The cost of shares issued to the ESOP, but not yet earned is shown as a reduction of equity. Compensation expense is based on the market price of shares as they are committed to be released to participant accounts and the shares become outstanding for earnings per share computations. As of March 31, 2011, 127,809 shares have been allocated to eligible participants in the Cape Bank Employee Stock Ownership Plan.
Stock Benefit Plan: The Company has an Equity Incentive Plan (the “Stock Benefit Plan”) under which incentive and non-qualified stock options, stock appreciation rights (SARs) and restricted stock awards (RSAs) may be granted periodically to certain employees and directors. Under the fair value method of accounting for stock options, the fair value is measured on the date of grant using the Black-Scholes option pricing model with market assumptions. This amount is amortized as salaries and employee benefits expense on a straight-line basis over the vesting period. Option pricing models require the use of highly subjective assumptions, including expected stock price volatility, which, if changed, can significantly affect fair value estimates.

 

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Income Taxes: Income taxes are accounted for under the asset and liability method. Deferred tax assets and liabilities are recognized for the future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases and operating loss and tax credit carryforwards. The principal types of accounts resulting in differences between assets and liabilities for financial statement and tax purposes are the allowance for loan losses, deferred compensation, deferred loan fees, charitable contributions, depreciation and other-than-temporary impairment charges. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. The effect on deferred tax assets and liabilities of a change in tax rates is recognized in income in the period that includes the enactment date. A valuation allowance is recorded against net deferred tax assets when management has concluded that it is not more likely than not that a portion or all will be realized.
Beginning with the adoption of FASB Interpretation No. 48, Accounting for Uncertainty in Income Taxes, included in FASB ASC Subtopic 740-10 — Income Taxes — Overall, the Company recognizes the effect of income tax positions only if those positions are more likely than not of being sustained. Recognized income tax positions are measured at the largest amount that is greater than 50% likely of being realized. Changes in recognition or measurement are reflected in the period in which the change in judgment occurs. Prior to the adoption of Interpretation 48, the Company recognized the effect of income tax positions only if such positions were probable of being sustained.
The Company records interest and penalties related to uncertain tax positions as non-interest expense.
Earnings Per Share: Basic earnings (loss) per common share is the net income (loss) divided by the weighted average number of common shares outstanding during the period. ESOP shares are not considered outstanding for this calculation unless earned. Diluted earnings per share includes the dilutive effect of additional potential common shares issuable under stock option and restricted stock awards, if any.
Comprehensive Income (Loss): Comprehensive income includes net income as well as certain other items which result in a change to equity during the period. Other comprehensive income includes unrealized gains and losses on securities available for sale which are also recognized as separate components of equity as follows:
                         
    Before Tax     Tax Benefit     Net of Tax  
    Amount     (Expense)     Amount  
    (in thousands)  
Three months ended March 31, 2011
                       
Unrealized holding gains arising during the period
  $ 140     $ (47 )   $ 93  
Non-credit related unrealized gain on other-than-temporarily impaired CDOs
    516       (175 )     341  
Reclassification adjustment for gain on sale of AFS securities
    (148 )     50       (98 )
Reclassification adjustment for credit related OTTI included in net income
    211       (72 )     139  
 
                 
Other comprehensive income, net
  $ 719     $ (244 )   $ 475  
 
                 
 
                       
Three months ended March 31, 2010
                       
Unrealized holding gains arising during the period
  $ 425     $ (178 )   $ 247  
Non-credit related unrealized gain on other-than-temporarily impaired CDOs
    149       (51 )     98  
Reclassification adjustment for credit related OTTI included in net income
    2,571       (874 )     1,697  
 
                 
Other comprehensive income, net
  $ 3,145     $ (1,103 )   $ 2,042  
 
                 

 

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Operating Segments: While the chief decision makers monitor the revenue streams of the various products and services, operations are managed and financial performance is evaluated on a Company-wide basis. Operating segments are aggregated into one as operating results for all segments are similar. Accordingly, all of the financial service operations are considered by management to be aggregated in one reportable operating segment.
Effect of Newly Issued Accounting Standards:
In December 2010, the FASB issued (ASU) 2010-28 Intangibles—Goodwill and Other (Topic 350) covering when to perform step 2 of the Goodwill Impairment Test for reporting units with zero or negative carrying amounts. This Update is intended to modify step 1 of the goodwill impairment test for reporting units with zero or negative carrying amounts as these entities will be required to perform step 2 of the goodwill impairment test if it is more likely than not that a goodwill impairment exists. The amendments in this Update are effective for all entities that have recognized goodwill and have one or more reporting units whose carrying amount for purposes of performing step 1 of the goodwill impairment test is zero or negative. For public entities, the amendments in this Update are effective for fiscal years and interim periods within those years, beginning after December 15, 2010. Early adoption is not permitted. No significant impact to amounts reported in the consolidated financial position or results of operations are expected from the adoption of ASU 2010-28.
In December 2010, the FASB issued (ASU) 2010-29 Business Combinations (Topic 805) Disclosure of Supplementary Pro Forma Information for Business Combinations. This Update specifies that if a public entity presents comparative financial statements, the entity should disclose revenue and earnings of the combined entity as though the business combination(s) that occurred during the current year had occurred as of the beginning of the comparable prior annual reporting period only. The amendments in this Update also expand the supplemental pro forma disclosures under Topic 805 to include a description of the nature and amount of material, nonrecurring pro forma adjustments directly attributable to the business combination included in the reported pro forma revenue and earnings. The amendments in this Update are effective prospectively for business combinations for which the acquisition date is on or after the beginning of the first annual reporting period beginning on or after December 15, 2010. Early adoption is permitted. No significant impact to amounts reported in the consolidated financial position or results of operations are expected from the adoption of ASU 2010-29.
In January 2011, the FASB issued (ASU) 2011-01 Receivables (Topic 310) Deferral of the Effective Date of Disclosures about Troubled Debt Restructurings in Update No. 2010-20. This Update temporarily delays the effective date of the disclosures about troubled debt restructurings in Update 2010-20 for public entities. The amendments in this Update delay the effective date of the new disclosures about troubled debt restructurings for public entities and the coordination of the guidance for determining what constitutes a troubled debt restructuring until interim and annual periods ending after June 15, 2011. No significant impact to amounts reported in the consolidated financial position or results of operations are expected from the adoption of ASU 2011-01.
NOTE 3 — INVESTMENT SECURITIES
The amortized cost, gross unrealized gains or losses and the fair value of the Company’s investment securities available for sale are as follows:
                                 
            Gross     Gross        
    Amortized     Unrealized     Unrealized        
    Cost     Gains     Losses     Fair Value  
    (in thousands)  
March 31, 2011
                               
Investment securities available for sale
                               
Debt securities
                               
U.S. Government and agency obligations
  $ 65,475     $ 13     $ (957 )   $ 64,531  
Municipal bonds
    24,728       439       (635 )     24,532  
Collateralized debt obligations
    9,518             (7,369 )     2,149  
Corporate bonds
    16,376       69       (48 )     16,397  
 
                       
Total debt securities
  $ 116,097     $ 521     $ (9,009 )   $ 107,609  
 
                       
 
                               
Mortgage-backed securities
                               
GNMA pass-through certificates
  $ 2,290     $ 53     $     $ 2,343  
FHLMC pass-through certificates
    3,081       128             3,209  
FNMA pass-through certificates
    10,835       491       (52 )     11,274  
Collateralized mortgage obligations
    23,993       236       (118 )     24,111  
 
                       
Total mortgage-backed securities
  $ 40,199     $ 908     $ (170 )   $ 40,937  
 
                       
 
                               
Total securities available for sale
  $ 156,296     $ 1,429     $ (9,179 )   $ 148,546  
 
                       

 

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            Gross     Gross        
    Amortized     Unrealized     Unrealized        
    Cost     Gains     Losses     Fair Value  
    (in thousands)  
December 31, 2010
                               
Investment securities available for sale
                               
Debt securities
                               
U.S. Government and agency obligations
  $ 72,470     $ 52     $ (787 )   $ 71,735  
Municipal bonds
    25,811       456       (861 )     25,406  
Collateralized debt obligations
    9,715             (8,581 )     1,134  
Corporate bonds
    17,994       187       (46 )     18,135  
 
                       
Total debt securities
  $ 125,990     $ 695     $ (10,275 )   $ 116,410  
 
                       
 
                               
Mortgage-backed securities
                               
GNMA pass-through certificates
  $ 2,318     $ 50     $     $ 2,368  
FHLMC pass-through certificates
    3,299       134             3,433  
FNMA pass-through certificates
    16,542       765       (41 )     17,266  
Collateralized mortgage obligations
    17,728       309       (107 )     17,930  
 
                       
Total mortgage-backed securities
  $ 39,887     $ 1,258     $ (148 )   $ 40,997  
 
                       
 
                               
Total securities available for sale
  $ 165,877     $ 1,953     $ (10,423 )   $ 157,407  
 
                       
The table below indicates the length of time individual securities have been in a continuous unrealized loss position at March 31, 2011.
                                                 
    Less Than 12 Months     12 Months or Longer     Total  
          Unrealized           Unrealized           Unrealized  
Description of Securities   Fair Value     Losses     Fair Value     Losses     Fair Value     Losses  
    (in thousands)  
U.S. Government and agency obligations
  $ 57,518     $ (957 )   $     $     $ 57,518     $ (957 )
Municipal bonds
    5,148       (73 )     2,420       (562 )     7,568       (635 )
Corporate bonds
    8,179       (48 )                 8,179       (48 )
Collateralized debt obligations
    20       (366 )     2,129       (7,003 )     2,149       (7,369 )
Mortgage-backed securities
    13,751       (170 )     14       (0 )     13,765       (170 )
 
                                   
 
                                               
Total temporarily impaired investment securities
  $ 84,616     $ (1,614 )   $ 4,563     $ (7,565 )   $ 89,179     $ (9,179 )
 
                                   
The table below indicates the length of time individual securities have been in a continuous unrealized loss position at December 31, 2010.
                                                 
    Less Than 12 Months     12 Months or Longer     Total  
            Unrealized             Unrealized             Unrealized  
Description of Securities   Fair Value     Losses     Fair Value     Losses     Fair Value     Losses  
    (in thousands)  
U.S. Government and agency obligations
  $ 52,688     $ (787 )   $     $     $ 52,688     $ (787 )
Municipal bonds
    6,853       (220 )     2,916       (641 )     9,769       (861 )
Corporate bonds
    9,427       (46 )                 9,427       (46 )
Collateralized debt obligations
    35       (364 )     1,099       (8,217 )     1,134       (8,581 )
Mortgage-backed securities
    6,675       (110 )     3,140       (38 )     9,815       (148 )
 
                                   
 
                                               
Total temporarily impaired investment securities
  $ 75,678     $ (1,527 )   $ 7,155     $ (8,896 )   $ 82,833     $ (10,423 )
 
                                   

 

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Management evaluates investment securities to determine if they are other-than-temporarily impaired on at least a quarterly basis. The evaluation process applied to each security includes, but is not limited to, the following factors: whether the security is performing according to its contractual terms, determining if there has been an adverse change in the expected cash flows for investments within the scope of FASB Accounting Standards Codification (ASC) Topic 325, “Investments Other”, the length of time and the extent to which the fair value has been less than cost, whether the Company intends to sell, or would more likely than not be required to sell an impaired debt security before a recovery of its amortized cost basis, credit rating downgrades, the percentage of performing collateral that would need to default or defer to cause a break in yield and/or a temporary interest shortfall, and a review of the underlying issuers.
At March 31, 2011, the Company’s investment securities portfolio consisted of 319 securities, 91 of which were in an unrealized loss position. The gross unrealized losses in the Company’s investment securities portfolio related primarily to the collateralized debt obligation securities, which are discussed in detail below, and accounted for 80.3% of the total gross unrealized losses at March 31, 2011. The remaining securities with unrealized losses consist of investments that are backed by the U.S. Government or U.S. sponsored agencies which the government has affirmed its commitment to support, and municipal obligations which had unrealized losses that were caused by changing credit spreads in the market as a result of the current economic environment. Because the Company has no intention to sell these securities, nor is it more likely than not that we will be required to sell the securities, the Company does not consider these investments to be OTTI.
As of March 31, 2011, the book value of our pooled trust preferred collateralized debt obligations totaled $9.5 million with an estimated fair value of $2.1 million and is comprised of 24 securities. Of those, 16 have been principally issued by bank holding companies (PreTSL deals, MM Community I, and Alesco VI), and 8 have been principally issued by insurance companies (I-PreTSL deals). All of our pooled securities are mezzanine tranches and possess credit ratings below investment grade. As of March 31, 2011, 16 of our securities had no excess subordination and 8 of our securities had excess subordination which ranged from 3.4% to 14.3% of the current performing collateral. Excess subordination is the amount by which the underlying performing collateral exceeds the outstanding bonds in the current class, plus all senior classes. It is a static measure of credit enhancement, but does not incorporate structural elements of the CDO. Management utilizes excess subordination as a measure to identify which tranches are at a greater risk for a future break in cash flows. However, a current subordination deficit or “zero excess subordination” does not indicate the tranche will not ultimately receive all principal and interest due. For example, this measure does not consider the potential for recovery of issuers that are currently deferring payments. Some issuers have elected to defer payments, which contractually they are permitted to do for a period of up to 5 years, even though going concern issues may not exist. This supports management’s position that a deferral is not necessarily indicative of a default or that a default is imminent. On average, deferring issuers underlying the bank issued CDOs comprise approximately 60% of the total dollar value related to issuer defaults and deferrals. As such, our assumptions used in the calculation of discounted cash flows anticipate a 15% recovery rate on deferring issuers as compared to no recovery of issuers that have defaulted. The recovery rate assumption represents management’s best estimate based on current facts and circumstances. In addition, due to projected discounted cash flows that do not support the receipt of interest, the Company is not accruing interest on any of the bank issued CDO securities. Accordingly, these securities are considered non-performing assets.
The following table provides additional information related to our pooled trust preferred collateralized debt obligations as of March 31, 2011:
Pooled Trust Preferred Collateralized Debt Obligations
(dollars in thousands)
                                                                         
                                                            Amount of        
                                                            Deferrals     Excess  
                                                            and     Subordination  
                                                    Current     Defaults     as a % of  
    Number                                         Moody’s/   Number of     as a % of     Current  
    of         Book     Fair     Unrealized     Realized     Fitch   Performing     Current     Performing  
Deal   Securities     Class   Value     Value     Loss     Loss     Ratings   Issuers     Collateral     Collateral  
PreTSL II
    2     Mezzanine   $ 431     $ 92     $ (339 )   $ (635 )   Ca/C     23       39.90 %     0.00 %
PreTSL VI
    1     Mezzanine     42       20       (22 )     (16 )   Ca/D     3       73.60 %     0.00 %
PreTSL XIX
    1     Mezzanine     966       243       (723 )     (614 )   C/C     53       24.30 %     0.00 %
I-PreTSL I
    2     Mezzanine     1,834       416       (1,418 )         NR/CCC     16       17.40 %     9.55 %
I-PreTSL II
    2     Mezzanine     2,717       624       (2,093 )         NR/B     29       4.90 %     14.33 %
I-PreTSL III
    3     Mezzanine     2,703       621       (2,082 )         B2/CCC     24       11.20 %     11.32 %
I-PreTSL IV
    1     Mezzanine     439       113       (326 )         Ba2/CCC     29       11.60 %     3.36 %
MM Comm I
    1     Mezzanine     386       20       (366 )     (1,153 )   NR/C     7       61.80 %     0.00 %
 
                                                             
Total
    13         $ 9,518     $ 2,149     $ (7,369 )   $ (2,418 )                            
 
                                                             

 

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Lack of liquidity in the market for trust preferred collateralized debt obligations, credit rating downgrades and market uncertainties related to the financial industry are factors contributing to the impairment on these securities. The table above excludes 11 CDO securities which have been completely written-off and, therefore, have no book value. The recognized loss associated with these securities is $14.5 million.
The following table provides additional information related to our pooled trust preferred collateralized debt obligations as of December 31, 2010:
Pooled Trust Preferred Collateralized Debt Obligations
(dollars in thousands)
                                                                         
                                                            Amount of        
                                                            Deferrals     Excess  
                                                            and     Subordination  
                                                    Current     Defaults     as a % of  
    Number                                         Moody’s/   Number of     as a % of     Current  
    of         Book     Fair     Unrealized     Realized     Fitch   Performing     Current     Performing  
Deal   Securities     Class   Value     Value     Loss     Loss     Ratings   Issuers     Collateral     Collateral  
PreTSL II
    2     Mezzanine   $ 419     $ 15     $ (403 )   $ (635 )   Ca/C     23       37.70 %     0.00 %
PreTSL VI
    1     Mezzanine     43       1       (41 )     (16 )   Ca/D     2       81.00 %     0.00 %
PreTSL XIX
    1     Mezzanine     1,168       20       (1,148 )     (614 )   C/C     52       24.60 %     0.00 %
I-PreTSL I
    2     Mezzanine     1,833       251       (1,582 )         NR/CCC     16       17.36 %     9.11 %
I-PreTSL II
    2     Mezzanine     2,715       375       (2,340 )         NR/B     29       4.87 %     14.33 %
I-PreTSL III
    3     Mezzanine     2,701       375       (2,326 )         B2/CCC     24       11.16 %     10.75 %
I-PreTSL IV
    1     Mezzanine     439       63       (376 )         Ba2/CCC     29       11.58 %     2.82 %
MM Comm I
    1     Mezzanine     399       35       (364 )     (1,153 )   NR/C     7       61.80 %     0.00 %
 
                                                             
Total
    13         $ 9,715     $ 1,134     $ (8,581 )   $ (2,418 )                            
 
                                                             
On a quarterly basis, we evaluate our investment securities for other-than-temporary impairment (“OTTI”). As required by FASB ASC Topic No. 320, “Investments — Debt and Equity Securities”, if we do not intend to sell a debt security, and it is not more likely than not that we will be required to sell the security, an OTTI write-down is separated into a credit loss portion and a portion related to all other factors. The credit loss portion is recognized in earnings as net OTTI losses, and the portion related to all other factors is recognized in accumulated other comprehensive income, net of taxes. The credit loss portion is defined as the difference between the amortized cost of the security and the present value of the expected future cash flows for the security. The Company has evaluated these securities and determined that the decreases in estimated fair value are temporary with the exception of 16 bank issued pooled trust preferred CDO securities. The Company’s estimate of projected cash flows it expected to receive was less than the securities’ carrying value resulting in a net credit impairment charge to earnings for the three months ended March 31, 2011 of $211,000.
Our CDOs are beneficial interests in securitized financial assets within the scope of FASB ASC Topic No. 325, “Investments — Other”, and are therefore evaluated for OTTI using management’s estimate of future cash flows. If these estimated cash flows determine that it is probable an adverse change in cash flows has occurred, then OTTI would be recognized in accordance with FASB ASC Topic No. 320. The Company uses a third party model (“model”) to assist in calculating the present value of current estimated cash flows to the previous estimate. The present value of the expected cash flows is calculated based on the contractual terms of the security, and is discounted at a rate equal to the effective interest rate implicit in the security at the date of acquisition.
The model also takes into account individual defaults and deferrals that have already occurred by any participating issuer within the pool of entities that make up the security’s underlying collateral. With regard to expected defaults and deferrals, the Company performs an ongoing analysis of these securities utilizing both readily available market data and analytical models obtained from the third party. On a quarterly basis we evaluate the underlying collateral of each pooled trust preferred security in our portfolio to determine the appropriate default/deferral assumptions to use in our calculation of discounted cash flows. This process entails obtaining each security’s issuer list which include the most recent financial and credit quality metrics. We then identify issuers that have metrics that are similar to those that have defaulted or are deferring payments. As part of our evaluation we consider such measures as liquidity, capital adequacy, profitability, and credit quality and analyze ratios such as ROAA, net interest margin, tier 1 risk based capital, tangible equity to tangible assets, texas ratio, reserves to loans and non-performing loans to loans. Our evaluation also takes into consideration current economic indicators as well as recent default/deferral trends of underlying issuers. Management then develops a projected default/deferral rate for each security based on this analysis. This rate is then applied to the cash flow model developed by the third party to calculate the present value of discounted cash flows for each security. The model assumptions relative to expected recoveries of defaulted issuers and deferring issuers were discussed earlier in this Note. Furthermore, we perform back-testing by comparing actual default/deferral rates to previous projections. The results are used to refine future projections on a continuous basis. Lastly, we continually evaluate the securities for the potential of future impairment by reviewing the FDIC failed bank list and deferral announcements made by the underlying issuers of each CDO security in our portfolio.

 

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In general, CDOs are callable within five to ten years of issuance with a quarterly call frequency. Due to current market conditions, the cost to refinance or issue capital at a lower rate than what is currently outstanding, and the limited history of CDOs, prepayments are difficult to predict. The model assumes that prepayments will be limited to those issuers that are acquired by large banks with low financing costs. A 1% annual prepayment assumption has been used in the model and is indicative of management’s belief that consolidation in the banking industry will occur over the next several years as market conditions begin to improve. Additionally, commencing with a date ten years from the issuance date, the Trustee can solicit bids in an auction format for the purchase of all the outstanding collateral securities. The highest bid will be accepted that is at least equal to the sum of the outstanding liabilities at par plus accrued and unpaid interest. However, given the uncertain future of the CDO market, credit quality issues with the underlying issuers, and a decline in market value, the model assumes that a successful call auction is highly unlikely. Therefore, the model expects that the securities will extend through their full 30-year maturity.
The amortized cost and fair value of debt securities and mortgage-backed securities available for sale at March 31, 2011, by contractual maturities, are shown below. Expected maturities will differ from contractual maturities because borrowers may have the right to call or prepay obligations with or without call or prepayment penalties.
                 
    Available for Sale  
    Amortized        
    Cost     Fair Value  
    (in thousands)  
 
               
Due within one year or less
  $ 4,245     $ 4,269  
Due after one year but within five years
    86,882       86,199  
Due after five years but within ten years
    5,854       5,977  
Due after ten years
    19,116       11,164  
Mortgage-backed securities
    40,199       40,937  
 
           
 
               
Total investment securities
  $ 156,296     $ 148,546  
 
           
The following table presents a summary of the cumulative credit related OTTI charges recognized as components of earnings for CDO securities still held by the Company at March 31, 2011 and 2010 (in thousands):
                 
    For the three months ended March 31,  
    2011     2010  
Beginning balance of cumulative credit losses on CDO securities
  $ (16,918 )   $ (13,493 )
Additional credit losses for which other than temporary impairment was previously recognized
    (211 )     (2,571 )
 
           
Ending balance of cumulative credit losses on CDO securities, March 31, 2011
  $ (17,129 )   $ (16,064 )
 
           

 

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NOTE 4 — LOANS RECEIVABLE
Loans receivable consist of the following:
                 
    March 31,     December 31,  
    2011     2010  
    (in thousands)  
 
               
Commercial mortgage
  $ 408,389     $ 413,487  
Residential mortgage
    257,550       258,047  
Construction
    14,228       15,191  
Home equity loans and lines of credit
    47,436       47,875  
Commercial business loans
    49,063       48,223  
Other consumer loans
    1,277       2,207  
 
           
Loans receivable, gross
    777,943       785,030  
 
               
Less:
               
Allowance for loan losses
    13,032       12,538  
Deferred loan fees
    226       174  
 
           
Loans receivable, net
  $ 764,685     $ 772,318  
 
           
Activity in the allowance for loan losses is as follows:
                 
    Three months ended March 31,  
    2011     2010  
    (in thousands)  
 
               
Balance at beginning of period
  $ 12,538     $ 13,311  
Provisions charged to operations
    2,400       244  
Charge-offs
    (1,943 )     (2,164 )
Recoveries
    37       485  
 
           
Balance at end of period
  $ 13,032     $ 11,876  
 
           
The following table summarizes activity related to the allowance for loan losses by category for the three months ended March 31, 2011:
                                                                         
    At or for the three months ended March 31, 2011  
    (in thousands)  
    Commercial                                     Home Equity                    
    Secured by     Commercial             Other     Residential     & Lines     Other              
    Real Estate     Term Loans     Construction     Commercial (1)     Mortgage     of Credit     Consumer     Unallocated     Total  
Balance at beginning of period
  $ 9,515     $ 84     $ 736     $ 464     $ 861     $ 195     $ 13     $ 670     $ 12,538  
Charge-offs
    (1,051 )     (86 )     (606 )           (83 )     (90 )     (27 )           (1,943 )
Recoveries
    16             5       5                   11             37  
Provision for loan losses
    836       93       729       505       132       114       11       (20 )     2,400  
 
                                                     
Balance at end of period
  $ 9,316     $ 91     $ 864     $ 974     $ 910     $ 219     $ 8     $ 650     $ 13,032  
 
                                                     
     
(1)  
includes commercial lines of credit

 

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Impaired loans at March 31, 2011 and December 31, 2010 were as follows:
                 
    March 31,     December 31,  
    2011     2010  
    (in thousands)  
Non-accrual loans (1)
  $ 41,565     $ 40,827  
Loans delinquent greater than 90 days and still accruing
    2,067       2,639  
Troubled debt restructured loans
    8,163       7,732  
Loans less than 90 days and still accruing
    7,852       8,514  
 
           
Total impaired loans
  $ 59,647     $ 59,712  
 
           
     
(1)  
includes non-accruing TDRs paying in accordance with restructured terms totaling $11.6 million at March 31, 2011 and $11.8 million at December 31, 2010.
                 
    Three months ended     Three months ended  
    March 31, 2011     March 31, 2010  
    (in thousands)  
Average recorded investment of impaired loans
  $ 61,242     $ 39,889  
Interest income recognized during impairment
  $ 251     $ 94  
Cash basis interest income recognized
  $ 149     $ 119  
At March 31, 2011, non-performing loans had a principal balance of $43.6 million compared to $43.5 million at December 31, 2010. Loan balances past due 90 days or more and still accruing interest, but which management expects will eventually be paid in full, amounted to approximately $2.1 million at March 31, 2011 and $2.6 million at December 31, 2010.

 

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The following table presents impaired loans at March 31, 2011:
                                         
            Unpaid             Average     Interest  
    Recorded     Principal     Related     Recorded     Income  
March 31, 2011   Investment     Balance     Allowance     Investment     Recognized  
    (in thousands)  
Impaired loans with a related allowance
                                       
Commercial secured by real estate
  $ 21,658     $ 21,879     $ 3,293     $ 19,106     $ 170  
Commercial secured by other
                             
Construction
    3,398       3,398       719       3,398       16  
Other commercial
    900       900       550       900        
Residential mortgage
    147       191       17       147        
Home equity loans and lines of credit
    200       200       52       200        
Other consumer loans
                             
Unallocated
                             
 
                             
Impaired loans with a related allowance
  $ 26,303     $ 26,568     $ 4,631     $ 23,751     $ 186  
 
                             
 
                                       
Impaired loans with no related allowance
                                       
Commercial secured by real estate
  $ 20,335     $ 25,680     $     $ 23,801     $ 21  
Commercial secured by other
                             
Construction
    3,299       5,709             3,827        
Other commercial
    3,410       4,272             3,469        
Residential mortgage
    5,985       6,457             6,028       37  
Home equity loans and lines of credit
    315       393             366       7  
Other consumer loans
                             
Unallocated
                             
 
                             
Impaired loans with no related allowance
  $ 33,344     $ 42,511     $     $ 37,491     $ 65  
 
                             
 
                                       
Total impaired loans
                                       
Commercial secured by real estate
  $ 41,993     $ 47,559     $ 3,293     $ 42,907     $ 191  
Commercial secured by other
                             
Construction
    6,697       9,107       719       7,225       16  
Other commercial
    4,310       5,172       550       4,369        
Residential mortgage
    6,132       6,648       17       6,175       37  
Home equity loans and lines of credit
    515       593       52       566       7  
Other consumer loans
                             
Unallocated
                             
 
                             
Total impaired loans
  $ 59,647     $ 69,079     $ 4,631     $ 61,242     $ 251  
 
                             

 

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The following table presents impaired loans at December 31, 2010:
                                         
            Unpaid             Average     Interest  
    Recorded     Principal     Related     Recorded     Income  
December 31, 2010   Investment     Balance     Allowance     Investment     Recognized  
    (in thousands)  
 
                                       
Impaired loans with a related allowance
                                       
Commercial secured by real estate
  $ 21,449     $ 21,689     $ 3,510     $ 21,826     $ 273  
Commercial secured by other
                             
Construction
    4,966       4,966       603       4,623        
Other commercial
    2,223       2,249       67       2,166        
Residential mortgage
    619       663       19       183       5  
Home equity loans and lines of credit
    66       66       35       66        
Other consumer loans
                             
Unallocated
                             
 
                             
Impaired loans with a related allowance
  $ 29,323     $ 29,633     $ 4,234     $ 28,864     $ 278  
 
                             
 
                                       
Impaired loans with no related allowance
                                       
Commercial secured by real estate
  $ 18,923     $ 24,426     $     $ 20,999     $ 84  
Commercial secured by other
    86       411             337        
Construction
    3,980       6,671             2,790        
Other commercial
    2,162       3,398             2,362        
Residential mortgage
    4,508       4,903             4,600       21  
Home equity loans and lines of credit
    730       772             576        
Other consumer loans
                             
Unallocated
                             
 
                             
Impaired loans with no related allowance
  $ 30,389     $ 40,581     $     $ 31,664     $ 105  
 
                             
 
                                       
Total impaired loans
                                       
Commercial secured by real estate
  $ 40,372     $ 46,115     $ 3,510     $ 42,825     $ 357  
Commercial secured by other
    86       411             337        
Construction
    8,946       11,637       603       7,413        
Other commercial
    4,385       5,647       67       4,528        
Residential mortgage
    5,127       5,566       19       4,783       26  
Home equity loans and lines of credit
    796       838       35       642        
Other consumer loans
                             
Unallocated
                             
 
                             
Total impaired loans
  $ 59,712     $ 70,214     $ 4,234     $ 60,528     $ 383  
 
                             

 

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The following table presents loans by past due status at March 31, 2011:
                                                         
                    90 Days                              
                    or More     Total                        
    30-59 Days     60-89 Days     Delinquent     Delinquent                     Total  
March 31, 2011   Delinquent     Delinquent     and Accruing     and Accruing     Non-accrual     Current     Loans  
    (in thousands)  
Real estate loans:
                                                       
Commercial mortgage
  $ 8,844     $ 5,831     $     $ 14,675     $ 27,357     $ 366,357     $ 408,389  
Residential mortgage
    1,167       254       1,973       3,394       2,720       251,436       257,550  
Construction
    1,799                   1,799       5,037       7,392       14,228  
Home equity loans and lines of credit
    106       98       94       298       421       46,717       47,436  
Commercial business loans
    914       74             988       6,030       42,045       49,063  
Other consumer loans
    16                   16             1,261       1,277  
 
                                         
Total
  $ 12,846     $ 6,257     $ 2,067     $ 21,170     $ 41,565     $ 715,208     $ 777,943  
 
                                         
The following table presents loans by past due status at December 31, 2010:
                                                         
                    90 Days                              
                    or More     Total                        
    30-59 Days     60-89 Days     Delinquent     Delinquent                     Total  
December 31, 2010   Delinquent     Delinquent     and Accruing     and Accruing     Non-accrual     Current     Loans  
    (in thousands)  
Real estate loans:
                                                       
Commercial mortgage
  $ 1,305     $ 94     $     $ 1,399     $ 27,781     $ 384,307     $ 413,487  
Residential mortgage
    796       477       2,207       3,480       2,449       252,118       258,047  
Construction
                            3,980       11,211       15,191  
Home equity loans and lines of credit
    164       103       432       699       363       46,813       47,875  
Commercial business loans
                            6,254       41,969       48,223  
Other consumer loans
          16             16             2,191       2,207  
 
                                         
Total
  $ 2,265     $ 690     $ 2,639     $ 5,594     $ 40,827     $ 738,609     $ 785,030  
 
                                         
Our policies provide for the classification of loans based on an analysis of the credit conditions of the borrower and the value of the collateral when appropriate. There is no specific credit metrics used to determine the risk rating.
Risk Rating 1-5 — Acceptable credit quality ranging from High Pass (cash or near cash as collateral) to Management Attention/Pass (acceptable risk) with some deficiency in one or more of the following areas: management experience, debt service coverage levels, balance sheet leverage, earnings trends and the industry of the borrower.
Risk Rating 6 — Watch List reflects loans that management believes warrant special consideration and may be loans that are delinquent or current in their payments. These loans have potential weakness which increases their risk to the bank and have shown some signs of weakness but have fallen short of being a Substandard loan.
Management believes that the Substandard category is best considered in three discrete classes: RR 7.0 “performing substandard loans;” RR 7.5; and RR 7.9
Risk Rating 7.0 — The class is mostly populated by customers that have a history of repayment (less than 2 delinquencies in the past year) but exhibit some signs of weakness manifested in either cash flow or collateral. In some cases, while cash flow is below the policy levels, the customer is in a cash business and has never presented financial reports that reflect sufficient cash flow for a global cash flow coverage ratio of 1.20.
Risk Rating 7.5 — These are loans that share many of the characteristics of the RR 7.0 loans as they relate to cash flow and/or collateral, but have the further negative of historic delinquencies. These loans have not yet declined in quality to require a FASB ASC Topic No. 310 Receivables analysis, but nonetheless this class has a greater likelihood of migration to a more negative risk rating.

 

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Risk Rating 7.9 — These loans have undergone a FASB ASC Topic No. 310 Receivables analysis or have a specific reserve. For those that have a FASB ASC Topic No. 310 Receivables analysis, no general reserve is allowed. More often than not, those loans in this class with specific reserves have had the reserve placed by Management pending information to complete a FASB ASC Topic No. 310 Receivables analysis. Upon completion of the FASB ASC Topic No. 310 Receivables analysis reserves are adjusted or charged off.
The following table presents commercial loans by credit quality indicator at March 31, 2011.
                                                 
    Risk Ratings  
    Grades     Grade     Grade     Grade     Grade        
March 31, 2011   1-5     6     7     7.5     7.9     Total  
    (in thousands)  
 
                                               
Commercial secured by real estate
  $ 344,488     $ 12,931     $ 17,188     $ 9,134     $ 35,303     $ 419,044  
Commercial term loans
    5,140       12       9                   5,161  
Construction
    5,034             2,400             6,794       14,228  
Other commercial
    26,054       988       1,073       822       4,310       33,247  
 
                                   
 
  $ 380,716     $ 13,931     $ 20,670     $ 9,956     $ 46,407     $ 471,680  
 
                                   
The following table presents commercial loans by credit quality indicator at December 31, 2010.
                                                 
    Risk Ratings  
    Grades     Grade     Grade     Grade     Grade        
December 31, 2010   1-5     6     7     7.5     7.9     Total  
    (in thousands)  
 
                                               
Commercial secured by real estate
  $ 348,166     $ 12,064     $ 23,720     $ 14,248     $ 26,730     $ 424,928  
Commercial term loans
    4,887       14                   86       4,987  
Construction
    3,725       120       2,400             8,946       15,191  
Other commercial
    24,262       1,252       3,297       822       2,162       31,795  
 
                                   
 
  $ 381,040     $ 13,450     $ 29,417     $ 15,070     $ 37,924     $ 476,901  
 
                                   
The following table presents consumer loans by credit quality indicator at March 31, 2011.
                                         
            30-89 Days             Impaired        
March 31, 2011   Current     Delinquent     Non-accrual     Loans     Total  
    (in thousands)  
Real estate loans:
                                       
Residential mortgage
  $ 250,134     $ 1,421     $ 2,720     $ 3,275     $ 257,550  
Home equity loans and lines of credit
    46,717       204       421       94       47,436  
Other consumer loans
    1,261       16                     1,277  
 
                             
Total consumer loans
  $ 298,112     $ 1,641     $ 3,141     $ 3,369     $ 306,263  
 
                             

 

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The following table presents consumer loans by credit quality indicator at December 31, 2010.
                                         
            30-89 Days             Impaired        
December 31, 2010   Current     Delinquent     Non-accrual     Loans     Total  
    (in thousands)  
Real estate loans:
                                       
Residential mortgage
  $ 252,118     $ 1,273     $ 2,449     $ 2,207     $ 258,047  
Home equity loans and lines of credit
    46,813       267       363       432       47,875  
Other consumer loans
    2,191       16                   2,207  
 
                             
Total consumer loans
  $ 301,122     $ 1,556     $ 2,812     $ 2,639     $ 308,129  
 
                             
NOTE 5 — FAIR VALUE
FASB ASC Topic No. 820, “Fair Value Measurements and Disclosures” establishes a fair value hierarchy which requires an entity to maximize the use of observable inputs and minimize the use of unobservable inputs when measuring fair value. The standard describes three levels of inputs that may be used to measure fair value:
Level 1: Quoted prices (unadjusted) for identical assets or liabilities in active markets that the entity has the ability to access as of the measurement date.
Level 2: Significant other observable inputs other than Level 1 prices such as quoted prices for similar assets or liabilities; quoted prices in markets that are not active; or other inputs that are observable or can be corroborated by observable market data.
Level 3: Significant unobservable inputs that reflect a reporting entity’s own assumptions about the assumptions that market participants would use in pricing an asset or liability.
The fair values of securities available for sale are determined by obtaining quoted prices on nationally recognized securities exchanges (Level 1 inputs) or matrix pricing, which is a mathematical technique widely used in the industry to value debt securities without relying exclusively on quoted prices for the specific securities but rather by relying on the securities’ relationship to other benchmark quoted securities (Level 2 inputs).
Collateralized debt obligation securities which are issued by financial institutions and insurance companies were historically priced using Level 2 inputs. The decline in the level of observable inputs and market activity in this class of investments by the measurement date has been significant and resulted in unreliable external pricing. Broker pricing and bid/ask spreads, when available, vary widely. The once active market has become comparatively inactive. As such, these investments are now priced using Level 3 inputs.
The Company obtained the pricing for these securities from an independent third party who prepared the valuations using a market valuation approach. Information such as historical and current performance of the underlying collateral, deferral/default rates, collateral coverage ratios, break in yield calculations, cash flow projections, liquidity and credit premiums required by a market participant, and financial trend analysis with respect to the individual issuing financial institutions and insurance companies, is utilized in determining individual security valuations. Due to current market conditions as well as the limited trading activity of these securities, the market value of the securities is highly sensitive to assumption changes and market volatility.
The fair value of impaired loans with specific allocations of the allowance for loan losses is generally based on recent real estate appraisals. These appraisals may utilize a single valuation approach or a combination of approaches including comparable sales and the income approach. Adjustments are routinely made in the appraisal process by the appraisers to adjust for differences between the comparable sales and income data available. Such adjustments are typically significant and result in a Level 3 classification of the inputs for determining fair value.

 

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Assets and Liabilities Measured on a Recurring Basis
Assets and liabilities measured at fair value on a recurring basis are summarized below:
                                                 
    Fair Value Measurements     Fair Value Measurements  
    at March 31, 2011     at December 31, 2010  
    Quoted                     Quoted              
    Prices                     Prices              
    in Active     Significant     Significant     in Active     Significant     Significant  
    Markets for     Other     Other     Markets for     Other     Other  
    Identical     Observable     Observable     Identical     Observable     Observable  
    Assets     Inputs     Inputs     Assets     Inputs     Inputs  
    (Level 1)     (Level 2)     (Level 3)     (Level 1)     (Level 2)     (Level 3)  
    (in thousands)     (in thousands)  
Investment securities available for sale:
                                               
U.S. Government and agency obligations
  $     $ 64,531     $     $     $ 71,735     $  
Municipal bonds
          24,532                   25,406        
Collateralized debt obligations
                2,149                   1,134  
Corporate bonds
          16,397                   18,135        
Mortgage-backed securities
          40,937                   40,997        
 
                                   
Total securities available for sale
  $     $ 146,397     $ 2,149     $     $ 156,273     $ 1,134  
 
                                   
The table below presents a reconciliation and income statement classification of gains and losses for all assets measured at fair value on a recurring basis using significant unobservable inputs (Level 3) for the three months ended March 31, 2011 and March 31, 2010.
                 
    Fair Value Measurements  
    Using Significant  
    Unobservable Inputs  
    (Level 3)  
    CDO Securities  
    Available for Sale  
    (in thousands)  
    Three months ended March 31,  
    2011     2010  
Beginning balance
  $ 1,134     $ 1,456  
Accretion of discount
    14       56  
Payments received
           
Unrealized holding gain (loss)
    1,212       2,644  
Other-than-temporary impairment included in earnings
    (211 )     (2,571 )
 
           
 
               
Ending balance
  $ 2,149     $ 1,585  
 
           

 

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Assets and Liabilities Measured on a Non-Recurring Basis
Assets and liabilities measured at fair value on a non-recurring basis are summarized below:
                                                 
    Fair Value Measurements     Fair Value Measurements  
    at March 31, 2011     at December 31, 2010  
    Quoted                     Quoted              
    Prices                     Prices              
    in Active     Significant     Significant     in Active     Significant     Significant  
    Markets for     Other     Other     Markets for     Other     Other  
    Identical     Observable     Unobservable     Identical     Observable     Unobservable  
    Assets     Inputs     Inputs     Assets     Inputs     Inputs  
    (Level 1)     (Level 2)     (Level 3)     (Level 1)     (Level 2)     (Level 3)  
    (in thousands)     (in thousands)  
Assets:
                                               
Impaired loans:
                                               
Commercial secured by real estate
  $     $ 26,397     $ 15,596     $     $ 35,891     $ 4,481  
Commercial secured by other
                            86        
Construction
          3,934       2,763             8,657       289  
Other commercial
          1,674       2,636             3,947       438  
Residential mortgage
          5,820       312             5,127        
Home equity loans
          515                   796        
 
                                   
Total impaired loans
  $     $ 38,340     $ 21,307     $     $ 54,504     $ 5,208  
 
                                   
Other real estate owned:
                                               
Commercial
  $     $ 2,976     $     $     $ 2,257     $  
Residential mortgage
          1,005                   998        
 
                                   
Total other real estate owned
  $     $ 3,981     $     $     $ 3,255     $  
 
                                   
Loans held for sale
  $     $ 947     $     $     $ 1,224     $  
Assets held for sale
  $     $     $     $     $ 479     $  
Goodwill
  $     $     $ 22,575     $     $     $ 22,575  
Other intangibles
  $     $     $ 417     $     $     $ 445  
Other real estate owned properties are recorded at the lower of cost or estimated fair market value, less the estimated cost to sell, at the date of foreclosure. Fair market value is estimated by using professional real estate appraisals.

 

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The following disclosure of estimated fair value amounts has been determined by the Bank using available market information and appropriate valuation methodologies. However, considerable judgment is necessarily required to interpret market data to develop the estimates of fair value. Accordingly, the estimates presented herein are not necessarily indicative of the amounts the Company could realize in a current market exchange. The use of different market assumptions and/or estimation methodologies may have a material effect on the estimated fair value amounts.
                                 
    At March 31, 2011     At December 31, 2010  
    Carrying     Fair     Carrying     Fair  
    Amount     Value     Amount     Value  
    (in thousands)  
 
                               
Assets
                               
Cash and cash equivalents
  $ 26,516     $ 26,516     $ 14,997     $ 14,997  
Interest-bearing time deposits
  $ 9,602     $ 9,675     $ 9,361     $ 9,440  
Investment securities
  $ 148,546     $ 148,546     $ 157,407     $ 157,407  
Loans held for sale
  $ 947     $ 947     $ 1,224     $ 1,224  
Loans receivable
  $ 764,685     $ 772,794     $ 772,318     $ 780,277  
FHLB Stock
  $ 8,028     $ 8,028     $ 8,721     $ 8,721  
Bank owned life insurance
  $ 28,499     $ 28,499     $ 28,252     $ 28,252  
Accrued interest receivable
  $ 4,088     $ 4,088     $ 4,029     $ 4,029  
 
                               
Liabilities
                               
Savings deposits
  $ 83,730     $ 83,730     $ 84,312     $ 84,312  
NOW, checking and MMDA deposits
  $ 352,911     $ 352,911     $ 361,973     $ 361,973  
Certificates of deposit
  $ 324,323     $ 327,180     $ 306,783     $ 309,897  
Borrowings
  $ 154,238     $ 158,369     $ 169,637     $ 174,553  
Accrued interest payable
  $ 580     $ 580     $ 714     $ 714  
The carrying amount is the estimated fair value for cash and cash equivalents, interest bearing deposits, and accrued interest receivable and payable.
Investment securities — The fair value is determined as previously described.
Loans held for sale — The fair value is equal to the carrying value since the time from when a loan is closed and settled is generally not more than two weeks.
Loans — The fair values of all loans are estimated by discounting the estimated future cash flows using the Company’s interest rates currently offered for loans with similar terms to borrowers of similar credit quality which is not an exit price under FASB ASC Topic No. 820, “Fair Value Measurements and Disclosures”. The carrying value and fair value of loans include the allowance for loan losses.
FHLB stock — Ownership in equity securities of FHLB of New York is restricted and there is no established market for their resale. The carrying amount is a reasonable estimate of fair value.
Deposits — The fair value of deposits with no stated maturity, such as money market deposit accounts, checking accounts and savings accounts, is equal to the amount payable on demand. The fair value of certificates of deposit is based on the discounted value of contractual cash flows. The discount rate is equivalent to the rate currently offered by the Company for deposits of similar size, type and maturity.
Borrowings — The fair value of borrowings, which includes Federal Home Loan Bank of New York advances and securities sold under agreement to repurchase, is based on the discounted value of contractual cash flows. The discount rate is equivalent to the rate currently offered for borrowings of similar maturity and terms.
The Company’s unused loan commitments, standby letters of credit and undisbursed loans have no carrying amount and have been estimated to have no realizable fair value. Historically, a majority of the unused loan commitments have not been drawn upon.
The fair value estimates presented herein are based on pertinent information available to management as of March 31, 2011 and December 31, 2010. Although management is not aware of any factors that would significantly affect the estimated fair value amounts, such amounts have not been comprehensively revalued for purposes of these financial statements since March 31, 2011 and, therefore, current estimates of fair value may differ significantly from the amounts presented herein.

 

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NOTE 6 — OTHER REAL ESTATE OWNED
At March 31, 2011, other real estate owned (OREO) totaled $4.0 million, net of an allowance for losses of $277,000, and consisted of three residential properties and eight commercial properties. At December 31, 2010, OREO totaled $3.3 million, net of an allowance for losses of $305,000, and consisted of three residential and eight commercial properties.
For the three months ended March 31, 2011, the Company sold four commercial OREO properties and one residential OREO property with an aggregate carrying value totaling $928,000. The Company recorded net gains on the sale of OREO of $63,000 in the first quarter of 2011 compared to net gains of $265,000 recorded in the first quarter of 2010. Also, during the current quarter, the Company added four commercial properties and one residential property to OREO with aggregate carrying values of $1.6 million and $100,000, respectively.
Net expenses applicable to OREO were $34,000 for the three month period ending March 31, 2011, which included a provision for losses on OREO of $47,000 and net gains on the sale of OREO of $63,000. For the three months ended March 31, 2010, net expenses applicable to OREO of $43,000 included net gains on the sale of OREO of $265,000 and a provision for losses on OREO totaling $184,000. As of the date of this filing, the Company has agreements of sale for three OREO properties with an aggregate carrying value totaling $1.4 million.
NOTE 7— DEPOSITS
Deposits are as follows:
                 
    March 31,     December 31,  
    2011     2010  
    (in thousands)  
Savings accounts
  $ 83,730     $ 84,312  
NOW accounts and money market funds
    282,407       293,706  
Non-interest bearing checking
    70,504       68,267  
Certificates of deposit of less than $100,000
    171,422       170,524  
Certificates of deposit of $100,000 or more
    152,901       136,259  
 
           
 
  $ 760,964     $ 753,068  
 
           
NOTE 8 — INCOME TAXES
Income tax benefit for the three months ended March 31, 2011 was primarily impacted by the reversal of $7.7 million of the deferred tax asset valuation allowance. The balance of the valuation allowance remaining after the reduction was approximately $6.1 million as of March 31, 2011. The release of the valuation allowance was based on a pattern of earnings exhibited by the Company over the most recent 6 quarters, projected future taxable income and the recently announced business planning strategy which would result in the recognition of a capital gain. Based on these factors management has determined that it is more likely than not that a greater portion of its deferred tax assets are realizable and has adjusted the valuation allowance accordingly.
                 
    For the three months ended March 31,  
Income taxes   2011     2010  
Pre-tax income
  $ 824     $ 104  
Income tax benefit
  $ (7,420 )   $ (531 )
For more information about our income taxes, read Note 11, “Income Taxes,” in our 2010 Annual Report to Shareholders.

 

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NOTE 9 — STOCK BENEFIT PLAN
The Company has an Equity Incentive Plan under which incentive and non-qualified stock options, stock appreciation rights (SARs), and restricted stock awards (RSAs) may be granted periodically to certain employees and directors. Generally, stock options are granted with an exercise price equal to fair market value at the date of grant and expire in 10 years from the date of grant. Generally, stock options granted vest over a five-year period commencing on the first anniversary of the date of grant. Under the plan, 1,331,352 stock options are available to be issued.
Under the fair value method of accounting for stock options, the fair value for all stock options granted under the Equity Incentive Plan is measured on the date of grant using the Black-Scholes option pricing model with market assumptions. This amount is amortized as salaries and employee benefits on a straight-line basis over the vesting period. Option pricing models require the use of highly subjective assumptions, including expected stock price volatility, which, if changed, can significantly affect fair value estimates.
During 2010, the Company issued 740,000 incentive stock options to certain employees at prices ranging from $7.27 per share to $8.50 per share. In addition, in 2010, 23,600 non-qualified stock options were issued to directors at a price of $7.68 per share.
Stock option activity for the three months ended March 31, 2011 was as follows:
                         
                    Weighted  
            Weighted     Average  
            Average     Remaining  
    Number of     Exercise     Contractual  
    Options     Price     Life  
Outstanding at January 1, 2011
    763,600     $ 7.30        
Granted
                 
Forfeited
    (10,000 )   $ 7.27        
 
                   
Outstanding at March 31, 2011
    753,600     $ 7.30       9.2 years  
 
                 
Exercisable at March 31, 2011
        $        
 
                 
 
                       
Aggregate Intrinsic Value at March 31, 2011
                     
 
                 
The expected average risk-free rate is based on the U.S. Treasury yield curve on the day of grant. The expected average life represents the weighted average period of time that options granted are expected to be outstanding giving consideration to vesting schedules and expected option exercise activity. Expected volatility is based on historical volatilities of the Company’s common stock as well as the historical volatility of the stocks of the Company’s peer banks. The expected dividend yield is based on the expected dividend yield over the life of the option and the Company’s historical information.
On July 1, 2010, the Company issued 11,000 restricted stock awards to directors at a price of $7.68 per share. The restricted stock awards will vest in five equal annual installments, with the first installment becoming exercisable on the first anniversary of the date of grant, or July 1, 2011.

 

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Restricted stock activity for the three months ended March 31, 2011 was as follows:
                 
    Restricted     Weighted Average  
    Common     Fair Value at  
    Shares     Grant Date  
Outstanding at January 1, 2011
    11,000     $ 7.68  
Granted
           
Forfeited
           
 
           
Outstanding at March 31, 2011
    11,000     $ 7.68  
 
           
At March 31, 2011, unrecognized compensation costs on unvested stock options and restricted stock awards was $2.2 million which will be amortized on a straight-line basis over the remaining vesting period. Stock-based compensation expense and related tax effects recognized in connection with unvested stock options and restricted stock awards for the three months ended March 31, 2011 was as follows. There was no stock-based compensation expense for the three month period ended March 31, 2010.
         
    Three months ended  
    March 31, 2011  
    (in thousands)  
Compensation expense:
       
Common stock options
  $ 124  
Restricted common stock
    4  
 
     
Total compensation expense
    128  
Tax benefit
    3  
 
     
Net income effect
  $ 125  
 
     
At March 31, 2011, 753,600 options were outstanding, leaving 567,752 options available to be issued. As of March 31, 2011, based on the option agreements, there were no vested or exercisable options.
NOTE 10 — EARNINGS PER SHARE
Basic earnings per common share is the net income (loss) divided by the weighted average number of common shares outstanding during the period. ESOP shares are not considered outstanding for this calculation unless earned. Diluted earnings per share includes the dilutive effect of additional potential common shares issuable under stock option and restricted stock awards, if any.
As of March 31, 2011, options to purchase 753,600 shares were outstanding, and accordingly, were included in determining diluted earnings per common share. In addition, 11,000 shares of restricted stock were outstanding and included in the earnings per share calculation. There were no options or restricted stock outstanding in the comparable 2010 period. The following is the calculation of basic earnings per share for the three months ended March 31, 2011 and March 31, 2010.
                 
    Three months ended March 31,  
    2011     2010  
    (in thousands, except share data)  
 
               
Net income
  $ 8,244     $ 635  
 
           
 
               
Weighted average shares outstanding
    12,393,888       12,338,966  
Basic earnings per share
  $ 0.67     $ 0.05  
Diluted weighted average shares outstanding
    12,396,463       12,338,966  
Diluted basic earnings per share
  $ 0.67     $ 0.05  
NOTE 11 — SALE OF BANK PREMISES
On April 11, 2011, the Company entered into an Agreement of Sale to sell the Cape Bank main office complex and an adjoining vacant lot located in Cape May Court House, NJ. The Company will lease back the portion of the complex it currently occupies. The sale is subject to customary closing conditions and is anticipated to occur in the second quarter of 2011. The sale price is $7.2 million with a book value of approximately $3.7 million as of March 31, 2011. The Company anticipates a pre-tax gain of approximately $3.2 million after all costs are recorded. The gain will be recorded over the initial three-year lease term.

 

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Item 2.  
Management’s Discussion and Analysis of Financial Condition and Results of Operations
Forward Looking Statements
Certain statements contained herein are “forward-looking statements” within the meaning of Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934. Such forward-looking statements may be identified by reference to a future period or periods, or by the use of forward-looking terminology, such as “may”, “will”, “believe”, “expect”, “estimate”, “anticipate”, “continue”, or similar terms or variations on those terms, or the negative of those terms. Forward-looking statements are subject to numerous risks and uncertainties, including, but not limited to, those related to the economic environment, particularly in the market areas in which the Company operates, competitive products and pricing, fiscal and monetary policies of the U.S. Government, changes in government regulations affecting financial institutions, including regulatory fees and capital requirements, changes in prevailing interest rates, acquisitions and the integration of acquired businesses, credit risk management, asset-liability management, the financial and securities markets and the availability of and costs associated with sources of liquidity.
Cape Bancorp wishes to caution readers not to place undue reliance on any such forward-looking statements, which speak only as of the date made. The Company wishes to advise readers that the factors listed above could affect the Company’s financial performance and could cause the Company’s actual results for future periods to differ materially from any opinions or statements expressed with respect to future periods in any current statements.
Overview
Cape Bancorp is a Maryland corporation that was incorporated on September 14, 2007 for the purpose of becoming the holding company of Cape Bank (formerly Cape Savings Bank) in connection with Cape Bank’s mutual-to-stock conversion, Cape Bancorp’s initial public offering and simultaneous acquisition of Boardwalk Bancorp, Inc. (“Boardwalk Bancorp”), Linwood, New Jersey and its wholly-owned New Jersey chartered bank subsidiary, Boardwalk Bank. The Company disclosed that the stockholders of Boardwalk Bancorp, Inc. and the depositors of Cape Savings Bank approved the merger by the requisite vote required by state law and federal law. As a result of these transactions, Boardwalk Bancorp was merged with, and into, Cape Bancorp and Boardwalk Bank was merged with and into Cape Bank. As of January 31, 2008, Cape Savings Bank changed its name to Cape Bank.
The merger of Cape Bank and Boardwalk Bank on January 31, 2008 created the largest community bank headquartered in Atlantic and Cape May Counties, with a total of 18 branches providing complimentary branch coverage. The merger resulted in a well-capitalized community oriented bank with a significant commercial loan presence. For the three years prior to the merger both banks had experienced strong asset quality and financial performance. The severe economic recession has affected the merged financial institution as a whole, as well as the loan portfolios of each of the constituent banks to the merger. Subsequently, the Bank received regulatory approval for the closing of two branches in Cape May County, effective on December 3, 2010 and February 4, 2011.
At March 31, 2011, the Company had total assets of $1.062 billion compared to $1.061 billion at December 31, 2010. For the three months ended March 31, 2011 and 2010, the Company had total revenues of $13.4 million and $11.4 million, respectively. Net income for the three months ended March 31, 2011, totaled $8.2 million compared to net income of $635,000 for the three months ended March 31, 2010.
Cape Bank is a New Jersey chartered savings bank originally founded in 1923. We are a community bank focused on providing deposit and loan products to retail customers and to small and mid-sized businesses from our main office located at 225 North Main Street, Cape May Court House, New Jersey 08210, and 15 branch offices located in Atlantic and Cape May Counties, New Jersey and a loan production office (opened in February 2011) located in Burlington County, New Jersey. The Bank received regulatory approval for the closing of two branches in Cape May County, which were effective on December 3, 2010 and February 4, 2011. We attract deposits from the general public and use those funds to originate a variety of loans, including commercial mortgages, commercial business loans, residential mortgage loans, home equity loans and lines of credit and construction loans. Our retail and business banking deposit products include savings accounts, checking accounts, money market accounts, and certificates of deposit with terms ranging from 30 days to 84 months. At March 31, 2011, 93.1% of our loan portfolio was secured by real estate and over 60.6% of our portfolio was commercial related loans. We also maintain an investment portfolio.

 

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We offer banking services to individuals and businesses predominantly located in our primary market area of Cape May and Atlantic Counties, New Jersey. The Company opened a loan production office in Burlington County, New Jersey in February 2011. Our business and results of operations are significantly affected by local and national economic conditions, as well as market interest rates. The severe recession of 2008 and 2009, and the continued economic weakness throughout 2010 in the local and national economies has significantly increased our level of non-performing loans and assets and loan foreclosure activity. Non-performing loans as a percentage of total loans increased to 5.61% at March 31, 2011 from 5.54% at December 31, 2010. Non-performing assets (non-performing loans, other real estate owned and non-accruing investment securities) as a percentage of total assets increased to 4.55% at March 31, 2011 from 4.41% at December 31, 2010. The ratio of our allowance for loan losses to total loans increased to 1.68% at March 31, 2011 from 1.60% at December 31, 2010. Loan charge-offs were $1.9 million for the three months ended March 31, 2011 compared to $1.1 million for the three months ended March 31, 2010. Of the $1.9 million of loans charged-off during the current period, $2.0 million were fully reserved for as of December 31, 2010. Our total loan portfolio decreased from $784.8 million at December 31, 2010 to $777.7 million at March 31, 2011, as a result of the $1.9 million in charge-offs, transfers to OREO of $1.7 million, payoffs and normal amortization. We believe our existing loan underwriting practices are appropriate in the current market environment while continuing to address the local credit needs. Total deposits increased $7.9 million from $753.1 million at December 31, 2010 to $761.0 at March 31, 2011. Increases in certificates of deposit of $17.5 million and non-interest bearing checking accounts of $2.2 million more than offset a decline in NOW and money market accounts of $11.3 million.
Our principal business is acquiring deposits from individuals and businesses in the communities surrounding our offices and using these deposits to fund loans and other investments. We offer personal and business checking accounts, commercial mortgage loans, residential mortgage loans, construction loans, home equity loans and lines of credit and other types of commercial and consumer loans. At March 31, 2011, our retail market area primarily included the area surrounding our 16 offices located in Cape May and Atlantic Counties, New Jersey. In addition, the Company opened a loan production office in Burlington County, New Jersey in February 2011.
During the remainder of 2011, Cape Bank will continue to emphasize the following:
  1)  
Managing our credit underwriting and administration through the economic recovery.
  2)  
Managing non-performing assets to performing status or disposal.
  3)  
Managing net interest income and interest rate risk in an uncertain rate environment.
Managing our credit underwriting and administration through the economic recovery:
Based on our experience during the credit crisis and economic downturn, we have taken steps to improve our credit underwriting and administration. Changes in the Commercial Loan and Credit Departments were significant during the latter part of 2010 as each of our new Chief Lending Officer (CLO) and Chief Credit Officer (CCO) had the opportunity to introduce their new approaches and credit culture. The CLO has undertaken and completed a review of all credit files to update and reanalyze the credits. The CCO has taken over the active management of all credits that are rated “Substandard.”
In the third quarter of 2010, the new CLO and CCO undertook a reassessment of the Bank’s loan risk rating system. This has led to the adoption of a more traditional approach to credit rating and the categorization of more loans as “Classified.”
The Bank also has a “Watch List” meeting two months every quarter to review criticized loans over $500 thousand, in addition to a quarterly report to the Board of Directors.
The CLO has introduced a more rigorous program of external credit training and has actively mentored our relationship managers. The training has inculcated the cash flow approach to the credit culture and created a more uniform approach to credit presentations to the Management Loan Committee, the Director’s Loan Committee and the Board of Directors.
Beginning in 2009, the Bank has continued to de-emphasize extensions of credit to both the hospitality and restaurant industries. The current loan portfolio has high concentrations in both segments which have experienced considerable weakness during the economic downturn.
For 2011, we anticipate a gradual decrease in the amount of problem assets based on improvement of national and local economic trends, including the local unemployment rate declining, residential building permits leveling off and the economic activity occurring in the Atlantic City area related to casinos. The Bank’s local market has had specific economic development with the Revel Casino hotel obtaining permanent financing with expected completion by the summer of 2012. It is anticipated that this construction project may produce approximately 2,000 jobs and the finished project may result in approximately 5,500 jobs within the Bank’s market area.

 

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Loan demand within our market area is expected to remain moderate during 2011. Median home sales prices in Atlantic County declined from 2009 to 2010 by 5.3% while in Cape May County the median home sales price increased by 13.1% for the same period. The number of home sales in both counties decreased from the third quarter of 2009 compared to the third quarter of 2010. Additionally, we have been able to sell some of our other real estate owned properties, which may indicate that potential purchasers believe that market values are not likely to decrease further.
Managing non-performing assets to performing status or disposal:
Our non-performing assets began to increase in 2008, and continued to increase through 2010 and into 2011. The deterioration in our local real estate market began during the first quarter of 2008 and continued to decline through 2009. Median home sales prices are mixed within our market area as noted previously. Residential building permits for Atlantic and Cape May Counties have leveled off for both Atlantic and Cape May Counties in 2010 at 2009 levels, although still below 2008 levels, which may be an indication that a floor has been reached. Unemployment has also affected non-performing assets and has increased from December 2008 to December 2010 in both Atlantic and Cape May Counties by 31% and 10% respectively, although the unemployment rate did decline in such counties from 2009 to 2010. These negative economic trends have contributed to a significant increase in non-performing assets from $3.95 million at December 31, 2007 to $48.0 million at March 31, 2011. This increase was affected by the sustained national recession and by the significant increase in our total loan portfolio during the period. The ratio of our allowance for loan losses to non-performing loans decreased from 102.85% in 2007 to 29.87% at March 31, 2011; net charge-offs to average loans increased from 0.06% in 2007 to 0.97% for the first quarter 2011; impaired loans increased from $4.0 million in 2007 to $59.6 million at March 31, 2011; and delinquent loans increased from $15.7 million at December 31, 2007 to $48.1 million at March 31, 2011. Delinquent loans also increased in number during this same time period.
Management has given significant attention to these assets over the past year, including adding experienced staff, and has developed processes to actively manage delinquencies from their inception at 15 days delinquent to their resolution, either through charge-off or foreclosure or working with borrowers to bring their loans current. Our approach is to identify impaired loans, determine the loss amount if any, and recognize the appropriate loss at that time.
Reducing the level of non-performing assets during 2011 will improve our results of operations by converting non-earning assets to earning assets and reducing the expense of managing non-performing assets, which will benefit our interest income, net interest margin and net income. While loan demand is expected to remain moderate during 2011, there is some evidence that continued economic deterioration may have leveled off or slightly improved during the fourth quarter of 2010 through the beginning of 2011. Moreover, residential building permits have stabilized and unemployment within Atlantic and Cape May Counties did decline from 2009 to 2010 by 10.1% and 19.5% respectively.
Managing net interest income and interest rate risk in a potentially rising rate environment:
The potential exists for the Federal Reserve Bank to raise the target Fed Funds rate in 2011. An increase in interest rates will present us with the challenge of managing interest rate risk with a cumulative one year liability sensitive balance sheet. As detailed in “—Net Interest Income Analysis”, a rising interest rate environment indicates that net interest income would decrease over a one-year horizon. This analysis assumes instantaneous and sustained rate shock intervals of 100 and 200 basis points on a static balance sheet. Management will focus on several strategies to negate such effects, such as extending long-term liabilities, increasing core deposit balances, reducing the amount of long term fixed rate loans in the portfolio, and shortening the average life of investments within the investment portfolio.
2011 Overview
Our market area has been significantly affected by the severe economic recession which has affected unemployment and real estate values. Unemployment in Atlantic and Cape May County was 13.9% and 17.0% respectively as of February 2011. Median home sales prices have declined in Atlantic County but increased in Cape May County when comparing Q3 2009 to Q3 2010, while residential building permits, which have been declining since 2008, have leveled off in both counties from 2009 to 2010.
During 2011, Cape Bank will be focusing on core banking practices with an emphasis on managing non-performing assets. We intend to adhere to our existing loan underwriting practices, which we believe are appropriate in the current market. The recognition of additional goodwill impairment is dependent on many variables, some of which are not directly controllable by Cape Bank. However, with expected decreases in non-performing assets and a steady net interest margin and efficiency ratio, additional goodwill impairment is not probable. Our capital remains strong at Cape Bank and there is no expectation of raising additional capital through government programs or by any other means during 2011.

 

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Our market area has been significantly affected by the severe economic recession which has affected unemployment and real estate values. Unemployment in Atlantic and Cape May Counties was 13.9% and 17.0%, respectively, as of February 2011, which while still higher than the New Jersey or national levels, they are 2.1% and 3.4% lower, respectively, than February 2010. As of August 2010, unemployment in Atlantic and Cape May Counties was 11.5% and 7.3% respectively, an improvement from August of 2009 of 2.5% and 3.9%, respectively. These rates were favorably influenced by the summer season. Home sales prices have declined in both counties from 2008 to 2009, sales volume showed improvement year-over-year for the first half of 2010, but did decline during the third quarter of 2010. Median sale prices improved during 2010 in both Atlantic and Cape May counties from the prior twelve month period ended September 30, 2010. Seasonal businesses enjoyed a very good season with the weather providing ideal conditions. Local lodging facilities based on the barrier islands appear to have had a strong 2010 season with little indication of discounting needed to keep hotels fully occupied. Seasonal merchants have indicated a better season in 2010 than in 2009, however not as strong a result as the crowds may have implied. Early indications from local lodging owners indicate a stronger pre-booking season in 2011 than experienced in 2010.
During the past two and a half years the Bank’s yield curve has steepened as rates tied to the prime rate have decreased as the Federal Reserve has decreased the targeted Fed Funds Rate from a high of 5.25% in 2007 to its current low of 0.25%. Mid and long-term rates have remained in a tighter range than short-term rates during the past two years. As the yield curve steepened during the past two and a half years, our net interest margin increased; although we incurred a loss in both 2008 and 2009, we recorded net income of $4.0 million for the twelve month period ended December 31, 2010 and $8.2 million for the three-month period ended March 31, 2011. The losses incurred in 2008 and 2009 were primarily the result of expenses related to OTTI, goodwill impairment, provision for loan losses and a deferred tax asset valuation allowance. These items and others are discussed in more detail later in this report.
The Bank’s net interest margin for the twelve month period ended December 31, 2008, 2009 and 2010 was 3.48%, 3.54% & 3.66%, respectively. For the three-month period ended March 31, 2011, the Bank’s net interest margin was 3.78%. This improvement is the result of our cost of funds declining 140 basis points offset in part by the yield on our earning assets declining 94 basis points from 2008 to March 31, 2011. During the period from 2008 to March 31, 2011 our yield curve steepened as a result of short-term rates dropping consistent with the decline in the Fed Funds rate. Commercial loans tied to the prime rate were affected most significantly during this period of declining short-term interest rates. The cost of funds during the same period dropped significantly in conjunction with the decrease in the Fed Funds Rate. Borrowing rates at the FHLB of NY declined during this time and our average FHLB borrowing costs decreased from 3.40% in 2008 to 3.23% for the three month period ended March 31, 2011. In addition, average certificates of deposit costs decreased from 3.55% in 2008 to 1.53% for the three month period ended March 31, 2011.
The historically low interest rate environment, which has been significantly influenced by the target Fed Funds rate of 0.0% to 0.25% set by the Federal Reserve in the fourth quarter of 2008, has benefited the Bank’s net interest income as our cost of funds decreased more than the decrease in the yield on our assets during the twelve month period ended December 31, 2010 and the three month period ended March 31, 2011. We do not expect to continue to benefit significantly from the downward repricing of our liabilities during the remainder of 2011; however we do expect our net interest margin to be maintained at or near its current level. The full positive impact of the variable yield curve has been mitigated by the significant increase in our non-performing loans and assets, which has reduced our net interest income.
The anticipated increase in market interest rates, driven by the target Fed Funds rate set by the Federal Reserve, would cause compression in the Bank’s net interest margin. The magnitude of this potential change is discussed in more detail in Item 3—Quantitative and Qualitative Disclosures About Market Risk.
For the remainder of 2011, Cape Bank will be focusing on core banking practices with an emphasis on managing non-performing assets. We intend to adhere to our existing prudent loan underwriting practices, which we believe are appropriate in the current market.
The recognition of goodwill impairment is dependent on many variables, some of which are not directly controllable by Cape Bank. However, with non-performing assets expected to remain stable and continued earnings, additional goodwill impairment is not probable.
Comparison of Financial Condition at March 31, 2011 and December 31, 2010
At March 31, 2011, the Company’s total assets were $1.062 billion, an increase of $597,000 from the December 31, 2010 level of $1.061 billion.
Cash and cash equivalents increased $11.5 million, or 76.8%, to $26.5 million at March 31, 2011 from $15.0 million at December 31, 2010. The majority of this increase is attributable to higher interest-bearing cash balances due to proceeds from maturities and sales of investment securities that had not been completely reinvested by March 31, 2011.

 

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Interest-bearing deposits increased to $9.6 million at March 31, 2011 from $9.4 million at December 31, 2010, an increase of $241,000 or 2.6%. The Company invests in time deposits of other banks generally for terms of one year to five years and not to exceed $250,000, which is the amount currently insured by the Federal Deposit Insurance Corporation.
Total loans decreased to $777.7 million at March 31, 2011 from $784.8 million at December 31, 2010, a decrease of $7.1 million or 0.91%. Net loans decreased $7.6 million, net of an increase in the allowance for loan losses of $494,000. Delinquent loans increased $13.4 million to $48.1 million or 6.18% of total gross loans at March 31, 2011 from $34.7 million, or 4.43% of total gross loans at December 31, 2010. Total delinquent loans by portfolio at March 31, 2011 were $41.2 million of commercial mortgage and commercial business loans, $6.1 million of residential mortgage loans and $715,000 of consumer loans. At March 31, 2011, delinquent loan balances by number of days delinquent were: 31 to 59 days — $12.8 million; 60 to 89 days — $6.3 million; and 90 days and greater — $29.0 million. The increase in delinquencies is primarily attributable to borrowers who have commercial real estate investments and are experiencing reduced cash flows due to the current economic environment. These loans have been previously past due at times, but are continuing to make payments, albeit slower than in recent quarters. Our Special Assets group is actively managing these credits.
At March 31, 2011, the Company had $43.6 million in non-performing loans or 5.61% of total gross loans, an increase of $86,000 from $43.5 million, or 5.61% of total gross loans at December 31, 2010. At March 31, 2011, non-performing loans by loan portfolio category were as follows: $38.4 million of commercial loans, $4.7 million of residential mortgage loans, and $495,000 of consumer loans. Of these stated delinquencies, the Company had $2.1 million of loans that were 90 days or more delinquent and still accruing (12 residential mortgage loans for $2.0 million and 3 consumer loans for $94,000). These loans are well secured and we anticipate no losses will be incurred.
At March 31, 2011, commercial non-performing loans had collateral type concentrations of $12.1 million (10 loans or 32%) secured by B&B and hotels, $11.2 million (23 loans or 29%) secured by commercial buildings and equipment, $5.7 million (21 loans or 15%) secured by residential, duplex and multi-family properties, $4.9 million (10 loans or 13%) secured by restaurant properties, $2.8 million (9 loans or 7%) secured by land and building lots, $843,000 (5 loans or 2%) secured by retail stores, and $646,000 (2 loans or 2%) secured by marina properties. The three largest commercial non-performing loans are $11.6 million, $4.1 million, and $2.8 million.
We believe we have appropriately charged-off or established adequate loss reserves on problem loans that we have identified. For the remainder of 2011, we anticipate a gradual decrease in the amount of problem assets. This improvement is due, in part, to our disposing of assets collateralizing loans that have gone through foreclosure. We are aggressively managing all loan relationships, and where necessary, we will continue to apply our loan work-out experience to protect our collateral position and actively negotiate with mortgagors to resolve these non-performing loans.
Total investment securities decreased $8.9 million, or 5.63%, to $148.5 million at March 31, 2011 from $157.4 million at December 31, 2010. At March 31, 2011 and December 31, 2010 all of the Company’s investment securities were classified as available-for-sale (AFS). The decrease in the portfolio is primarily due to the sale of approximately $10.0 million in corporate bonds, MBS, and municipal bond securities, which occurred in the month of March and resulted in a net gain of $148,000. Most of the proceeds had not been reinvested as of March 31, 2011. Included in the security sales were 2 securities (a private label CMO and a zero coupon municipal bond) which had indications of potential credit losses in the first quarter of 2011. These factors were not apparent at December 31, 2010. The securities were sold for a combined loss of $261,000. Management decided to sell the securities rather than to weather future volatility and risk the increasing likelihood of OTTI. The Company also experienced additional OTTI related to its CDO portfolio during the current quarter. This segment of the portfolio has been adversely impacted by the continued downturn in the economy which has caused many bank issuers to fail and therefore default on their obligations while others have elected to defer future payments of interest on such securities. At March 31, 2011, these securities had a cost basis of $9.5 million and a fair market value of $2.1 million. For the three-month period ended March 31, 2011, the Company recorded a $211,000 charge to earnings related to the credit loss portion of impairment.
At March 31, 2011, other real estate owned (OREO) totaled $4.0 million, net of an allowance for losses of $277,000, and consisted of three residential properties and eight commercial properties. At December 31, 2010, OREO totaled $3.3 million, net of an allowance for losses of $305,000 and consisted of three residential and eight commercial properties. For the three months ended March 31, 2011, the Company sold four commercial OREO properties and one residential OREO property with an aggregate carrying value totaling $928,000. Also, during the current quarter, the Company added four commercial and one residential property to OREO with aggregate carrying values of $1.7 million. As of the date of this filing, the Company has agreements of sale for three OREO properties with an aggregate carrying value totaling $1.4 million.

 

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At March 31, 2011, Cape Bancorp’s total deposits increased to $761.0 million from $753.1 million at December 31, 2010, an increase of $7.9 million or 1.05%. At March 31, 2011, NOW and money market accounts totaled $282.4 million, a decrease of $11.3 million, or 3.85%, from $293.7 million at December 31, 2010. Savings accounts decreased $582,000, or 0.69%, to $83.7 million at March 31, 2011, from $84.3 million at December 31, 2010. Non-interest bearing deposits increased $2.2 million, or 3.28%, to $70.5 million at March 31, 2011 from $68.3 million at December 31, 2010. Certificates of deposit increased $17.5 million, or 5.72%, to $324.3 million at March 31, 2011 from $306.8 million at December 31, 2010.
Borrowings decreased $15.4 million, or 9.08%, to $154.2 million at March 31, 2011 from $169.6 million at December 31, 2010. Funding sources originating primarily from an increase in deposits and a decline in loan balances were used to pay down borrowings. At March 31, 2011, the Company’s borrowings to assets ratio decreased to 14.5% from 16.0% at December 31, 2010. Borrowings to total liabilities decreased to 16.8% at March 31, 2011 from 18.3% at December 31, 2010.
At March 31, 2011, the Company’s total equity increased to $141.1 million from $132.2 million at December 31, 2010, an increase of $9.0 million, or 6.77%. The increase in equity is primarily attributable to the net income of $8.2 million and a decrease in accumulated other comprehensive loss, net of tax of $475,000. At March 31, 2011, stockholders’ equity totaled $141.1 million or 13.29% of period end assets, and tangible equity totaled $118.1 million or 11.37% of period end tangible assets.

 

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The following tables set forth average balance sheets, average yields and costs, and certain other information for the periods indicated. All average balances are daily average balances. Non-accrual loans were included in the computation of average balances, but have been reflected in the table as loans carrying a zero yield. The yields set forth below include the effect of deferred fees, discounts and premiums that are amortized or accreted to interest income or expense. Yields and rates have been annualized.
                                                 
    For the Three Months Ended March 31,  
    2011     2010  
            Interest                     Interest        
    Average     Income/     Average     Average     Income/     Average  
    Balance     Expense     Yield     Balance     Expense     Yield  
    (dollars in thousands)  
Assets
                                               
Interest-earning deposits
  $ 18,335     $ 32       0.71 %   $ 12,456     $ 40       1.30 %
Investments
    171,019       1,245       2.91 %     172,723       919       2.13 %
Loans
    785,621       10,835       5.59 %     802,735       11,606       5.86 %
 
                                   
Total interest-earning assets
    974,975       12,112       5.04 %     987,914       12,565       5.16 %
Noninterest-earning assets
    99,722                       101,420                  
Allowance for loan losses
    (12,897 )                     (13,519 )                
 
                                           
Total assets
  $ 1,061,800                     $ 1,075,815                  
 
                                           
 
                                               
Liabilities and Stockholders’ Equity
                                               
Interest-bearing demand accounts
  $ 135,347       112       0.34 %   $ 112,395       105       0.38 %
Savings accounts
    83,396       54       0.26 %     79,467       87       0.44 %
Money market accounts
    154,168       327       0.86 %     143,629       463       1.31 %
Certificates of deposit
    312,081       1,179       1.53 %     359,917       1,726       1.94 %
Borrowings
    170,074       1,354       3.23 %     182,784       1,587       3.52 %
 
                                   
Total interest-bearing liabilities
    855,066       3,026       1.44 %     878,192       3,968       1.83 %
Noninterest-bearing deposits
    67,825                       62,892                  
Other liabilities
    5,483                       5,730                  
 
                                           
Total liabilities
    928,374                       946,814                  
Stockholders’ equity
    133,426                       129,001                  
 
                                           
Total liabilities & stockholders’ equity
  $ 1,061,800                     $ 1,075,815                  
 
                                           
 
                                               
Net interest income
          $ 9,086                     $ 8,597          
 
                                           
Net interest spread
                    3.60 %                     3.33 %
Net interest margin
                    3.78 %                     3.53 %
Net interest income and margin (tax equivalent basis) (1)
          $ 9,202       3.83 %           $ 8,735       3.59 %
 
                                       
Ratio of average interest-earning assets to average interest-bearing liabilities
    114.02 %                     112.49 %                
 
                                           
 
     
(1)  
In order to present pre-tax income and resultant yields on tax-exempt investments on a basis comparable to those on taxable investments, a tax equivalent yield adjustment is made to interest income. The tax equilvalent adjustment has been computed using a Federal income tax rate of 35%, and has the effect of increasing interest income by $116,000, and $138,000 for the three month period ended March 31, 2011 and 2010, respectively. The average yield on investments increased to 3.23% from 2.91% for the three month period ended March 31, 2011 and increased to 2.48% from 2.13% for the three month period ended March 31, 2010.

 

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Rate/Volume Analysis
The following table presents the effects of changing rates and volumes on our net interest income for the periods indicated. The average rate column shows the effects attributable to changes in rate (changes in rate multiplied by prior volume). The average volume column shows the effects attributable to changes in volume (changes in volume multiplied by prior rate). The net change column represents the sum of the prior columns. For purposes of this table, changes attributable to both rate and volume, which cannot be segregated, have been allocated proportionately, based on the changes due to rate and the changes due to volume.
                         
    For the Three Months Ended March 31, 2011  
    Compared to March 31, 2010  
    Increase (decrease) due to changes in:  
    Average     Average     Net  
    Volume     Rate     Change  
    (in thousands)  
Interest-Earning Assets
                       
Interest-earning deposits
  $ 14     $ (22 )   $ (8 )
Investments
    (9 )     335       326  
Loans
    (244 )     (527 )     (771 )
 
                 
Total interest income
    (239 )     (214 )     (453 )
 
                 
 
                       
Interest-Bearing Liabilities
                       
Interest-bearing demand accounts
    20       (13 )     7  
Savings accounts
    4       (37 )     (33 )
Money market accounts
    32       (168 )     (136 )
Certificates of deposit
    (211 )     (336 )     (547 )
Borrowings
    (106 )     (127 )     (233 )
 
                 
Total interest expense
    (261 )     (681 )     (942 )
 
                 
 
                       
Total net interest income
  $ 22     $ 467     $ 489  
 
                 
Comparison of Operating Results for the Three Months Ended March 31, 2011 and 2010
General. Net income for the three months ended March 31, 2011 was $8.2 million, or $.67 per share, primarily resulting from the reversal of $7.7 million, or $.62 per share, of the deferred tax asset valuation allowance. This compares to net income of $635,000, or $.05 per share for the three months ended March 31, 2010. The following is a summary of certain significant pre-tax income and expense events that occurred during the first quarter of 2011: an OTTI charge related to the CDO investment portfolio of $211,000; net gains on the sale of investment securities of $148,000; a provision for loan losses of $2.4 million; loan related expenses of $286,000 and OREO expenses totaling $105,000. The three months ended March 31, 2010 included an OTTI charge related to the CDO investment portfolio of $2.6 million, a provision for loan losses of $244,000, net gains on OREO sales of $265,000, loan related expenses in the amount of $218,000, and OREO expenses totaling $308,000 which included $184,000 for the establishment of an OREO valuation allowance. In addition, the first quarter of 2010 included a reversal of interest income on non-earning CDOs in the amount of $611,000.
Interest Income. Interest income decreased $453,000, or 3.6%, to $12.1 million for the three months ended March 31, 2011, from $12.6 million for the three months ended March 31, 2010. The decrease consists primarily of a $771,000 decrease related to interest income on loans partially offset by a $326,000 increase in interest income on investments. Average loan balances for the three month period ended March 31, 2011 decreased $17.1 million, or 2.1%, to $785.6 million from $802.7 million for the three month period ended March 31, 2010. Due to the economic downturn, loan demand has not been sufficient to offset monthly principal reductions, pay-offs, charge-offs and the transfer of loans to OREO resulting in the decline in average loan balances. The average yield on the investment portfolio increased from 2.13% for the three months ended March 31, 2010 to 2.91% for the three months ended March 31, 2011. This increase was largely driven by interest income in the prior year period being adversely impacted by the $590,000 write-off of interest receivables related to non-performing bank issued CDO securities. This has been partially offset by the effect of a strategy implemented over the past year and a half to shorten the duration of the investment portfolio. As a result, interest income was adversely impacted by this strategy in the short-term because longer duration, higher yielding mortgage-backed securities and municipal bonds have been sold and partially replaced with callable, short-term U.S. Government and agency obligations and corporate bonds, which have yields that are below the portfolio average. The average balance of investment securities decreased $1.6 million, or 0.99%, to $171.0 million for the three months ended March 31, 2011 compared to $172.7 million for the three months ended March 31, 2010.

 

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Interest Expense. Interest expense decreased $942,000, or 23.7%, to $3.0 million for the three months ended March 31, 2011, from $4.0 million for the three months ended March 31, 2010, resulting from a decline in interest expense on certificates of deposit of $547,000 or 31.7%, to $1.2 million for the three months ended March 31, 2011, from $1.7 million for the three months ended March 31, 2010. This decline of interest expense is primarily the result of a reduction in interest rates paid on certificates of deposit where the cost of these deposits declined from 1.94% for the three months ended March 31, 2010 to 1.53% for the three months ended March 31, 2011 due to lower market interest rates. Interest expense on borrowings (Federal Home Loan Bank of New York advances) was $1.4 million for the three months ended March 31, 2011 compared to $1.6 million for the three months ended March 31, 2010. Average borrowings for the three month period ended March 31, 2011 declined to $170.1 million from $182.8 million for the three month period ended March 31, 2010. The cost of borrowings declined from 3.52% for the 2010 period to 3.23% for the three month period ended March 31, 2011. This resulted from a higher average of lower cost overnight borrowing balance for the three month period ended March 31, 2011 thereby driving down the cost of borrowings for that period. The interest rate on these overnight advances ranged from 0.35% to 0.48% during the three month period ended March 31, 2011.
Net Interest Income. Net interest income increased $489,000, or 5.7%, to $9.1 million for the three months ended March 31, 2011, from $8.6 million for the three months ended March 31, 2010. The net interest margin increased 25 basis points to 3.78% for the three months ended March 31, 2011 from 3.53% for the three months ended March 31, 2010. The ratio of average interest-earning assets to average interest-bearing liabilities increased to 114.02% during the three months ended March 31, 2011, from 112.49% for the three months ended March 31, 2010.
Provision for Loan Losses. In accordance with FASB ASC Topic No. 450 Contingencies, we establish provisions for loan losses which are charged to operations in order to maintain the allowance for loan losses at a level we consider necessary to absorb credit losses incurred in the loan portfolio that are both probable and reasonably estimable at the balance sheet date. In determining the level of the allowance for loan losses, we consider, among other things, past and current loss experience, evaluations of real estate collateral, current economic conditions, volume and type of lending, external factors such as competition and regulation, adverse situations that may affect a borrower’s ability to repay a loan and the levels of delinquent loans.
Generally, loans are placed on non-accrual status when payment of principal or interest is 90 days or more delinquent unless the loan is considered well secured and in the process of collection. Loans are also placed on non-accrual status when they are less than 90 days delinquent, if collection of principal or interest in full is in doubt. This determination is normally the result of the review of the borrower’s financial statements or other information that is obtained by the Bank.
All loans that are on non-accrual status are reviewed by management monthly to determine if a specific reserve or charge-off is appropriate. At this point in the delinquency collection efforts, the primary consideration is collateral value. When the Bank has a current appraisal, generally less than six months old, and management agrees that the property has not deteriorated in value since the appraisal, then management will analyze the loan in accordance with FASB ASC Topic No. 310 Receivables. When a current appraisal is not available, the Bank will request one. Upon receipt of the appraisal, we will review the loan in accordance with FASB ASC Topic No. 310 Receivables. Prior to receipt of an appraisal, management will consider, based on its knowledge of the market and other available information pertinent to the particular loan being reviewed, allocating a specific reserve for that loan. Loans are charged-off partially or in full based upon the results of a completed FASB ASC Topic No. 310 Receivables analysis. We also perform a FASB ASC Topic No. 310 Receivables analysis on loans that are not collateralized by real estate.
The amount of the allowance is based on management’s judgment of probable losses, and the ultimate losses may vary from such estimates as more information becomes available or conditions change. We assess the allowance for loan losses and make provisions for loan losses on a quarterly basis.
We recorded a provision for loan losses of $2.4 million for the three months ended March 31, 2011 compared to $244,000 for the three months ended March 31, 2010. The ratio of the allowance for loan losses to non-performing loans (coverage ratio) decreased to 29.87% at March 31, 2011, from 39.89% at March 31, 2010. For the three months ended March 31, 2011, charge-offs were $1.9 million compared to $2.2 for the three months ended March 31, 2010. Included in the 2011 charge-offs of $1.9 million were partial charge-offs totaling $1.3 million. The amount of non-performing loans for which the full loss has been charged-off to total loans is 0.08%. The amount of non-performing loans for which the full loss has been charged-off to total non-performing loans is 0.87% which represents the charge-off rate for non-performing loans for which the full loss has been charged-off. The coverage ratio is already net of loan charge-offs. Loan loss recoveries for the three months ended March 31, 2011 were $37,000 compared to $485,000 for the three months ended March 31, 2010.

 

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Our allowance for loans losses increased $494,000, or 3.9%, to $13.0 million at March 31, 2011, from $12.5 million at December 31, 2010. The ratio of our allowance for loan losses to total loans increased to 1.68% at March 31, 2011, from 1.60% at December 31, 2010. This increase in the ratio of the allowance for loan losses to total was primarily the result of the $7.6 million decline in loans from December 31, 2010. The quarterly loan loss allowance methodology did not require additional provisions to the loan loss allowance account for the $1.1 million of charge-offs that were fully reserved. Certain impaired loans (troubled debt restructurings) have a valuation allowance determined by discounting expected cash flows at the respective loan’s effective interest rate. Included in the allowance for loan losses at March 31, 2011 was an impairment reserve for TDRs in the amount of $418,000 compared to $431,000 at December 31, 2010.
Non-Interest Income. Non-interest income totaled $1.256 million for the three months ended March 31, 2011 compared to the three months ended March 31, 2010 expense of $1.155 million. The increase in non-interest income resulted from the Company recognizing an OTTI charge to non-interest income on CDOs totaling $2.6 million for the three months ended March 31, 2010 compared to a similar charge of $211,000 for the three months ended March 31, 2011. In addition, for the three months ended March 31, 2010, the Company recorded net gains from the sale of OREO of $265,000 compared to net gains on OREO sales of $63,000 for the three months ended March 31, 2011, and gains on the sale of investment securities were $148,000 for the three months ended March 31, 2011 compared to no gains for the three months ended March 31, 2010.
Non-Interest Expense. Non-interest expense increased $24,000 or 0.3%, to $7.118 million for the three months ended March 31, 2011 from $7.094 million for the three months ended March 31, 2010. Increases in salaries and employee benefits ($162,000), loan related expenses ($68,000) and other expenses ($168,000) were offset by a reduction in occupancy and equipment expenses ($182,000) and a reduction in OREO expenses ($203,000). The increase in salaries and employee benefits expense is primarily attributable to increased health care costs, stock option expense and an increase in salary expense. The increase in other expenses results primarily from executive search fees and increased consulting costs related to the Special Assets group. The decline in occupancy and equipment expenses primarily resulted from higher snow removal and utility expense in the first quarter of 2010 due to the harsh winter of 2010. Fewer OREO write-downs in the 2011 period versus the 2010 period attributed to the reduction in OREO expenses.
Income Tax Expense (Benefit). For the three months ended March 31, 2011, the Company recorded a net tax benefit of $7.4 million resulting from the reversal of $7.7 million of the deferred tax asset valuation allowance. The release of a portion of the valuation allowance was based on a pattern of earnings exhibited by the Company over the most recent 6 quarters, projected future taxable income and the recently announced business planning strategy which would result in the recognition of a capital gain. Management considered these items in determining the amount of the deferred tax asset that was more likely than not realizable. This compared to a tax benefit of $531,000 for the three months ended March 31, 2010 which also resulted from a reduction in the valuation allowance.
Liquidity and Capital Resources
Liquidity refers to our ability to meet the cash flow requirements of depositors and borrowers as well as our operating cash needs with cost-effective funding. We generate funds to meet these needs primarily through our core deposit base and the maturity or repayment of loans and other interest-earning assets, including investments. Proceeds from the maturity, redemption, and return of principal of investment securities totaled $17.8 million through March 31, 2011 and were used either for liquidity or to invest in securities of similar quality as our current investment portfolio. We also have available unused wholesale sources of liquidity, including overnight federal funds and repurchase agreements, advances from the FHLB of New York, borrowings through the discount window at the Federal Reserve Bank of Philadelphia and access to certificates of deposit through brokers. We can also raise cash through the sale of earning assets, such as loans and marketable securities. As of March 31, 2011, the Company’s entire investment portfolio, with a fair market value of $148.5 million, was classified as available-for-sale.
Liquidity risk arises from the possibility that we may not be able to meet our financial obligations and operating cash needs or may become overly reliant upon external funding sources. In order to manage this risk, our Board of Directors has established a Liquidity Management Policy and Contingency Funding Plan that identifies primary sources of liquidity, establishes procedures for monitoring and measuring liquidity and quantifies minimum liquidity requirements based on limits approved by our Board of Directors. This policy designates our Asset/Liability Committee (“ALCO”) as the body responsible for meeting these objectives. The ALCO, which includes members of executive management, reviews liquidity on a periodic basis and approves significant changes in strategies that affect balance sheet or cash flow positions. Liquidity is centrally managed on a daily basis by our Chief Financial Officer and the Treasury Department.

 

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Cape Bank’s long-term liquidity source is a large core deposit base and a strong capital position. Core deposits are the most stable source of liquidity a bank can have due to the long-term relationship with a deposit customer. The level of deposits during any period is sometimes influenced by factors outside of management’s control, such as the level of short-term and long-term market interest rates and yields offered on competing investments, such as money market mutual funds. Deposits increased $7.9 million, or 1.1%, during the first three months of 2011, and comprised 82.67% of total liabilities at March 31, 2011, as compared to 81.07% at December 31, 2010.
Banks and bank holding companies are subject to regulatory capital requirements administered by federal banking agencies. Capital adequacy guidelines and, additionally for banks, prompt corrective action regulations, involve quantitative measures of assets, liabilities, and certain off-balance-sheet items calculated under regulatory accounting practices. Capital amounts and classifications are also subject to qualitative judgments by regulators. Failure to meet capital requirements can initiate regulatory action. Management believes as of March 31, 2011, the Company and Bank meet all capital adequacy requirements to which it is subject.
The Bank is subject to various regulatory capital requirements administered by the federal banking agencies. Failure to meet minimum capital requirements can initiate certain mandatory, and possibly additional discretionary actions by regulators that, if undertaken, could have a direct material effect on the Bank’s financial statements. Under capital adequacy guidelines and the regulatory framework for prompt corrective action, the Bank must meet specific capital guidelines that involve quantitative measures of the Bank’s assets, liabilities and certain off-balance sheet items as calculated under regulatory accounting practices. The Bank’s capital amounts and classification are also subject to qualitative judgments by the regulators about components, risk weightings and other factors.
Quantitative measures established by regulation to ensure capital adequacy require the Bank to maintain minimum amounts and ratios (set forth in the table below) of total and tier I capital (as defined in the regulations) to risk-weighted assets (as defined), and of tier I capital (as defined) to average assets (as defined).
As of March 31, 2011 and December 31, 2010, the Bank was categorized as well-capitalized under the regulatory framework for prompt corrective action. To be categorized as well-capitalized, the Bank must maintain minimum total risk-based, tier I risk-based, and tier I leverage ratios as set forth in the table. There are no conditions or events since that notification that management believes have changed the institution’s category.

 

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The actual capital amounts, ratios and minimum regulatory guidelines for Cape Bank are as follows:
                                                 
                    Per Regulatory Guidelines  
    Actual     Minimum     “Well Capitalized”  
    Amount     Ratio     Amount     Ratio     Amount     Ratio  
    (dollars in thousands)  
 
                                               
March 31, 2011
                                               
Risk based capital ratios:
                                               
Tier I
  $ 101,514       12.35 %   $ 32,879       4.00 %   $ 49,319       6.00 %
Total capital
  $ 111,827       13.60 %   $ 65,781       8.00 %   $ 82,226       10.00 %
Leverage ratio
  $ 101,514       9.87 %   $ 41,140       4.00 %   $ 51,426       5.00 %
 
                                               
December 31, 2010
                                               
Risk based capital ratios:
                                               
Tier I
  $ 103,092       12.65 %   $ 32,598       4.00 %   $ 48,897       6.00 %
Total capital
  $ 113,313       13.90 %   $ 65,216       8.00 %   $ 81,520       10.00 %
Leverage ratio
  $ 103,092       9.96 %   $ 41,402       4.00 %   $ 51,753       5.00 %
Critical Accounting Policies
In the preparation of our consolidated financial statements, we have adopted various accounting policies that govern the application of accounting principles generally accepted in the United States. Our significant accounting policies are described in Note 2 of the Notes to Consolidated Financial Statements.
Certain accounting policies involve significant judgments and assumptions by us that have a material impact on the carrying value of certain assets and liabilities. We consider these accounting policies to be critical accounting policies. The judgments and assumptions we use are based on historical experience and other factors, which we believe to be reasonable under the circumstances. Actual results could differ from these judgments and estimates under different conditions, resulting in a change that could have a material impact on the carrying values of our assets and liabilities and our results of operations.
Allowance for Loan Losses. We consider the allowance for loan losses to be a critical accounting policy. The allowance for loan losses is the amount estimated by management as necessary to cover losses inherent in the loan portfolio at the balance sheet date. The allowance is established through the provision for loan losses, which is charged to income. Determining the amount of the allowance for loan losses necessarily involves a high degree of judgment.
In evaluating the allowance for loan losses, management considers historical loss factors, the mix of the loan portfolio (types of loans and amounts), geographic and industry concentrations, current national and local economic conditions and other factors related to the collectability of the loan portfolio, including underlying collateral values, estimated future cash flows. All of these estimates are susceptible to significant change. Groups of homogeneous loans are evaluated in the aggregate under FASB ASC Topic No. 450 Contingencies, using historical loss factors adjusted for economic conditions and other environmental factors. Other environmental factors include trends in delinquencies and classified loans, loan concentrations by loan category and by property type, seasonality of the portfolio, internal and external analysis of credit quality, and single and total credit exposure. Certain loans that indicate underlying credit or collateral concerns may be evaluated individually for impairment in accordance with FASB ASC Topic No. 310 Receivables. If a loan is impaired and repayment is expected solely from the collateral, the difference between the outstanding balance and the value of the collateral will be charged-off. For potentially impaired loans where the source of repayment may include other sources of repayment, the evaluation may factor these potential sources of repayment and indicate the need for a specific reserve for any potential shortfall. This evaluation is inherently subjective, as it requires estimates that are susceptible to significant revision as more information becomes available or as projected events change.

 

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Management reviews the level of the allowance quarterly. Although we believe that we use the best information available to establish the allowance for loan losses, future adjustments to the allowance may be necessary if economic conditions differ substantially from the assumptions used in making the evaluation. In addition, the FDIC and the New Jersey Department of Banking and Insurance, as an integral part of their examination process, periodically review our allowance for loan losses. Such agencies may require us to recognize adjustments to the allowance based on judgments about information available to them at the time of their examination. A large loss could deplete the allowance and require increased provisions to replenish the allowance, which would adversely affect earnings. See Note 2 — Summary of Significant Accounting Policies of the Notes to Consolidated Financial Statements.
Securities Impairment. The Company’s investment portfolio includes 24 securities in pooled trust preferred collateralized debt obligations, 16 of which have been principally issued by bank holding companies, and 8 of which have been principally issued by insurance companies. The portfolio also includes 1 private label (non-agency) collateralized mortgage obligation (“CMO”). With the exception of the non-agency collateralized mortgage obligation, all of the aforementioned securities have below investment grade credit ratings. These investments may pose a higher risk of future impairment charges by the Company as a result of the current downturn in the U.S. economy and its potential negative effect on the future performance of the bank issuers and underlying mortgage loan collateral.
Through March 31, 2011 all 16 of the bank-issued pooled trust preferred collateralized debt obligation securities have had OTTI recognized in earnings due to credit impairment in this and prior periods. Of those securities, 11 have been completely written off and the 5 remaining bank-issued CDOs have a total book value of $1.8 million and a fair value of $374,000 at March 31, 2011. These write-downs were a direct result of the impact that the credit crisis has had on the underlying collateral of the securities. Consequently many bank issuers have failed causing them to default on their security obligations while recent stress tests and potential recommendations by the U.S. Government and the banking regulators have resulted in some bank trust preferred issuers electing to defer future payments of interest on such securities. At March 31, 2011 the CDO securities principally issued by insurance companies, none of which have been OTTI, had an aggregate book value of $7.7 million and a fair value of $1.8 million. A continuation of issuer defaults and elections to defer payments could adversely affect valuations and result in future impairment charges.
Approximately $879,000 of the collateralized mortgage obligations are non-agency and consist of 1 security. This security had an unrealized gain of $32,000 at March 31, 2011. Since this security has been performing according to its contractual terms, and has maintained a strong credit rating the Company does not have immediate concerns about potential impairment. Should deteriorating financial conditions cause delinquencies in the underlying mortgage loan collateral to deteriorate such that we no longer receive monthly payments on the security, the likelihood of OTTI will increase.
Income Taxes. The Company is subject to the income and other tax laws of the United States and the State of New Jersey. These laws are complex and are subject to different interpretations by the taxpayer and the various taxing authorities. In determining the provisions for income and other taxes, management must make judgments and estimates about the application of these inherently complex laws, related regulations and case law. In the process of preparing the Company provision and tax returns, management attempts to make reasonable interpretations of applicable tax laws. These interpretations are subject to challenge by the taxing authorities upon audit or to reinterpretation based on management’s ongoing assessment of facts and evolving case law.
The Company and its subsidiaries file a consolidated federal income tax return and separate entity state income tax returns. The provision for federal and state income taxes is based on income and expenses, as reported in the consolidated financial statements, rather than amounts reported on the Company’s federal and state income tax returns. When income and expenses are recognized in different periods for tax purposes than for book purposes, applicable deferred tax assets and liabilities are recognized for the future tax consequences attributable to the differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. The effect on deferred tax assets and liabilities of a change in tax rates is recognized as income or expense in the period that includes the enactment date. Deferred federal and state tax assets are reduced by a valuation allowance when, in the opinion of management, it is more likely than not that some portion or all of the deferred tax assets will not be realized. As of March 31, 2011, a valuation allowance of approximately $6.1 million had been established against the Company’s deferred tax assets representing a decrease of $7.7 million from December 31, 2010. Management considered several factors, discussed in Footnote 8 to the Financial Statements, in determining the amount of the deferred tax asset that was more likely than not realizable.

 

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On a quarterly basis, management assesses the reasonableness of its effective federal and state tax rate based upon its current best estimate of net income and the applicable taxes expected for the full year.
Effect of Newly Issued Accounting Standards.
In December 2010, the FASB issued (ASU) 2010-28 Intangibles—Goodwill and Other (Topic 350) covering when to perform step 2 of the Goodwill Impairment Test for reporting units with zero or negative carrying amounts. This Update is intended to modify step 1 of the goodwill impairment test for reporting units with zero or negative carrying amounts as these entities will be required to perform step 2 of the goodwill impairment test if it is more likely than not that a goodwill impairment exists. The amendments in this Update are effective for all entities that have recognized goodwill and have one or more reporting units whose carrying amount for purposes of performing step 1 of the goodwill impairment test is zero or negative. For public entities, the amendments in this Update are effective for fiscal years and interim periods within those years, beginning after December 15, 2010. Early adoption is not permitted. No significant impact to amounts reported in the consolidated financial position or results of operations are expected from the adoption of ASU 2010-28.
In December 2010, the FASB issued (ASU) 2010-29 Business Combinations (Topic 805) Disclosure of Supplementary Pro Forma Information for Business Combinations. This Update specifies that if a public entity presents comparative financial statements, the entity should disclose revenue and earnings of the combined entity as though the business combination(s) that occurred during the current year had occurred as of the beginning of the comparable prior annual reporting period only. The amendments in this Update also expand the supplemental pro forma disclosures under Topic 805 to include a description of the nature and amount of material, nonrecurring pro forma adjustments directly attributable to the business combination included in the reported pro forma revenue and earnings. The amendments in this Update are effective prospectively for business combinations for which the acquisition date is on or after the beginning of the first annual reporting period beginning on or after December 15, 2010. Early adoption is permitted. No significant impact to amounts reported in the consolidated financial position or results of operations are expected from the adoption of ASU 2010-29.
In January 2011, the FASB issued (ASU) 2011-01 Receivables (Topic 310) Deferral of the Effective Date of Disclosures about Troubled Debt Restructurings in Update No. 2010-20. This Update temporarily delays the effective date of the disclosures about troubled debt restructurings in Update 2010-20 for public entities. The amendments in this Update delay the effective date of the new disclosures about troubled debt restructurings for public entities and the coordination of the guidance for determining what constitutes a troubled debt restructuring until interim and annual periods ending after June 15, 2011. No significant impact to amounts reported in the consolidated financial position or results of operations are expected from the adoption of ASU 2011-01.
Item 3.  
Quantitative and Qualitative Disclosures About Market Risk
General. The majority of our assets and liabilities are monetary in nature. Consequently, interest rate risk is a significant risk to our net interest income and earnings. Our assets, consisting primarily of mortgage-related assets, have longer maturities than our liabilities, consisting primarily of deposits. As a result, a principal part of our business strategy is to manage interest rate risk and limit the exposure of our net interest income to changes in market interest rates. Accordingly, we have an Interest Rate Risk Committee of the Board as well as an Asset/Liability Committee, comprised of our Chief Executive Officer, Chief Operating Officer, Chief Financial Officer, Vice Presidents of Commercial and Residential Lending, Vice President of Retail Funding and Treasurer. The Interest Rate Risk Committee is responsible for evaluating the interest rate risk inherent in our assets and liabilities, for recommending to our Board of Directors the level of risk that is appropriate, given our business strategy, operating environment, capital, liquidity and performance objectives, and for managing this risk consistent with the guidelines approved by the Board of Directors.
We have sought to manage our interest rate risk in order to minimize the exposure of our earnings and capital to changes in interest rates. As part of our ongoing asset-liability management, we currently use the following strategies to manage our interest rate risk:
   
originating commercial loans that generally tend to have shorter repricing or reset periods and higher interest rates than residential mortgage loans;
   
investing in shorter duration investment grade corporate securities, U.S. Government agency obligations and mortgage-backed securities;
   
obtaining general financing through lower cost deposits, brokered deposits and advances from the Federal Home Loan Bank;
   
originating adjustable rate and short-term consumer loans;
   
selling a portion of our long-term fixed rate residential mortgage loans; and
   
lengthening the terms of borrowings and deposits.
By shortening the average maturity of our interest-earning assets by increasing our investments in shorter term loans, as well as loans with variable interest rates, helps to better match the maturities and interest rates of our assets and liabilities, thereby reducing the exposure of our net interest income to changes in market interest rates.
Net Interest Income Analysis. We analyze our sensitivity to changes in interest rates through our net interest income model. Net interest income is the difference between the interest income we earn on our interest-earning assets, such as loans and securities, and the interest we pay on our interest-bearing liabilities, such as deposits and borrowings. In our model, we estimate what our net interest income would be for a twelve-month period. We then calculate what the net interest income would be for the same period under the assumption that interest rates experience an instantaneous and sustained increase of 100 or 200 basis points or decrease of 100 or 200 basis points.

 

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The table below sets forth, as of March 31, 2011, our calculation of the estimated changes in our net interest income that would result from the designated instantaneous and sustained changes in interest rates. Computations of prospective effects of hypothetical interest rate changes are based on numerous assumptions, including relative levels of market interest rates, loan prepayments and deposit decay, and should not be relied upon as indicative of actual results.
                             
        Net Interest Income  
Change in     Estimated     Increase (Decrease) in  
Interest Rates     Net Interest     Estimated Net Interest Income  
(basis points)(1)     Income     Amount     Percent  
      (dollars in thousands)  
                             
  +200     $ 33,800     $ (2,302 )     -6.38 %
  +100     35,013     $ (1,089 )     -3.02 %
  0     36,102            
  -100     36,315     213       0.59 %
  -200     34,345     $ (1,757 )     -4.87 %
 
     
(1)  
Assumes an instantaneous and sustained uniform change in interest rates at all maturities.
The table above indicates that at March 31, 2011, in the event of a 100 basis point increase in interest rates, we would experience a $1.1 million decrease in net interest income. In the event of a 100 basis point decrease in interest rates, we would experience a $213,000 increase in net interest income.
Certain shortcomings are inherent in the methodologies used in determining interest rate risk through changes in net interest income. Modeling changes require making certain assumptions that may or may not reflect the manner in which actual yields and costs respond to changes in market interest rates. In this regard, the net interest income information presented assumes that the composition of our interest-sensitive assets and liabilities existing at the beginning of a period remains constant over the period being measured and assumes that a particular change in interest rates is reflected uniformly across the yield curve regardless of the duration or repricing of specific assets and liabilities. Accordingly, although interest rate risk calculations provide an indication of our interest rate risk exposure at a particular point in time, such measurements are not intended to and do not provide a precise forecast of the effect of changes in market interest rates on our net interest income and will differ from actual results.
Item 4.  
Controls and Procedures
(a) Evaluation of Disclosure Controls and Procedures
Under the supervision and with the participation of our management, including our Principal Executive Officer and Principal Financial Officer, we evaluated the effectiveness of the design and operation of our disclosure controls and procedures (as defined in Rule 13a-15(e) and 15d-15(e) under the Exchange Act) as of March 31, 2011 (the “Evaluation Date”). Based upon that evaluation, the Principal Executive Officer and Principal Financial Officer concluded that, as of the Evaluation Date, our disclosure controls and procedures were effective in timely alerting them to the material information relating to us (or our consolidated subsidiaries) required to be included in our periodic SEC filings.
(b) Changes in internal controls
There were no changes made in our internal control over financial reporting during the Company’s first fiscal quarter that have materially affected, or are reasonably likely to materially affect, the Company’s internal control over financial reporting.
Part II — Other Information
Item 1.  
Legal Proceedings
The Company and its subsidiaries are subject to various legal actions arising in the normal course of business. In the opinion of management, the resolution of these legal actions is not expected to have a material adverse effect on the Company’s financial condition or results of operations.

 

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Item 1A.  
Risk Factors
In addition to the other information contained in this Quarterly Report on Form 10-Q, the following risk factor represents material updates and additions to the risk factors previously disclosed in the Company’s Annual Report on Form 10-K for the Year Ended December 31, 2010, as filed with the Securities and Exchange Commission. Additional risks not presently known to us, or that we currently deem immaterial, may also adversely affect our business, financial condition or results of operations. Further, to the extent that any of the information contained in this Quarterly Report on Form 10-Q constitutes forward-looking statements, the risk factors set forth below also are cautionary statements identifying important factors that could cause our actual results to differ materially from those expressed in any forward-looking statements made by or on behalf of us.
Financial Reform Legislation will, among other things, tighten capital standards, create a new Consumer Financial Protection Bureau, and result in new laws and regulations that are expected to increase our cost of operations.
A wide range of regulatory initiatives directed at the financial services industry have been proposed in recent months. One of those initiatives, the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010 (the “Dodd-Frank Act”), was signed into law by President Obama on July 21, 2010. The Dodd-Frank Act represents a comprehensive overhaul of the financial services industry within the United States, establishes the new federal Bureau of Consumer Financial Protection (the “BCFP”), and will require the BCFP and other federal agencies to implement many new rules. At this time, it is difficult to predict the extent to which the Dodd-Frank Act or the resulting regulations will impact the Company’s business. However, compliance with these new laws and regulations will result in additional costs, which may adversely impact the Company’s results of operations, financial condition or liquidity, any of which may impact the market price of the Company’s common stock. Additional risks not presently known to us, or that we currently deem immaterial, may also adversely affect our business, financial condition or results of operations.
Item 2.  
Unregistered Sales of Equity Securities and Use of Proceeds
(a)  
There were no sales of unregistered securities during the period covered by this Report.
(b)  
Not applicable.
(c)  
There were no issuer repurchases of securities during the period covered by this Report.
Item 3.  
Defaults Upon Senior Securities
Not applicable.
Item 4.  
Reserved
Item 5.  
Other Information
Not applicable

 

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Item 6.  
Exhibits
The following exhibits are either filed as part of this report or are incorporated herein by reference:
         
  3.1    
Articles of Incorporation of Cape Bancorp, Inc. *
       
 
  3.2    
Amended and Restated Bylaws of Cape Bancorp, Inc. * *
       
 
  4    
Form of Common Stock Certificate of Cape Bancorp, Inc. *
       
 
  10.1    
Form of Employee Stock Ownership Plan *
       
 
  10.2    
Form of Change in Control Agreement *
       
 
  10.3    
Amended and Restated Phantom Incentive Stock Option Plan *
       
 
  10.4    
Amended and Restated Phantom Restricted Stock Plan *
       
 
  10.5    
Form of Director Retirement Plan *
       
 
  10.6    
Benefit Equalization Plan *
       
 
  31.1    
Certification of Chief Executive Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
       
 
  31.2    
Certification of Chief Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
       
 
  32    
Certification of Chief Executive Officer and Chief Financial Officer pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
 
     
*  
Filed as exhibits to the Company’s Registration Statement on Form S-1, and any amendments thereto, with the Securities and Exchange Commission (Registration No. 333-146178).
 
**  
Filed as an exhibit to the Company’s Current Report Form 8-K with the Securities and Exchange Commission on July 18, 2008.

 

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Table of Contents

SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
         
 
  CAPE BANCORP, INC.    
 
       
Date: May 4, 2011
  /s/ Michael D. Devlin
 
Michael D. Devlin
   
 
  President and Chief Executive Officer    
 
       
Date: May 4, 2011
  /s/ Guy Hackney
 
Guy Hackney
   
 
  Executive Vice President and Chief Financial Officer    

 

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