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Table of Contents

 

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

 

 

FORM 10-Q/A

Amendment No. 1

 

 

QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF

THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended September 30, 2010

Commission file number 000-13580

 

 

SUFFOLK BANCORP

(Exact Name of Registrant as Specified in Its Charter)

 

 

 

New York State   11-2708279

(State or Other Jurisdiction of

Incorporation or Organization)

 

(I.R.S. Employer

Identification No.)

 

4 West Second Street, Riverhead, New York   11901
(Address of Principal Executive Offices)   (Zip Code)

(631) 727-5667

(Registrant’s Telephone Number, Including Area Code)

 

 

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 filing requirements for the past 90 days.    Yes  x    No  ¨

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 (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).    Yes  ¨    No  ¨

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 the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.

 

Large accelerated filer   ¨    Accelerated filer   x
Non-accelerated filer   ¨  (Do not check if a smaller reporting company)    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  ¨    No  x

Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date.

9,684,950 SHARES OF COMMON STOCK OUTSTANDING AS OF November 1, 2010

 

 

 


Table of Contents

EXPLANATORY NOTE

Suffolk Bancorp (“Suffolk”) is filing this Amendment No. 1 to its Quarterly Report on Form 10-Q for the period ended September 30, 2010, originally filed with the Securities and Exchange Commission (the “SEC”) on November 9, 2010. This Amendment is being filed to amend and restate our unaudited consolidated financial statements as of and for the three and nine months ended September 30, 2010 and related disclosures to correct for a misstatement in the provision and allowance for loan losses.

This quarterly report on Form 10-Q/A for the quarterly period ended September 30, 2010 is being filed to reflect the financial statement restatement. In summary, as of and for the three and nine months ended September 30, 2010, this financial statement restatement has resulted in:

 

   

No impact on our cash and cash equivalents or overall cash flow.

 

   

Increases in our provision for loan losses of $12.1 million (461%; 84%) and decreases in our net income of $7.8 million (167%; 71%) and our basic earnings-per-share by $0.81 (165%;71%) for the three and nine months ended September 30, 2010, respectively.

 

   

Decreases in our total loans of $7.4 million (0.65%), our total assets, retained earnings and total stockholders’ equity of $7.8 million (0.46%; 8.0% and 5.2%), respectively, increases in our allowance for loan losses of $4.7 million (21.4%) and our other assets of $4.3 million (21.2%) as of September 30, 2010.

For a more detailed description of the financial statement restatement, see Note 2, “Restatement of Financial Statements” to our notes to the unaudited consolidated financial statements.

Suffolk has not modified or updated the information in the initial Form 10-Q, except as necessary to reflect the effects of the restatement which took into consideration subsequent additional information about conditions that existed at September 30, 2010, and to reflect legal proceedings and subsequent events as disclosed in Note 12 and Note 13, respectively. This Amendment continues to speak as of the dates described herein, and we have not updated the disclosures contained in the initial Form 10-Q to reflect any events that occurred subsequent to such dates except with regard to the restatement. Information not affected by the restatement is unchanged and reflects the disclosures made at the time of the filing of the initial Form 10-Q on November 9, 2010. Accordingly, this Amendment should be read in conjunction with our subsequent filings with the SEC, as information in such filings may update or supersede certain information contained in this Amendment.

In addition, as required by Rule 12b-15 under the Securities Exchange Act of 1934, as amended, new certifications by our principal executive officer and principal financial officer are filed herewith as Exhibits 31.1, 31.2, 32.1 and 32.2.

For the convenience of the reader, this Amendment sets forth the initial Form 10-Q in its entirety, although Suffolk is only amending and restating Items 1, 2 and 4 of Part 1 and Item 6 of Part II of the initial Form 10-Q affected by the corrected financial information.


Table of Contents

SUFFOLK BANCORP AND SUBSIDIARIES

Table of Contents

 

Item 1 - FINANCIAL STATEMENTS

     2   

CONSOLIDATED STATEMENTS OF CONDITION AS OF

     2   

CONSOLIDATED STATEMENTS OF OPERATIONS FOR THE THREE MONTHS ENDED

     3   

CONSOLIDATED STATEMENTS OF OPERATIONS FOR THE NINE MONTHS ENDED

     4   

CONSOLIDATED STATEMENTS OF CASH FLOWS FOR THE NINE MONTHS ENDED

     5   

NOTES TO THE UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS

     6   

(1) Basis of Presentation

     6   

(2) Restatement of Financial Statements

     6   

(3) Stock-based Compensation

     7   

(4) Income Taxes

     9   

(5) Fair Value

     9   

(6) Investment Securities

     13   

(7) Allowance for Loan Losses

     15   

(8) Comprehensive Income

     16   

(9) Retirement Plan

     17   

(10) Recent Accounting Pronouncements

     18   

(11) Regulatory Matters

     18   

(12) Legal Proceedings

     19   

(13) Subsequent Events

     20   

Item 2 - MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

     21   

Recent Developments

     21   

Basic Performance and Current Activities

     22   

Net Income (Loss)

     23   

Interest Income

     23   

Interest Expense

     23   

Net Interest Income

     23   

Other Income

     26   

Other Expense

     27   

Capital Resources

     27   

Credit Risk

     27   

Critical Accounting Policies, Judgments and Estimates

     28   

Allowance for Loan Losses

     28   

Deferred Tax Assets and Liabilities

     34   

Investment Securities

     34   

Item 3 - Quantitative and Qualitative Disclosures about Market Risk

     35   

Market Risk

     35   

Business Risks and Uncertainties

     35   

Item 4 - Controls and Procedures

     35   

Allowance for Loan and Lease Losses

     35   

Financial Reporting Staffing Resources

     36   

Interdepartmental Communications

     36   

Governance and Management Accountability

     36   

Item 1 - Legal Proceedings

     38   

Item 1A - Risk Factors

     38   

Item 2 - Unregistered Sales of Equity Securities and Use of Proceeds

     40   

Item 6 - Exhibits

     40   

SIGNATURES

     40   

 

Page 1


Table of Contents

Item 1 - FINANCIAL STATEMENTS

SUFFOLK BANCORP AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CONDITION AS OF

(in thousands of dollars, except for share data)

 

     September 30, 2010     December 31, 2009  
    

unaudited

Restated

       

ASSETS

    

Cash & Due from Banks

   $ 58,028      $ 37,007   

Federal Reserve Bank Stock

     652        652   

Federal Home Loan Bank Stock

     3,531        8,346   

Investment Securities:

    

Available for Sale, at Fair Value

     446,399        437,000   

Held to Maturity (Fair Value of $11,085 and $10,096, respectively)

    

Obligations of States & Political Subdivisions

     10,050        9,243   

Other Securities

     100        100   
  

 

 

   

 

 

 

Total Investment Securities

     456,549        446,343   
  

 

 

   

 

 

 

Total Loans

     1,134,457        1,160,379   

Less: Allowance for Loan Losses

     26,659        12,333   
  

 

 

   

 

 

 

Net Loans

     1,107,798        1,148,046   
  

 

 

   

 

 

 

Premises & Equipment, Net

     22,368        23,346   

Accrued Interest Receivable, Net

     7,895        7,223   

Goodwill

     814        814   

Other Assets

     24,465        22,719   
  

 

 

   

 

 

 

TOTAL ASSETS

   $ 1,682,100      $ 1,694,496   
  

 

 

   

 

 

 

LIABILITIES & STOCKHOLDERS’ EQUITY

    

Demand Deposits

   $ 521,527      $ 487,648   

Saving, N.O.W. & Money Market Deposits

     629,126        578,551   

Time Certificates of $100,000 or more

     214,064        211,898   

Other Time Deposits

     110,561        107,181   
  

 

 

   

 

 

 

Total Deposits

     1,475,278        1,385,278   

Federal Home Loan Bank Borrowings

     40,000        150,800   

Dividend Payable on Common Stock

     2,126        2,115   

Accrued Interest Payable

     650        829   

Other Liabilities

     20,418        18,303   
  

 

 

   

 

 

 

TOTAL LIABILITIES

     1,538,472        1,557,325   
  

 

 

   

 

 

 

STOCKHOLDERS’ EQUITY

    

Common Stock (par value $2.50; 15,000,000 shares authorized; 9,665,245 and 9,615,494 shares outstanding at September 30, 2010 and December 31, 2009, respectively)

     34,169        34,031   

Surplus

     22,784        21,685   

Treasury Stock at Par (4,002,158 and 3,996,878 shares, respectively)

     (10,005     (9,992

Retained Earnings

     89,835        93,154   
  

 

 

   

 

 

 
     136,783        138,878   

Accumulated Other Comprehensive Income (Loss), Net of Tax

     6,845        (1,707
  

 

 

   

 

 

 

TOTAL STOCKHOLDERS’ EQUITY

     143,628        137,171   
  

 

 

   

 

 

 

TOTAL LIABILITIES & STOCKHOLDERS’ EQUITY

   $ 1,682,100      $ 1,694,496   
  

 

 

   

 

 

 

See accompanying notes to consolidated financial statements.

 

Page 2


Table of Contents

SUFFOLK BANCORP AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF OPERATIONS FOR THE THREE MONTHS ENDED

(in thousands of dollars except for share and per share data)

 

     September 30, 2010     September 30, 2009  
    

unaudited

Restated

    unaudited  

INTEREST INCOME

    

Federal Funds Sold & Interest from Bank Deposits

   $ 3      $ 44   

United States Treasury Securities

     71        94   

Obligations of States & Political Subdivisions

     1,979        1,804   

Mortgage-Backed Securities

     1,888        1,836   

U.S. Government Agency Obligations

     202        354   

Other Securities

     95        123   

Loans

     17,464        17,261   
  

 

 

   

 

 

 

Total Interest Income

     21,702        21,516   
  

 

 

   

 

 

 

INTEREST EXPENSE

    

Saving, N.O.W. & Money Market Deposits

     827        934   

Time Certificates of $100,000 or more

     709        960   

Other Time Deposits

     436        584   

Borrowings

     363        564   
  

 

 

   

 

 

 

Total Interest Expense

     2,335        3,042   
  

 

 

   

 

 

 

Net-interest Income

     19,367        18,474   

Provision for Loan Losses

     14,729        975   
  

 

 

   

 

 

 

Net-interest Income After Provision for Loan Losses

     4,638        17,499   
  

 

 

   

 

 

 

OTHER INCOME

    

Service Charges on Deposit Accounts

     1,215        1,354   

Other Service Charges, Commissions & Fees

     1,007        929   

Fiduciary Fees

     243        237   

Other Operating Income

     202        246   
  

 

 

   

 

 

 

Total Other Income

     2,667        2,766   
  

 

 

   

 

 

 

OTHER EXPENSE

    

Salaries & Employee Benefits

     7,457        7,190   

Net Occupancy Expense

     1,336        1,250   

Equipment Expense

     511        586   

FDIC Assessments

     862        517   

Other Operating Expense

     2,855        2,491   
  

 

 

   

 

 

 

Total Other Expense

     13,021        12,034   
  

 

 

   

 

 

 

(Loss) Income Before Income Taxes

     (5,716     8,231   

(Benefit) Provision for Income Taxes

     (2,579     2,203   
  

 

 

   

 

 

 

NET (LOSS) INCOME

   $ (3,137   $ 6,028   
  

 

 

   

 

 

 

Weighted Average: Common Shares Outstanding

     9,662,328        9,607,023   

                                   Dilutive Stock Options

     —          19,286   
  

 

 

   

 

 

 

Weighted Average Total Common Shares and Dilutive Options

     9,662,328        9,626,309   

(LOSS) EARNINGS PER COMMON SHARE Basic

   $ (0.32   $ 0.63   

                                           Diluted

   $ (0.32   $ 0.63   

DIVIDENDS PER COMMON SHARE

   $ 0.22      $ 0.22   

See accompanying notes to consolidated financial statements.

 

Page 3


Table of Contents

SUFFOLK BANCORP AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF OPERATIONS FOR THE NINE MONTHS ENDED

(in thousands of dollars except for share and per share data)

 

     September 30, 2010     September 30, 2009  
    

unaudited

Restated

    unaudited  

INTEREST INCOME

    

Federal Funds Sold & Interest from Bank Deposits

   $ 8      $ 48   

United States Treasury Securities

     213        292   

Obligations of States & Political Subdivisions

     5,818        5,254   

Mortgage-Backed Securities

     5,957        5,382   

U.S. Government Agency Obligations

     607        1,797   

Other Securities

     320        334   

Loans

     52,545        52,137   
  

 

 

   

 

 

 

Total Interest Income

     65,468        65,244   
  

 

 

   

 

 

 

INTEREST EXPENSE

    

Saving, N.O.W. & Money Market Deposits

     2,551        2,732   

Time Certificates of $100,000 or more

     2,271        2,591   

Other Time Deposits

     1,365        2,002   

Federal Funds Purchased and Repurchase Agreements

     2        120   

Borrowings

     1,322        2,277   
  

 

 

   

 

 

 

Total Interest Expense

     7,511        9,722   
  

 

 

   

 

 

 

Net-interest Income

     57,957        55,522   

Provision for Loan Losses

     26,549        3,000   
  

 

 

   

 

 

 

Net-interest Income After Provision for Loan Losses

     31,408        52,522   
  

 

 

   

 

 

 

OTHER INCOME

    

Service Charges on Deposit Accounts

     3,745        4,019   

Other Service Charges, Commissions & Fees

     2,591        2,586   

Fiduciary Fees

     760        779   

Net Security Gains

     12        —     

Other Operating Income

     689        969   
  

 

 

   

 

 

 

Total Other Income

     7,797        8,353   
  

 

 

   

 

 

 

OTHER EXPENSE

    

Salaries & Employee Benefits

     21,682        20,892   

Net Occupancy Expense

     4,030        3,837   

Equipment Expense

     1,576        1,719   

FDIC Assessments

     2,089        2,202   

Other Operating Expense

     7,926        7,591   
  

 

 

   

 

 

 

Total Other Expense

     37,303        36,241   
  

 

 

   

 

 

 

Income Before Income Taxes

     1,902        24,634   

(Benefit) Provision for Income Taxes

     (1,285     7,239   
  

 

 

   

 

 

 

NET INCOME

   $ 3,187      $ 17,395   
  

 

 

   

 

 

 

Weighted Average: Common Shares Outstanding

     9,649,550        9,598,583   

                                   Dilutive Stock Options

     6,408        17,976   
  

 

 

   

 

 

 

Weighted Average Total Common Shares and Dilutive Options

     9,655,958        9,616,559   

EARNINGS PER COMMON SHARE Basic

   $ 0.33      $ 1.81   

                             Diluted

   $ 0.33      $ 1.81   

DIVIDENDS PER COMMON SHARE

   $ 0.66      $ 0.66   

See accompanying notes to consolidated financial statements.

 

Page 4


Table of Contents

SUFFOLK BANCORP AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CASH FLOWS FOR THE NINE MONTHS ENDED

(in thousands of dollars)

 

     September 30, 2010     September 30, 2009  
    

unaudited

Restated

    unaudited  

NET INCOME

   $ 3,187      $ 17,395   

ADJUSTMENTS TO RECONCILE NET INCOME TO NET CASH

    

CASH FLOWS FROM OPERATING ACTIVITIES

    

Provision for Loan Losses

     26,549        3,000   

Depreciation & Amortization

     1,881        1,896   

Net Security Gains

     (12     —     

Stock Based Compensation

     8        105   

Accretion of Discounts

     (118     (196

Amortization of Premiums

     2,122        973   

Increase in Accrued Interest Receivable

     (672     (893

Increase in Other Assets

     (7,594     (440

Decrease in Accrued Interest Payable

     (179     (1,338

Increase (Decrease) in Other Liabilities

     2,075        (90
  

 

 

   

 

 

 

Net Cash Provided by Operating Activities

     27,247        20,412   
  

 

 

   

 

 

 

CASH FLOWS FROM INVESTING ACTIVITIES

    

Principal Payments on Investment Securities Available for Sale

     22,689        26,398   

Proceeds from Sale of Investment Securities Available for Sale

     1,232        —     

Maturities of Investment Securities Available for Sale

     2,000        102,500   

Purchases of Investment Securities Available for Sale

     (22,904     (185,506

Maturities of Investment Securities Held to Maturity

     6,836        8,503   

Purchases of Investment Securities Held to Maturity

     (2,833     (7,369

Loan (Disbursements) & Repayments, Net

     13,740        (27,994

Purchases of Premises & Equipment, Net

     (904     (2,679
  

 

 

   

 

 

 

Net Cash Provided by (Used in) Investing Activities

     19,856        (86,147
  

 

 

   

 

 

 

CASH FLOWS FROM FINANCING ACTIVITIES

    

Net Increase in Deposit Accounts

     90,000        190,818   

Dividends Paid to Shareholders

     (6,361     (6,330

Stock Options and Stock Appreciation Rights Exercised

     209        —     

Dividend Reinvestment in Common Stock, Net

     870        574   

Short-term Borrowings and Repayments, Net

     (110,800     (121,520
  

 

 

   

 

 

 

Net Cash (Used in) Provided by Financing Activities

     (26,082     63,542   
  

 

 

   

 

 

 

Net Increase (Decrease) in Cash & Cash Equivalents

     21,021        (2,193

Cash & Cash Equivalents Beginning of Period

     37,007        41,513   
  

 

 

   

 

 

 

Cash & Cash Equivalents End of Period

   $ 58,028      $ 39,320   
  

 

 

   

 

 

 

Supplemental Disclosure of Cash Flow Information

    

Cash Received During the Nine Month Period for Interest

   $ 64,797      $ 64,303   
  

 

 

   

 

 

 

Cash Paid During the Nine Month Period for:

    

Interest

   $ 7,689      $ 11,060   

Income Taxes

     8,020        8,687   
  

 

 

   

 

 

 

Total Cash Paid for Interest & Income Taxes

   $ 15,709      $ 19,747   
  

 

 

   

 

 

 

See accompanying notes to consolidated financial statements.

 

Page 5


Table of Contents

SUFFOLK BANCORP AND SUBSIDIARIES

NOTES TO THE UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS

(1) Basis of Presentation

In the opinion of management, the accompanying unaudited consolidated financial statements of Suffolk Bancorp (“Suffolk”) and its consolidated subsidiaries, primarily Suffolk County National Bank (the “Bank”), have been prepared to reflect all adjustments (consisting solely of normally recurring accruals) necessary for a fair presentation of the financial condition and results of operations for the periods presented. Certain information and footnotes normally included in consolidated financial statements prepared in accordance with generally accepted accounting principles in the United States of America (“U.S. GAAP”) have been condensed or omitted. Notwithstanding, management believes that the disclosures are adequate to prevent the information from misleading the reader, particularly when the accompanying consolidated financial statements are read in conjunction with the audited consolidated financial statements and notes thereto included in the Registrant’s Annual Report on Form 10-K, for the year ended December 31, 2009. Certain reclassifications have been made to the prior year’s consolidated financial statements that conform to the current year’s presentation. Such reclassifications had no impact on net income.

(2) Restatement of Financial Statements

In August 2011, in consultation with the Audit Committee, Suffolk’s management determined it was not properly identifying loan losses in the period incurred. This was the result of deficiencies in Suffolk’s internal controls with respect to credit administration and credit risk management, primarily with regard to risk-rating as well as with respect to the timing and recognition of charge-offs, impaired loans, and classified loans. As a result, certain loans should have been considered impaired, charged-off, or classified. Consequently, Suffolk overstated loans, net; understated the allowance for loan losses; understated the provision for loan losses, overstated net income and earnings-per-common share; understated other assets; and overstated the capital ratios. The tables below detail the restated financial statement line items and Suffolk’s regulatory capital ratios. See Note 7 on page 15.

 

Page 6


Table of Contents

The effects of the restatement by line item for the periods presented in this Amendment No. 1 to its Quarterly Report on Form 10-Q follow: (in thousands, except per share and capital ratios)

 

Effect of Restatement on Consolidated Statements of Condition

 
     September 30, 2010        
     As Originally Reported     As Restated     Effect of Change  

Total loans

   $ 1,141,866      $ 1,134,457      $ (7,409

Allowance for loan losses

     21,964        26,659        4,695   

Other assets

     20,186        24,465        4,279   

Total assets

     1,689,925        1,682,100        (7,825

Retained earnings

     97,660        89,835        (7,825

Total stockholders’ equity

     151,453        143,628        (7,825

Effect on Consolidated Statements of Operations

 
     Three Months Ended September 30, 2010  
     As Originally Reported     As Restated     Effect of Change  

Provision for loan losses

   $ 2,625      $ 14,729      $ 12,104   

Net interest income after provision for loan losses

     16,742        4,638        (12,104

Income (loss) before income taxes

     6,388        (5,716     (12,104

Provision (benefit) for income taxes

     1,700        (2,579     (4,279

Net income (loss)

     4,688        (3,137     (7,825

Earnings (loss) per common share

      

Basic

   $ 0.49      $ (0.32   $ (0.81

Diluted

   $ 0.48      $ (0.32   $ (0.80

Effect on Consolidated Statements of Operations

 
     Nine Months Ended September 30, 2010  
     As Originally Reported     As Restated     Effect of Change  

Provision for loan losses

   $ 14,445      $ 26,549      $ 12,104   

Net interest income after provision for loan losses

     43,512        31,408        (12,104

Income before income taxes

     14,006        1,902        (12,104

Provision (benefit) for income taxes

     2,994        (1,285     (4,279

Net income

     11,012        3,187        (7,825

Earnings per common share

      

Basic

   $ 1.14      $ 0.33      $ (0.81

Diluted

   $ 1.14      $ 0.33      $ (0.81

Effect on Consolidated Statements of Cash Flows

 
     Nine Months Ended September 30, 2010  
     As Originally Reported     As Restated     Effect of Change  

Net income

   $ 11,012      $ 3,187      $ (7,825

Provision for loan losses

     14,445        26,549        12,104   

Increase in other assets

     (3,315     (7,594     (4,279

Effect on Suffolk’s Capital Ratios

 
     September 30, 2010  
     As Originally Reported     As Restated     Effect of Change  

Tier 1 Leverage Ratio

     8.49     8.03     -0.46

Tier 1 Risk-based Capital Ratio

     11.56     11.00     -0.56

Total Risk-based Capital Ratio

     12.82     12.26     -0.56

(3) Stock-based Compensation

At September 30, 2010, Suffolk had one stock-based employee compensation plan, the Suffolk Bancorp 2009 Stock Incentive Plan (“the Plan”), under which 500,000 shares of Suffolk’s common stock were originally reserved for issuance to key employees and directors, and of which none had yet been issued at that date. Options are awarded by a committee

 

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appointed by the Board of Directors. The Plan provides that the option price shall not be less than the fair value of the common stock on the date the option is granted. All options are exercisable for a period of ten years or less. The Plan provides for but does not require the grant of stock appreciation rights that the holder may exercise instead of the underlying option. When the stock appreciation right is exercised, the underlying option is canceled. The optionee receives shares of common stock or cash with a fair market value equal to the excess of the fair value of the shares subject to the option at the time of exercise (or the portion thereof so exercised) over the aggregate option price of the shares set forth in the option agreement. The exercise of stock appreciation rights is treated as the exercise of the underlying option. Options vest after one year and expire after ten years except as otherwise specified in the option agreement.

Stock-based compensation for all share-based payments to employees, including grants of employee stock options, is recorded in the financial statements based on their fair values. During the three months ended September 30, 2010, no compensation expense was recorded for stock-based compensation. During the nine months ended September 30, 2010, $8,000 of compensation expense, net of a tax benefit of $3,000, was recorded for stock-based compensation. As of September 30, 2010, there was no unrecognized compensation cost related to non-vested options under the Plan.

The following table presents the options granted, exercised, or expired from the 1999 Plan during the nine months ended September 30, 2010:

 

     Shares     Wtd. Avg. Exercise  

Balance at December 31, 2009

     154,500      $ 27.81   

Options granted

     —          —     

Options exercised

     (25,000     14.27   

Options expired or terminated

     (36,000     32.32   
  

 

 

   

 

 

 

Balance at September 30, 2010

     93,500      $ 29.69   
  

 

 

   

 

 

 

The following table presents certain information about the valuation of vested options outstanding on September 30, 2010 and December 31, 2009:

 

At, or during,

   9/30/2010     12/31/2009  

Exercisable options (vested)

     93,500        139,500   

Weighted average fair value of options (Black-Scholes model) at date of grant:

   $ 9.24      $ 9.24   

Black-Scholes Assumptions:

    

Risk-free interest rate

     3.17     3.17

Expected dividend yield

     3.06     3.06

Expected life in years

     10        10   

Expected volatility

     36.90     36.90

 

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The following table details contractual weighted-average lives of outstanding options at various prices:

 

     By range of exercise prices  

from

   $ 13.13       $ 28.30       $ 34.39   

to

     15.50         32.90         34.95   
  

 

 

    

 

 

    

 

 

 

Outstanding stock options

     14,000         57,000         22,500   

Weighted-average remaining life

     0.30         5.96         4.66   

Weighted-average exercise price

   $ 15.50       $ 31.17       $ 34.76   

Exercisable stock options

     14,000         57,000         22,500   

Weighted-average remaining life

     0.30         5.96         4.66   

Weighted-average exercise price

   $ 15.50       $ 31.17       $ 34.76   
            Weighted-average  

At all prices

   Options      price      life (yrs)  

Total outstanding (1)

     93,500       $ 29.69         4.80   

Total exercisable

     93,500       $ 29.69         4.80   

 

(1) Options to purchase 87,092 shares of common stock at a range of $28.30 - $34.95 per share were outstanding during the first nine months of 2010, and options to purchase 136,524 shares of common stock at a range of $31.18 - $34.95 per share were outstanding during the first nine months of 2009, but were not included in the computation of diluted Earnings-Per-Share (“EPS”) on the Consolidated Statement of Operations because the exercise price was greater than the average market price of the common shares. Options to purchase 93,500 shares of common stock at a range of $13.13 - $34.95 per share were outstanding during the quarter ended September 30, 2010, and options to purchase 135,214 shares of common stock at a range of $31.18 - $34.95 per share were outstanding during the quarter ended September 30 2009, but were not included in the computation of diluted EPS on the Consolidated Statement of Operations because of the net loss and the exercise price was greater than the average market price of the common shares. These options expire beginning in 2013.

(4) Income Taxes

Suffolk uses an asset and liability approach to accounting for income taxes. The asset and liability approach requires the recognition of deferred tax assets and liabilities for the expected future tax consequences of temporary differences between the carrying amounts and the tax bases of assets and liabilities. Deferred tax assets are recognized if it is more likely than not that a future benefit will be realized. It is management’s position that no valuation allowance is necessary against any of Suffolk’s deferred tax assets. Suffolk accounts for income taxes in accordance with Financial Accounting Standards Board (“FASB”) Accounting Standards Codification (“ASC”) 740, “Income Taxes,” which prescribes the recognition and measurement criteria related to tax positions taken or expected to be taken in a tax return. Suffolk had unrecognized tax benefits including interest of approximately $37,000 as of September 30, 2010. Suffolk recognizes interest and penalties accrued relating to unrecognized tax benefits in income tax expense.

(5) Fair Value

Suffolk records investments available for sale and impaired loans at fair value. Fair value measurement is determined based on the assumptions that market participants would use in pricing the asset or liability in an exchange. The definition of fair value includes the exchange price which is the price in an orderly transaction between market participants to sell an asset or transfer a liability in the principal market for the asset or liability. Market participant assumptions include assumptions about risk, the risk inherent in a particular valuation technique used to measure fair value and/or the risk inherent in the inputs to the valuation technique, as well as the effect of credit risk on the fair value of liabilities. Suffolk uses three levels of the fair value inputs to measure assets, as described below.

Basis of Fair Value Measurement:

Level 1 - Unadjusted, quoted prices in active markets that are accessible at the measurement date for identical, unrestricted assets or liabilities;

Level 2 - Quoted prices in markets that are not active, or inputs that use pricing models or matrix pricing;

Level 3 - Prices or valuation techniques that require inputs that are both significant to the fair value measurement and unobservable (i.e., supported by little or no market activity).

 

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The following table presents the carrying amounts and fair values of Suffolk’s financial instruments. FASB ASC 825, “Financial Instruments”, defines the fair value of a financial instrument as the amount at which the instrument could be exchanged in a current transaction between willing parties, other than in a forced sale or liquidation: (in thousands)

 

     September 30, 2010
Restated
     December 31, 2009  
     Carrying
Amount
     Fair
Value
     Carrying
Amount
     Fair
Value
 

Cash & cash equivalents

   $ 58,028       $ 58,028       $ 37,007       $ 37,007   

Investment securities available for sale

     446,399         446,399         437,000         437,000   

Investment securities held to maturity

     10,150         11,085         9,343         10,096   

Total loans

     1,134,457         1,166,671         1,160,379         1,178,429   

Deposits

     1,475,278         1,477,839         1,385,278         1,387,241   

Borrowings

     40,000         41,688         150,800         152,328   

Fair value estimates are made at a specific point in time and may be based on judgments regarding losses expected in the future, risk, and other factors that are subjective in nature. The methods and assumptions used to produce the fair value estimates follow.

Short-term financial instruments are valued at the carrying amounts included in the consolidated statements of condition, which are reasonable estimates of fair value due to the relatively short term of the instruments. This approach applies to cash and cash equivalents; accrued interest receivable; non-interest-bearing demand deposits; N.O.W., money market, and saving accounts; and accrued interest payable. Federal Home Loan Bank borrowings are measured using a discounted replacement cost of funds approach.

Fair values are estimated for portfolios of loans with similar characteristics. Loans are segregated by type. The fair value of performing loans was calculated by discounting scheduled cash flows through the estimated maturity using estimated market discount rates that reflect the credit and interest rate risk of the loan. Estimated maturity is based on the Bank’s history of repayments for each type of loan and an estimate of the effect of the current economy. Fair value for significant non-performing loans is based on recent external appraisals of collateral, if any. If appraisals are not available, estimated cash flows are discounted using a rate commensurate with the associated risk. Assumptions regarding credit risk, cash flows, and discount rates are made using available market information and specific borrower information.

The carrying amount and fair value of loans were as follows: (in thousands)

 

     September 30, 2010
Restated
     December 31, 2009  
     Carrying
Amount
     Fair
Value
     Carrying
Amount
     Fair
Value
 

Commercial, financial & agricultural

   $ 250,182       $ 254,249       $ 259,565       $ 261,333   

Commercial real estate

     422,158         440,688         375,652         383,392   

Real estate construction loans

     101,535         101,882         133,431         133,996   

Residential mortgages (1st & 2nd liens)

     203,847         211,907         214,501         221,502   

Home equity loans

     85,800         85,773         82,808         82,779   

Consumer loans, net of unearned discounts

     69,991         71,228         80,352         81,357   

Other loans

     944         944         14,070         14,070   
  

 

 

    

 

 

    

 

 

    

 

 

 

Totals

   $ 1,134,457       $ 1,166,671       $ 1,160,379       $ 1,178,429   
  

 

 

    

 

 

    

 

 

    

 

 

 

 

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Other assets measured at fair value were as follows: (in thousands)

 

            Fair Value Measurements Using  

Description

   September 30,  2010
Restated
     Active Markets for
Identical Assets
Quoted Prices
(Level 1)
     Significant
Other
Observable Inputs
(Level 2)
     Significant
Unobservable
Inputs

(Level 3)
 

Impaired loans

   $ 79,838       $ —         $ —         $ 79,838   

Mortgage servicing rights (1)

     1,515         —           —           1,515   
  

 

 

    

 

 

    

 

 

    

 

 

 

Total

   $ 81,353       $ —         $ —         $ 81,353   
  

 

 

    

 

 

    

 

 

    

 

 

 

 

(1) Mortgage servicing rights are measured at fair value on a recurring basis.

 

            Fair Value Measurements Using  

Description

   December 31, 2009      Active Markets for
Identical Assets
Quoted Prices
(Level 1)
     Significant
Other
Observable  Inputs

(Level 2)
     Significant
Unobservable
Inputs

(Level 3)
 

Impaired loans

   $ 29,309       $ —         $ —         $ 29,309   

Mortgage servicing rights (1)

     1,444         —           —           1,444   
  

 

 

    

 

 

    

 

 

    

 

 

 

Total

   $ 30,753       $ —         $ —         $ 30,753   
  

 

 

    

 

 

    

 

 

    

 

 

 

 

(1) Mortgage servicing rights are measured at fair value on a recurring basis.

Impaired loans are evaluated and valued at the time the loan is identified as impaired. The loans are measured based on the value of the collateral securing these loans less disposal costs, or techniques that are not supported by market activity for loans that are not collateral dependent and require management’s judgment. Collateral may be real estate and/or business assets including equipment, inventory and/or accounts receivable. The value of real estate collateral is determined based on appraisals by qualified licensed appraisers hired by Suffolk. The value of business equipment may be based on an appraisal by qualified licensed appraisers hired by Suffolk if significant, or may be valued based on the equipment’s net book value on the business’ financial statements. Inventory and accounts receivable collateral may be valued based on independent field examiner review or aging reports, if significant. Reviews by field examiners may be conducted based on the loan exposure and reliance on this type of collateral. Appraised and reported values may be discounted based on management’s historical knowledge, changes in market conditions from the time of valuation, and/or management’s expertise and knowledge of the client and client’s business. Impaired loans are reviewed and evaluated on at least a quarterly basis for additional impairment and adjusted accordingly, based on the same factors identified above.

The fair value of the investment portfolio, including mortgage-backed securities, was based on quoted market prices or market prices of similar instruments.

 

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The following tables summarize the valuation of financial instruments measured at fair value on a recurring basis in the consolidated statements of condition at September 30, 2010 and December 31, 2009, including the additional requirement to segregate classifications to correspond to the major security type classifications utilized for disclosure purposes: (in thousands)

 

            Fair Value Measurements Using  

Description

   September 30, 2010      Active Markets for
Identical Assets
Quoted Prices
(Level 1)
     Significant
Other
Observable  Inputs

(Level 2)
     Significant
Unobservable
Inputs

(Level 3)
 

U.S. Treasury securities

   $ 8,176       $ 8,176       $ —         $ —     

U.S. government agency debt

     42,634         42,634         —           —     

Collateralized mortgage obligations

     173,904         —           173,904         —     

Mortgage-backed securities

     533         —           533         —     

Obligations of states and political subdivisions

     221,152         —           221,152         —     
  

 

 

    

 

 

    

 

 

    

 

 

 

Total

   $ 446,399       $ 50,810       $ 395,589       $ —     
  

 

 

    

 

 

    

 

 

    

 

 

 
            Fair Value Measurements Using  

Description

   December 31, 2009      Active Markets for
Identical Assets
Quoted Prices
(Level 1)
     Significant
Other
Observable Inputs
(Level 2)
     Significant
Unobservable
Inputs

(Level 3)
 

U.S. Treasury securities

   $ 8,318       $ 8,318       $ —         $ —     

U.S. government agency debt

     43,205         43,205         —           —     

Collateralized mortgage obligations

     192,393         —           192,393         —     

Mortgage-backed securities

     599         —           599         —     

Obligations of states and political subdivisions

     192,485         —           192,485         —     
  

 

 

    

 

 

    

 

 

    

 

 

 

Total

   $ 437,000       $ 51,523       $ 385,477       $ —     
  

 

 

    

 

 

    

 

 

    

 

 

 

The types of instruments valued based on quoted market prices in active markets include most U.S. government debt and agency debt securities. Such instruments are generally classified within level 1 and level 2 of the fair value hierarchy. Suffolk does not adjust the quoted price for such instruments.

The types of instruments valued based on quoted prices in markets that are not active, broker or dealer quotations, or alternative pricing sources with reasonable levels of price transparency include state and municipal obligations, mortgage-backed securities and collateralized mortgage obligations. Such instruments are generally classified within level 2 of the fair value hierarchy.

FASB ASC 820, “Fair Value Measurements and Disclosures,” provides additional guidance in determining fair values when the volume and level of activity for the asset or liability have significantly decreased, particularly when there is no active market or where the price inputs being used represent distressed sales. It also provides guidelines for making fair value measurements more consistent with principles, reaffirming the need to use judgment to ascertain if a formerly active market has become inactive and in determining fair values when markets become inactive. Suffolk adopted this codification effective April 1, 2009. The adoption did not have a material impact on Suffolk’s financial condition and results of operations. The additional disclosures are included herein.

The fair value of certificates of deposit is calculated by discounting cash flows with applicable origination rates. At September 30, 2010, the fair value of certificates of deposit less than $100,000 totaling $112,052,000 had a carrying value of $110,561,000. At September 30, 2010, the fair value of certificates of deposit of $100,000 or more totaling $215,133,000 had a carrying value of $214,064,000.

The fair value of commitments to extend credit was estimated by either discounting cash flows or using the fees currently charged to enter into similar agreements, taking into account the remaining terms of the agreements and the current creditworthiness of the counterparties.

 

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Credit in the form of revolving open-end lines secured by one-to-four-family residential properties, commercial real estate, construction and land development loans, and lease financing arrangements was $126,233,000 and $148,309,000 as of September 30, 2010 and December 31, 2009, respectively.

The estimated fair value of written financial guarantees and letters of credit is based on fees currently charged for similar agreements. The contractual amounts of these commitments were $61,842,000 and $70,654,000 at September 30, 2010 and December 31, 2009, respectively. The fees charged for the commitments were not material in amount.

(6) Investment Securities

The amortized cost, estimated fair values, and gross unrealized gains and losses of Suffolk’s investment securities available for sale and held to maturity at September 30, 2010 and December 31, 2009, respectively, were: (in thousands)

 

    September 30, 2010     December 31, 2009  
    Amortized
Cost
    Estimated
Fair
Value
    Gross
Unrealized
Gains
    Gross
Unrealized
Losses
    Amortized
Cost
    Estimated
Fair
Value
    Gross
Unrealized
Gains
    Gross
Unrealized
Losses
 

Available for sale:

               

U.S. Treasury securities

  $ 8,022      $ 8,176      $ 154      $ —        $ 8,016      $ 8,318      $ 302      $ —     

U.S. government agency debt

    42,289        42,634        345        —          42,607        43,205        598        —     

Collateralized mortgage obligations

    168,386        173,904        7,245        (1,727     192,143        192,393        4,026        (3,776

Mortgage-backed securities

    477        533        56        —          546        599        53        —     

Obligations of states and political subdivisions

    203,769        221,152        17,386        (3     184,636        192,485        8,304        (455
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Balance

    422,943        446,399        25,186        (1,730     427,948        437,000        13,283        (4,231
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Held to maturity:

               

Obligations of states and political subdivisions

    10,050        10,985        935        —          9,243        9,996        755        (2

Other securities

    100        100        —          —          100        100        —          —     
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Balance

    10,150        11,085        935        —          9,343        10,096        755        (2
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total investment securities

  $ 433,093      $ 457,484      $ 26,121      $ (1,730   $ 437,291      $ 447,096      $ 14,038      $ (4,233
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

The amortized cost, maturities, and approximate fair value of Suffolk’s investment securities at September 30, 2010 were as follows: (in thousands)

 

    Available for Sale     Held to Maturity              
    U.S. Treasury
Securities
    U.S.
Govt. Agency
Debt
    Obligations of
States & Political
Subdivisions
    Obligations of
States & Political
Subdivisions
    Other
Securities
    Total
Amortized
Cost
    Total
Fair
Value
 

(1) Maturity (in years)

  Amortized
Cost
    Fair
Value
    Amortized
Cost
    Fair
Value
    Amortized
Cost
    Fair
Value
    Amortized
Cost
    Fair
Value
    Amortized
Cost
    Fair
Value
             

Within 1

  $ 8,022      $ 8,176      $ 27,113      $ 27,223      $ 1,006      $ 1,019      $ 2,276      $ 2,295      $ —        $ —        $ 38,417      $ 38,713   

After 1 but within 5

    —          —          15,176        15,411        29,036        31,496        3,888        4,169        —          —          48,100        51,076   

After 5 but within 10

    —          —          —          —          161,100        175,129        3,886        4,521        —          —          164,986        179,650   

After 10

    —          —          —          —          12,627        13,508        —          —          —          —          12,627        13,508   

Other Securities

    —          —          —          —          —          —          —          —          100        100        100        100   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Subtotal

    8,022        8,176        42,289        42,634        203,769        221,152        10,050        10,985        100        100        264,230        283,047   

Collateralized mortgage obligations

                        168,386        173,904   

Mortgage-backed securities

                        477        533   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total

  $ 8,022      $ 8,176      $ 42,289      $ 42,634      $ 203,769      $ 221,152      $ 10,050      $ 10,985      $ 100      $ 100      $ 433,093      $ 457,484   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

 

(1) Maturities shown are stated maturities. Securities backed by mortgages are expected to have substantial periodic prepayments resulting in weighted average lives considerably less than what would be surmised from the table above.

 

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As a member of the Federal Reserve System, the Bank owns Federal Reserve Bank stock with a book value of $652,000. The stock has no maturity and there is no public market for the investment.

As a member of the Federal Home Loan Bank of New York (“FHLB”), the Bank owns FHLB stock with a book value of $3,531,000. As of September 30, 2010, the Bank owns 17,314 shares valued at approximately $1,731,000 as its membership portion. The remaining $1,800,000 in stock is owned based on borrowing activity requirements. The stock has no maturity and there is no public market for the investment. Assets pledged as collateral to FHLB as of September 30, 2010 and December 31, 2009 totaled $361,146,000 and $330,471,000, respectively, consisting of eligible loans and investment securities as determined under FHLB guidelines.

At September 30, 2010 investment securities carried at $380,198,000 were pledged to secure trust deposits and public funds on deposit.

The table below indicates the length of time individual securities, both held-to-maturity and available-for-sale, have been held in a continuous unrealized loss position at the date indicated: (in thousands)

 

As of September 30, 2010           Less than 12 months      12 months or longer      Total  

Type of securities

   Number  of
Securities
     Fair
Value
     Unrealized
losses
     Fair
value
     Unrealized
losses
     Fair
value
     Unrealized
losses
 

Municipal securities

     3       $ 511       $ 3       $ —         $ —         $ 511       $ 3   

Collateralized mortgage obligations

     2         —           —           11,323         1,727         11,323         1,727   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total

     5       $ 511       $ 3       $ 11,323       $ 1,727       $ 11,834       $ 1,730   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 
As of December 31, 2009           Less than 12 months      12 months or longer      Total  

Type of securities

   Number of
Securities
     Fair
Value
     Unrealized
losses
     Fair
value
     Unrealized
losses
     Fair
value
     Unrealized
losses
 

Municipal securities

     48         17,914         455         83         2       $ 17,997       $ 457   

Collateralized mortgage obligations

     7         21,207         170         19,253         3,606         40,460         3,776   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total

     55       $ 39,121       $ 625       $ 19,336       $ 3,608       $ 58,457       $ 4,233   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Management has considered factors such as market value, cash flows, and analysis of underlying collateral regarding other-than-temporarily impaired securities and determined that there are no other-than-temporarily impaired securities as of September 30, 2010.

The unrealized losses in collateralized mortgage obligations at September 30, 2010 were caused by volatile interest rates, a significant widening of credit spreads across markets for these securities, and illiquidity and uncertainty in the financial markets. These securities include two private issues held at a continuous, unrealized loss for more than twelve months. Each of these securities has some level of credit enhancement, and none are collateralized by sub-prime loans. With the assistance of a third party, management reviews the characteristics of these securities periodically, including levels of delinquency and foreclosure, projected losses at various degrees of severity, and credit enhancement and coverage. These securities are performing according to their terms, and, in the opinion of management, will continue to do so.

Suffolk does not have the intent to sell these securities and does not anticipate that it will be necessary to sell these securities before the full recovery of principal and interest due, which may be at maturity. Therefore, Suffolk did not consider these investments to be other-than-temporarily impaired at September 30, 2010.

 

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(7) Allowance for Loan Losses

In August 2011, in consultation with the Audit Committee, Suffolk’s management determined it was not properly identifying loan losses in the period incurred. This was the result of deficiencies in Suffolk’s internal controls with respect to credit administration and credit risk management, primarily with regard to risk-rating as well as with respect to the timing and recognition of charge-offs, impaired loans, and classified loans. As a result, certain loans should have been considered impaired, charged-off, or classified. Consequently, Suffolk overstated loans, net; understated the allowance for loan losses; understated the provision for loan losses, overstated net income and earnings-per-common share; understated other assets; and overstated the capital ratios.

Suffolk takes into account applicable guidance under U.S. GAAP, including particularly “ASC 855 – Subsequent Events.” Under this statement, subsequent events are defined as events or transactions that occur after the balance sheet date but before financial statements are issued or are available to be issued. This statement requires that entities recognize in the financial statements the effects of all subsequent events that provide additional evidence about conditions that existed as of the balance sheet date, including any estimates underlying the financial statements. The entity should not recognize subsequent events that provide evidence about conditions that arose after the balance sheet date, but should disclose those events which are so important that nondisclosure would make the financial statements misleading.

One result of the analysis of subsequent events is that loans which would have been downgraded or charged off during the subsequent period through the date of the filing of this Form 10-Q/A because of their continuing deterioration have been recognized in the restated ALLL for the third quarter of 2010 since the credit deterioration could be traced to the third quarter of 2010 even though it had been identified after September 30, 2010. This resulted in an increase in charged-off loans totaling approximately $7.4 million. These charge-offs were reflected in the ALLL calculations as of September 30, 2010.

The following tables summarize the activity in the allowance for loan losses for the periods presented: (in thousands)

 

     Nine months  ended
September 30, 2010
Restated
     Year Ended
December 31, 2009
 

Allowance for loan losses, Beginning

   $ 12,333       $ 9,051   

Loans charged-off:

     

Commercial, financial & agricultural loans

     7,717         806   

Commercial real estate mortgages

     230         —     

Real estate construction loans

     3,620         —     

Residential mortgages (1st and 2nd liens)

     492         —     

Home equity loans

     65         —     

Consumer loans

     286         404   

Other loans

     —           —     
  

 

 

    

 

 

 

Total Charge-offs

   $ 12,410       $ 1,210   
  

 

 

    

 

 

 

Loans recovered after being charged-off

     

Commercial, financial & agricultural loans

     62         41   

Commercial real estate mortgages

     —           —     

Real estate construction loans

     —           —     

Residential mortgages (1st and 2nd liens)

     —           —     

Home equity loans

     —           —     

Consumer loans

     74         176   

Other loans

     —           —     
  

 

 

    

 

 

 

Total recoveries

   $ 136       $ 217   
  

 

 

    

 

 

 

Net loans charged-off

     12,274         993   

Reclass to allowance for contingent liabilities

     51         —     

Provision for loan losses

     26,549         4,275   
  

 

 

    

 

 

 

Allowance for loan losses, Ending

   $ 26,659       $ 12,333   
  

 

 

    

 

 

 

 

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The following tables summarize the activity in the allowance for loan losses for the periods presented: (in thousands)

 

     For the three months
ended September 30
 
     2010
(Restated)
    2009  

Allowance for loan losses, Beginning

   $ 20,815      $ 10,873   

Loans charged-off:

    

Commercial, financial & agricultural loans

     (6,350     (101

Commercial real estate mortgages

     (72     —     

Real estate construction loans

     (2,043     —     

Residential mortgages (1st and 2nd liens)

     (248     —     

Home equity loans

     —          —     

Consumer loans

     (192     (81

Other loans

     —          —     
  

 

 

   

 

 

 

Total charge-offs

     (8,905     (182
  

 

 

   

 

 

 

Loans recovered after being charged-off

    

Commercial, financial & agricultural loans

     3        30   

Commercial real estate mortgages

     —          —     

Real estate construction loans

     —          —     

Residential mortgages (1st and 2nd liens)

     —          —     

Home equity loans

     —          —     

Consumer loans

     17        20   

Other loans

     —          —     
  

 

 

   

 

 

 

Total recoveries

     20        50   
  

 

 

   

 

 

 

Net loans charged-off

     (8,885     (132

Reclass to allowance for contingent liabilities

     —          —     

Provision for loan losses

     14,729        975   
  

 

 

   

 

 

 

Allowance for loan losses, Ending

   $ 26,659      $ 11,716   
  

 

 

   

 

 

 

The following table summarizes impaired loans with and without valuation reserves by loan type: (in thousands)

 

     September 30, 2010 *      December 31, 2009  
     Impaired
Loans with
Valuation
Reserves
     Impaired
Loans
without
Valuation
Reserves
     Total
Impaired
Loans
     Total
Valuation
Reserves
     Impaired
Loans with
Valuation
Reserves
     Impaired
Loans
without
Valuation
Reserves
     Total
Impaired
Loans
     Total
Valuation
Reserves
 

Commercial, financial & agricultural loans

   $ 5,221       $ 10,289       $ 15,510       $ 3,209       $ 5,983       $ —         $ 5,983       $ 1,967   

Commercial real estate mortgages

     17,294         22,721         40,015         2,923         15,547         —           15,547         621   

Real estate construction loans

     4,829         23,650         28,479         573         10,774         —           10,774         407   

Residential mortgages (1st and 2nd liens)

     —           2,137         2,137         —           —           1,820         1,820         —     

Home equity loans

     —           371         371         —           —           65         65         —     

Consumer loans

     —           31         31         —           —           153         153         —     
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total

   $ 27,344       $ 59,199       $ 86,543       $ 6,705       $ 32,304       $ 2,038       $ 34,342       $ 2,995   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

 

* Restated

(8) Comprehensive Income

Comprehensive income includes net income and all other changes in equity during a period except those resulting from investments by owners and distributions to owners. Other comprehensive income includes revenues, expenses, gains, and losses that under generally accepted accounting principles are included in comprehensive income but excluded from net income. Comprehensive income and accumulated other comprehensive income are reported net of related income taxes. Accumulated other comprehensive income for the Bank consists of unrealized holding gains or losses on securities available for sale, and gains or losses on the unfunded projected benefit obligation of the pension plan.

 

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The following table summarizes the changes in accumulated other comprehensive income (loss): (in thousands)

 

For the period ended:

  September 30, 2010     December 31, 2009  

Balance January 1,

  $ (1,707   $ (11,430

Net Change in Unrealized Gain on Investment Securities - net of tax

    8,559        7,307   

Reclassification of gains on sales of securities recognized, net of tax

    (7     —     

Net Change in Other Comprehensive Gain on Pension and Postretirement Plan Projected Benefit Obligation

    —          2,416   
 

 

 

   

 

 

 

Total Accumulated Other Comprehensive Income (Loss)

  $ 6,845      $ (1,707
 

 

 

   

 

 

 

The unrealized gain on investment securities at September 30, 2010 is mainly attributable to increases, net of tax, of $3,128,000 in the market value of collateralized mortgage obligations and $5,663,000 in the market value of obligations of state and political subdivisions. This is offset by decreases of $88,000 in the market value of U.S. treasury securities and $151,000 in the market value of U.S. government agency debt. Also included in accumulated other comprehensive income at September 30, 2010, is the reclassification of gain on sale of securities recognized of $7,000, net of taxes.

(9) Retirement Plan

Suffolk accounts for its retirement plan in accordance with FASB ASC 715, “Compensation – Retirement Benefits” and FASB ASC 960, “Plan Accounting – Defined Benefit Pension Plans,” which require an employer that is a business entity and sponsors one or more single-employer defined benefit plans to recognize the funded status of a benefit plan in its statement of financial condition; recognize as a component of other comprehensive income, net of tax, the gains or losses and prior service costs or credits that arise during the period but are not recognized as components of net periodic benefit cost; measure defined benefit plan assets and obligations as of the date of fiscal year-end statements of financial position (with limited exceptions); and disclose in the notes to financial statements additional information about certain effects of net periodic benefit cost for the next fiscal year that arise from delayed recognition of the gains or losses, prior service costs or credits, and transition asset and obligation. Plan assets and benefit obligations shall be measured as of the date of its statement of financial condition and in determining the amount of net periodic benefit cost. Suffolk has adopted the provisions of the codification, which have been recorded in the accompanying consolidated statement of condition and disclosures.

Suffolk presents information concerning net periodic defined benefit pension expense for the quarter and year to date periods ended September 30, 2010 and 2009, including the following components: (in thousands)

 

     3 months
9/30/2010
    3 months
9/30/2009
    9 months
9/30/2010
    9 months
9/30/2009
 

Service cost

   $ 451      $ 451      $ 1,353      $ 1,244   

Interest cost

     510        505        1,529        1,393   

Expected return on plan assets

     (538     (418     (1,613     (1,154

Amortization of prior service cost

     181        258        543        713   

Amortization of unrecognized net actuarial loss

     —          —         
  

 

 

   

 

 

   

 

 

   

 

 

 

Net periodic benefit expense

   $ 604      $ 796      $ 1,812      $ 2,196   
  

 

 

   

 

 

   

 

 

   

 

 

 

There is no minimum required contribution for the pension plan year ending September 30, 2010. There were no additional contributions required to be made to the plan in the nine months ended September 30, 2010.

 

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(10) Recent Accounting Pronouncements

In January 2010, the FASB issued ASU No. 2010-06, which amends the authoritative accounting guidance under ASC Topic 820 “Fair Value Measurements and Disclosures.” The update requires the following additional disclosures. 1) Separately disclose the amounts of significant transfers in and out of Level 1 and Level 2 fair value measurements and describe the reasons for the transfers. 2) Information about purchases, sales, issuances and settlements need to be disclosed separately in the reconciliation for fair value measurements using Level 3. The update provides for amendments to existing disclosures as follows. 1) Fair value measurement disclosures are to be made for each class of assets and liabilities. 2) Disclosures about valuation techniques and inputs used to measure fair value for both recurring and nonrecurring fair value measurements. The update also includes conforming amendments to guidance on employers’ disclosures about postretirement benefit plan assets. The update is effective for interim and annual reporting periods beginning after December 15, 2009, except for the disclosures about purchases, sales, issuances and settlements in the roll forward of activity in Level 3 fair value measurements. Those disclosures are effective for fiscal years beginning after December 15, 2010, and for interim periods within those fiscal years. Suffolk has evaluated the provisions of ASU No. 2010-06 and determined there is no material effect on its disclosures, results of operations or financial condition.

In February 2010, the FASB issued ASU No. 2010-09, which amends the authoritative accounting guidance under ASC Topic 855 “Subsequent Events.” The update provides that a Securities and Exchange Commission (“SEC”) filer is required to evaluate subsequent events through the date financial statements are issued. However, an SEC filer is not required to disclose the date through which subsequent events have been evaluated. The update was effective as of the date of issuance. Adoption of this update did not have a material effect on Suffolk’s disclosures, results of operations or financial condition.

In April 2010, the FASB issued ASU No. 2010-18, which provides authoritative accounting guidance on ASC Subtopic 310-30 “Receivables – Loans and Debt Securities Acquired with Deteriorated Credit Quality.” The update provides that modifications of loans that are accounted for within a pool under Subtopic 310-30 do not result in the removal of those loans from the pool even if the modification of those loans would otherwise be considered a troubled debt restructuring. An entity will continue to be required to consider whether the pool of assets in which the loan is included is impaired if expected cash flows for the pool change. This update is effective for modification of loans accounted for within pools under Subtopic 310-30 occurring in the first interim or annual period ending on or after July 15, 2010. The amendments are to be applied prospectively. No additional disclosures are required. Suffolk has evaluated the provisions of this update and determined there is no material effect on its disclosures, results of operations or financial condition.

In July 2010, the FASB issued ASU No. 2010-20 which amends the authoritative accounting guidance under ASC Topic 310, “Receivables.” The update amends existing disclosures about an entity’s financing receivables on a disaggregated basis to require: (1) a roll-forward schedule of the allowance for credit losses from the beginning of the reporting period to the end of the reporting period on a portfolio segment basis, with the ending balance further disaggregated on the basis of impairment method; (2) for each disaggregated ending balance in item (1) above, the related recorded investment in financing receivables; (3) the non-accrual status of financing receivables by class of financing receivables; and (4) impaired financing receivables by class of financing receivables. In addition, the amendments require an entity to provide the following additional disclosures about its financing receivables: (1) credit quality indicators of financing receivables at the end of the reporting period by class of financing receivables; (2) the aging of past due financing receivables at the end of the reporting period by class of financing receivables; (3) the nature and extent of troubled debt restructurings that occurred during the period by class of financing receivables and their effect on the allowance for credit losses; (4) the nature and extent of financing receivables modified as troubled debt restructurings within the previous 12 months that defaulted during the reporting period by class of financing receivables and their effect on the allowance for credit losses; and (5) significant purchases and sales of financing receivables during the reporting period disaggregated by portfolio segment. The disclosures as of the end of a reporting period are effective for interim and annual reporting periods ending on or after December 15, 2010. The disclosures about activity that occurs during a reporting period are effective for interim and annual reporting periods beginning after December 15, 2010. Suffolk does not expect the provisions of this update to have a material effect on its results of operations or financial condition.

(11) Regulatory Matters

On October 25, 2010, the Bank, following discussion with the Office of the Comptroller of the Currency (the “OCC”) entered into a formal agreement with the OCC (the “Agreement”). The Agreement requires the Bank to take certain actions, including a review of management, the establishment of a three-year strategic plan and capital program, and the establishment of programs related to internal audit, maintaining an adequate allowance for loan losses, real property appraisal, credit risk management, credit concentrations, Bank Secrecy Act compliance and information technology.

 

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Management and the board of directors are committed to taking all necessary actions to promptly address the requirements of the Agreement, and believe that the Bank has already made measurable progress in addressing these requirements. In connection with the foregoing, the Bank has retained legal and other resources including the services of a qualified compliance consultant to assist and advise in meeting the requirements of the Agreement.

At September 30, 2010, the Bank had a Tier 1 leverage ratio of 7.93 percent, a Tier 1 risk-based capital ratio of 10.87 percent, and a total risk-based capital ratio of 12.14 percent. The Bank exceeded the capital ratios required to be deemed well capitalized with respect to 12 CFR 6.4 as of September 30, 2010 after taking into effect the restatement and the Bank management believes the Bank met all regulatory requirements applicable at that time. Subsequent to September 30, 2010, the Bank became subject to individual minimum capital ratios established by the OCC requiring the Bank to maintain a Tier 1 capital ratio of at least equal to 8.00 percent of adjusted total assets, to maintain a Tier 1 capital ratio at least equal to 10.50 percent of risk-weighted assets, and to maintain a total risk based capital ratio at least equal to 12.00 percent of risk-weighted assets. 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.

At September 30, 2010, Suffolk’s Tier 1 capital ratio was 8.03 percent of adjusted total assets, Tier 1 capital ratio was 11.00 percent of risk-weighted assets, and Total Risk Based capital ratio was 12.26 percent of risk-weighted assets.

The ability of the Bank to pay dividends to Suffolk is subject to certain regulatory restrictions. Generally, dividends declared in a given year by a national bank are limited to its net profit, as defined by regulatory agencies, for that year, combined with its retained net income for the preceding two years, less any required transfer to surplus or to fund for the retirement of any preferred stock of which the Bank has none as of September 30, 2010. In addition, a national bank may not pay any dividends in an amount greater than its undivided profits and a national bank may not declare any dividends if such declaration would leave the bank inadequately capitalized. Therefore, the ability of the Bank to declare dividends will depend on its future net income and capital requirements. In addition, under the Agreement the Bank is required to establish a dividend policy that will permit the declaration of a dividend only when the Bank is in compliance with its capital program and with the prior written determination of no supervisory objection by the OCC.

(12) Legal Proceedings (See Note 13)

On July 11, 2011 a shareholder derivative action, Robert J. Levy v. J. Gordon Huszagh, et al., No. 11 Civ. 3321 (JS), was filed in the U.S. District Court for the Eastern District of New York against the directors of Suffolk and a former officer of Suffolk. Suffolk was named as a nominal defendant. The complaint seeks damages against the individual defendants in an unspecified amount, and alleges that the individual defendants breached their fiduciary duties by making improper statements regarding the sufficiency of Suffolk’s allowance for loan losses and loan portfolio credit quality, and by failing to establish sufficient allowances for loan losses and to establish effective credit risk management policies. On September 30, 2011, Suffolk and the directors filed a motion to dismiss the complaint.

On October 28, 2011, a separate shareholder derivative action, Susan Forbush v. Edgar F. Goodale, et al., No. 33538/11, was filed in the Supreme Court of the State of New York for the County of Suffolk, against the directors of Suffolk and a former officer of Suffolk. Suffolk was named as a nominal defendant. The complaint asserts claims that are substantially similar to those asserted in the Levy action.

On October 20, 2011, a putative shareholder class action, James E. Fisher v. Suffolk Bancorp, et al., No. 11 Civ. 5114 (SJ), was filed in the U.S. District Court for the Eastern District of New York against Suffolk, its chief executive officer, and a former chief financial officer of Suffolk. The complaint alleges that the defendants violated Sections 10(b) and 20(a) of the Securities Exchange Act of 1934 by knowingly or recklessly making false statements about, or failing to disclose accurate information about, Suffolk’s financial results and condition, loan loss reserves, impaired assets, internal and disclosure controls, and banking practices. The complaint seeks damages in an unspecified amount on behalf of purchasers of Suffolk’s common stock between March 12, 2010 and August 10, 2011.

Suffolk has been informed that the SEC’s New York regional office is conducting an informal inquiry to determine whether there have been violations of the federal securities laws in connection with Suffolk’s financial reporting. The SEC has not asserted that any federal securities law violation has occurred. Suffolk believes it is in compliance with all federal securities laws and believes it has cooperated fully with the SEC’s informal inquiry. Although the ultimate outcome of the informal inquiry cannot be ascertained at this time, based upon information that presently is available to it, Suffolk does not believe that the informal inquiry, when resolved, will have a material adverse effect on Suffolk’s results of operations or financial condition.

The foregoing matters are in their preliminary phases and it is not possible to ascertain whether there is a reasonable possibility of a loss from these matters. Therefore, we have concluded that an amount for a loss contingency is not to be accrued or disclosed at this time. Suffolk believes that it has substantial defenses to the claims filed against it in these lawsuits and, to the extent that these actions proceed, Suffolk intends to defend itself vigorously.

 

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(13) Subsequent Events

Suffolk evaluated subsequent events to determine if there was an effect on these consolidated financial statements. Events which occurred subsequent to the balance sheet date but prior to the release of these restated financial statements have been accounted for in accordance with ASC 855, “Accounting for Subsequent Events.” Suffolk considered whether there were subsequent events that have occurred and is disclosing the following as well as the matter disclosed in Note 12 – “Legal Proceedings.”

 

   

As part of its de-leveraging strategy, in June 2011 Suffolk pre-paid a $40 million borrowing from the Federal Home Loan Bank of New York and incurred a $1 million penalty. Suffolk also sold approximately $40 million of investment securities in June 2011, realizing a gain of $1.6 million. These transactions were recorded in the second quarter of 2011 when they occurred.

 

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Item 2 - MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION

AND RESULTS OF OPERATIONS

For the Three and Nine Months Ended September 30, 2010 and 2009

Recent Developments

Suffolk has restated its consolidated financial statements as of September 30, 2010 and for the three and nine months then ended. See the explanatory note preceding the table of contents and Note 2 on page 6 for a detailed description of the financial statement restatement.

During the third quarter of 2010, increasing amounts of credit were available to a select group of highly-qualified borrowers as banks attempted to generate assets of high quality that would provide at least some spread over more highly liquid investments such as “fed funds” which had been priced at historically low rates of interest, typically well below one percent. However, deposits generally continued to increase as individuals and businesses hesitated either to spend or employ these funds elsewhere. The Dodd-Frank Wall Street Reform and Consumer Protection Act (the “Act”) was signed into law on July 21, 2010, and established the general direction of financial regulation. Much of the law extended discretion to regulators to promulgate regulations concerning a wide variety of issues. Uncertainty as to what those regulations might be and when they might take effect amplified that hesitation as businesses waited for clarity as to how they would affect their operations. Short-term rates remained near zero, and the “yield curve” remained comparatively steep in comparison with historic averages, with the margins between short- and long-term rates unusually wide, although a rally in the bond market continued to lower long term rates more than short, suggesting to observers that the net interest margin of many banks might compress going forward, after having widened during the past several quarters. Low short-term rates were primarily the result of continuing, low short-term targets set by the Federal Reserve Board for federal funds and discount rates. It was also the result of continuing concern about the possibility of inflation over the longer term as a result of deficit spending by the federal government, and the development of an offsetting concern late during the previous quarter that the recovery might stall, leading to deflation. Rates of unemployment remained high by historic standards.

As disclosed previously, the prolonged slump in the economy has strained the resources of some of Suffolk’s borrowers. Suffolk is a community bank that relies upon net interest income generated by the relationships it builds with the owners of small and medium-sized businesses, in contrast to certain large banks that profit from the proprietary trading of securities and derivatives. Our prospects remain tied more to “Main Street” than to Wall Street. At the start of the current recession, Suffolk’s primary market area was wealthier than many other markets. Owners of small businesses and other customers appeared to have greater financial reserves than similar customers in other regions of the nation, and the development of real estate, both residential and commercial, was more mature and therefore less speculative. This contributed to a steadier and less dramatic decline than elsewhere; and Suffolk’s borrowers remained current in their obligations longer. However, as time has passed, the economy appears to have stabilized at lower levels of output and higher levels of unemployment than before 2008.

At Suffolk, interest income increased slightly, however net interest income increased primarily due to reduced interest expense. The net interest margin increased to 5.13 percent in the third quarter of 2010, up from 4.89 percent during the third quarter of 2009. Net interest income was offset, however, by a substantially higher provision for loan losses, which increased by 1,411 percent over the third quarter of 2009. The net interest margin on a year to date basis increased to 5.06 percent in 2010, up from 4.98 percent for the comparable period in 2009. Net interest income was offset by a substantially higher provision for loan losses.

At September 30, 2010, of the $32,062,000 of non-performing loans, $29,247,000 was secured by collateral valued at approximately $62,416,000, having an average loan-to-value ratio of approximately 47 percent. The unsecured portion of $2,815,000 amounted to 25 basis points of net loans at quarter end. To determine the adequacy of the allowance for loan losses Suffolk considered not only the status of non-performing loans on its books, but the performance of Suffolk’s peers. Although Suffolk continues to work with borrowers to ensure the collection of nonperforming credits, some of these loans were being paid more slowly than originally anticipated. This increased the allowance for loan losses to $26,659,000 at September 30, 2010, up from $12,333,000 at December 31, 2009. The majority of non-performing loans are commercial and industrial loans, and loans secured by commercial real estate. The allowance is established through a provision for loan losses based on management’s evaluation of the risk inherent in the various components of the loan portfolio and other factors. See “Allowance for Loan Losses.”

 

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While non-performing assets as a percent of total assets increased much later at Suffolk than in peer banks, they increased from 144 basis points at September 30, 2009, to 173 basis points at December 31, 2009, 185 basis points at March 31, 2010, 212 basis points at June 30, 2010, and 182 basis points at September 30, 2010. Non-performing loans to total loans amounted to 215 basis points at September 30, 2009, 253 basis points at December 31, 2009, 270 basis points at March 31, 2010, 311 basis points at June 30, 2010, and 269 basis points at September 30, 2010. Of the $30,552,000 of loans not accruing interest, $7,765,000 represents credit to one borrower which, in consultation with the primary regulator of the Bank, management determined to place on non-accrual status, although all payments are current and have been since inception, and has a ratio of loan-to-current appraised-value (June 2010) of 59.7 percent. Without this credit, nonperforming assets would have totaled to $22,787,000, or 201 basis points, as a percent of total loans. As noted in the discussion above, most non-performing loans are well-collateralized. However, as they remain non-accruing over a period of time, on the basis of objective and selective criteria, Suffolk may or may not elect to charge these and other loans off prudentially, even when they remain in collection and there is the reasonable remaining expectation of the recovery of amounts owed and expenses incurred in collection. These charge-offs may or may not mirror trends, on a trailing basis, in ratios of non-performing assets to total assets and non-performing loans to total loans. The amounts charged off may be substantial in comparison with Suffolk’s past loss history, although they may result in net recoveries at some point in the future if the economy improves and borrowers’ financial conditions strengthen, although there can be no assurance that this will happen. Further discussion concerning the determination of the provision for loan losses is found in the following under the caption, “Allowance for Loan Losses.”

On October 25, 2010, the Bank, following discussion with the OCC, entered into a formal agreement with the OCC (the “Agreement”). The Agreement requires the Bank to take certain actions, including a review of management, the establishment of a three-year strategic plan and capital program, and the establishment of programs related to internal audit, maintaining an adequate allowance for loan losses, real property appraisal, credit risk management, credit concentrations, Bank Secrecy Act compliance and information technology.

Management and the board of directors are committed to taking all necessary actions to promptly address the requirements of the Agreement, and believe that the Bank has already made measurable progress in addressing these requirements. In connection with the foregoing, the Bank has retained legal and other resources including the services of a qualified compliance consultant to assist and advise in meeting the requirements of the Agreement.

While subject to the Agreement, Suffolk expects that its and the Bank’s management and board of directors will be required to focus a substantial amount of time on complying with its terms. There also is no guarantee that the Bank will be able to fully comply with the Agreement. If the Bank fails to comply with the terms of the Agreement, it could be subject to further regulatory enforcement actions.

Basic Performance and Current Activities

There was no return on average equity for the third quarter of 2010 due to the net loss as compared to 19.34 percent during the third quarter of 2009, and basic earnings(loss)-per-share decreased from $0.63 in the third quarter of 2009 to ($0.32) in the third quarter of 2010. For the first nine months of 2010, return on average equity decreased to 3.01 percent, down from 19.29 percent during the comparable period of 2009.

Although Suffolk’s net interest income after the provision for loan losses decreased, Suffolk’s net interest income and core performance improved. Key to maintaining performance was disciplined management of the balance sheet. These steps included:

 

   

Maintaining emphasis on both commercial and personal demand deposits, and non-maturity time deposits as a key part of relationships with customers while responding as necessary to demand in Suffolk’s market for certificates of deposit of all sizes. Suffolk continues its emphasis on the profitability of the whole relationship of its customers with the Bank, seeking when possible to both make loans to and obtain funding from the best qualified customers.

 

   

Managing net loan charge-offs and non-performing loans. During the third quarter of 2010, net charge-offs amounted to 318 basis points of average net loans, on an annualized basis. Non-performing loans, those more than 90 days past due, increased. Lending staff’s first efforts continue to be directed to the management of such credits, and then to developing new business with an emphasis on the most profitable customer relationships.

 

   

Managing the investment portfolio in a difficult rate environment and continued purchases of municipal securities, which provide liquidity as well as higher returns net of taxes, and some protection from falling interest rates.

 

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Pursuing the ongoing program of capital management, allowing total risk based capital (“TRBC”) to move upward to provide a greater cushion against uncertainty, and to respond to increases in regulatory requirements under discussion at various levels of government. Accordingly, maximum prudent leverage is thus applied to the shareholders’ investment while still anticipating changes in regulation through the retention of earnings when assets are growing. Growth in the core business during the quarter was sufficient to employ retained earnings and no shares were repurchased. Reinvested dividends were used to purchase additional shares from Suffolk.

Net Income (Loss)

The net loss totaled $(3,137,000) for the third quarter of 2010, down 152.00 percent from net income of $6,028,000 recorded during the same period last year. The loss-per-share for the quarter was $(0.32) versus earnings-per share of $0.63, during the same period last year, a decrease of 150.80 percent. Net income was $3,187,000 for the nine months ended September 30, 2010, down from $17,395,000 posted during the same period last year. Earnings-per-share was $0.33 for the nine month period ended September 30, 2010, down from $1.81 posted last year. The key reason for the decline was an increased provision for loan losses.

Interest Income

Interest income was $21,702,000 for the third quarter of 2010, up 0.86 percent from $21,516,000 posted for the same quarter in 2009. Average net loans during the third quarter of 2010 totaled $1,123,851,000 compared to $1,109,161,000 for the same period of 2009. During the third quarter of 2010, the yield on a fully taxable-equivalent basis was 5.72 percent on average earning assets of $1,590,211,000, up from 5.66 percent on average earning assets of $1,587,600,000 during the third quarter of 2009. Interest income remained relatively flat from quarter to quarter. Interest income was $65,468,000 for the first nine months of 2010, up 0.3 percent from $65,244,000 recorded in the first nine months of 2009. During the first nine months of 2010, the yield on a fully taxable-equivalent basis was 5.68 percent on average earning assets of $1,607,497,000, down from 5.81 percent on average earning assets of $1,560,306,000 during the first nine months of 2009.

Interest Expense

Interest expense for the third quarter of 2010 was $2,335,000, down 23.2 percent from $3,042,000 for the same period of 2009. During the third quarter of 2010, the cost of funds was 0.94 percent on average interest-bearing liabilities of $991,869,000, down from 1.19 percent on average interest-bearing liabilities of $1,018,949,000 during the third quarter of 2009. Interest expense was $7,511,000 for the first nine months of 2010, down 22.7 percent from $9,722,000 recorded last year to date. During the first nine months of 2010, the cost of funds was 0.96 percent on average interest-bearing liabilities of $1,042,415,000, down from 1.26 percent on average interest-bearing liabilities of $1,029,022,000 during the first nine months of 2009. Interest expense decreased due to decreased rates paid for all interest-bearing liabilities, in addition to a decrease in average borrowings outstanding.

A portion of the Bank’s demand deposits are reclassified as savings accounts on a daily basis. The purpose of the reclassification is to reduce the non-interest-bearing reserve balances that the Bank is required to maintain with the Federal Reserve Bank, and thereby increase funds available for investment. Although these balances are classified as saving accounts for regulatory purposes, they are included in demand deposits in the accompanying consolidated statements of condition.

Net Interest Income

Net interest income, before the provision for loan losses, is the largest component of Suffolk’s earnings. It was $19,367,000 for the third quarter of 2010, up 4.8 percent from $18,474,000 during the same period of 2009. The net interest margin for the quarter, on a fully taxable-equivalent basis, was 5.13 percent compared to 4.89 percent for the same period of 2009.

 

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The following table details the components of Suffolk’s net interest income for the quarter on a taxable-equivalent basis: (in thousands)

 

Quarters ended September 30,

   2010     2009  
     Average
Balance
     Interest     Average
Rate
    Average
Balance
     Interest     Average
Rate
 

INTEREST-EARNING ASSETS

              

U.S. Treasury securities

   $ 8,231       $ 72        3.52   $ 9,784       $ 97        3.97

Collateralized mortgage obligations

     179,152         1,879        4.20        145,479         1,826        5.02   

Mortgage backed securities

     534         9        6.77        610         10        6.56   

Obligations of states and political subdivisions

     226,280         3,006        5.31        197,631         2,739        5.54   

U.S. government agency obligations

     42,670         202        1.90        62,742         354        2.26   

Other securities

     4,966         95        7.65        6,434         123        7.65   

Federal funds sold and interest bearing bank deposits

     4,527         3        0.27        55,759         44        0.32   

Loans, net of allowance for loan losses

              

Commercial, financial & agricultural loans

     248,111         3,772        6.08        233,721         3,459        5.92   

Commercial real estate mortgages

     406,115         6,716        6.61        366,682         6,176        6.74   

Real estate construction loans

     112,634         1,706        6.06        131,561         2,158        6.56   

Residential mortgages (1st and 2nd liens)

     198,383         3,037        6.12        208,930         3,148        6.03   

Home equity loans

     85,446         923        4.32        80,851         844        4.18   

Consumer loans

     72,244         1,310        7.25        83,997         1,476        7.03   

Other loans (overdrafts)

     918         —          —          3,419         —          —     
  

 

 

    

 

 

   

 

 

   

 

 

    

 

 

   

 

 

 

Total interest-earning assets

   $ 1,590,211       $ 22,730        5.72   $ 1,587,600       $ 22,454        5.66
  

 

 

    

 

 

   

 

 

   

 

 

    

 

 

   

 

 

 

Cash and due from banks

   $ 43,922           $ 41,381        

Other non-interest-earning assets

     58,366             54,935        
  

 

 

    

 

 

   

 

 

   

 

 

    

 

 

   

 

 

 

Total assets

   $ 1,692,499           $ 1,683,916        

INTEREST-BEARING LIABILITIES

              

Saving, N.O.W. and money market deposits

   $ 607,447       $ 827        0.54   $ 580,544       $ 934        0.64

Time deposits

     328,868         1,145        1.39        346,768         1,544        1.78   
  

 

 

    

 

 

   

 

 

   

 

 

    

 

 

   

 

 

 

Total saving and time deposits

     936,315         1,972        0.84        927,312         2,478        1.07   

Federal funds purchased and securities sold under agreement to repurchase

     344         —          —          16         —          —     

Other borrowings

     55,210         363        2.63        91,621         564        2.46   
  

 

 

    

 

 

   

 

 

   

 

 

    

 

 

   

 

 

 

Total interest-bearing liabilities

   $ 991,869       $ 2,335        0.94   $ 1,018,949       $ 3,042        1.19
  

 

 

    

 

 

   

 

 

   

 

 

    

 

 

   

 

 

 

Rate spread

          4.78          4.47

Non-interest-bearing deposits

   $ 523,685           $ 508,810        

Other non-interest-bearing liabilities

     31,029             31,493        
  

 

 

    

 

 

   

 

 

   

 

 

    

 

 

   

 

 

 

Total liabilities

   $ 1,546,583           $ 1,559,252        

Stockholders’ equity

     145,916             124,664        
  

 

 

    

 

 

   

 

 

   

 

 

    

 

 

   

 

 

 

Total liabilities and stockholders’ equity

   $ 1,692,499           $ 1,683,916        

Net-interest income (taxable-equivalent basis) and effective interest rate differential

      $ 20,395        5.13      $ 19,412        4.89

Less: taxable-equivalent basis adjustment

        (1,028          (938  
  

 

 

    

 

 

   

 

 

   

 

 

    

 

 

   

 

 

 

Net-interest income

      $ 19,367           $ 18,474     
  

 

 

    

 

 

   

 

 

   

 

 

    

 

 

   

 

 

 

 

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For the nine months ended September 30, 2010, net interest income was $57,957,000, up 4.4 percent from $55,522,000 during the same period of 2009. The net interest margin on a fully taxable-equivalent basis was 5.06 percent compared to 4.98 percent for the same period of 2009.

The following table details the components of Suffolk’s net interest income for the first nine months of the year on a taxable-equivalent basis: (in thousands)

 

Year to date ended September 30,

   2010     2009  
     Average
Balance
     Interest     Average
Rate
    Average
Balance
     Interest     Average
Rate
 

INTEREST-EARNING ASSETS

              

U.S. Treasury securities

   $ 8,271       $ 217        3.49   $ 9,962       $ 298        3.99

Collateralized mortgage obligations

     185,323         5,929        4.27        131,515         5,351        5.42   

Mortgage backed securities

     571         28        6.60        604         31        6.84   

Obligations of states and political subdivisions

     217,706         8,836        5.41        191,154         7,979        5.57   

U.S. government agency obligations

     42,953         607        1.89        88,428         1,797        2.71   

Other securities

     7,376         320        5.79        8,359         334        5.33   

Federal funds sold and interest bearing bank deposits

     5,883         8        0.18        25,060         48        0.26   

Loans, net of allowance for loan losses

              

Commercial, financial & agricultural loans

     258,371         11,460        5.91        233,848         10,369        5.91   

Commercial real estate mortgages

     394,155         19,531        6.61        362,206         18,501        6.81   

Real estate construction loans

     121,034         5,570        6.14        133,890         6,821        6.79   

Residential mortgages (1st and 2nd liens)

     203,507         9,261        6.07        208,604         9,469        6.05   

Home equity loans

     84,117         2,656        4.21        77,540         2,446        4.21   

Consumer loans

     76,418         4,067        7.10        87,135         4,531        6.93   

Other loans (overdrafts)

     1,812         —          —          2,001         —          —     
  

 

 

    

 

 

   

 

 

   

 

 

    

 

 

   

 

 

 

Total interest-earning assets

   $ 1,607,497       $ 68,490        5.68   $ 1,560,306       $ 67,975        5.81
  

 

 

    

 

 

   

 

 

   

 

 

    

 

 

   

 

 

 

Cash and due from banks

   $ 43,512           $ 40,557        

Other non-interest-earning assets

     61,554             55,347        
  

 

 

    

 

 

   

 

 

   

 

 

    

 

 

   

 

 

 

Total assets

   $ 1,712,563           $ 1,656,210        

INTEREST-BEARING LIABILITIES

              

Saving, N.O.W. and money market deposits

   $ 602,044       $ 2,551        0.56   $ 567,270       $ 2,732        0.64

Time deposits

     329,926         3,636        1.47        320,462         4,593        1.91   
  

 

 

    

 

 

   

 

 

   

 

 

    

 

 

   

 

 

 

Total saving and time deposits

     931,970         6,187        0.89        887,732         7,325        1.10   

Federal funds purchased and securities sold under agreement to repurchase

     561         2        0.48        6,501         120        2.46   

Other borrowings

     109,884         1,322        1.60        134,789         2,277        2.25   
  

 

 

    

 

 

   

 

 

   

 

 

    

 

 

   

 

 

 

Total interest-bearing liabilities

   $ 1,042,415       $ 7,511        0.96   $ 1,029,022       $ 9,722        1.26
  

 

 

    

 

 

   

 

 

   

 

 

    

 

 

   

 

 

 

Rate spread

          4.72          4.55

Non-interest-bearing deposits

   $ 494,627           $ 470,598        

Other non-interest-bearing liabilities

     34,483             36,376        
  

 

 

    

 

 

   

 

 

   

 

 

    

 

 

   

 

 

 

Total liabilities

   $ 1,571,525           $ 1,535,996        

Stockholders’ equity

     141,038             120,214        
  

 

 

    

 

 

   

 

 

   

 

 

    

 

 

   

 

 

 

Total liabilities and stockholders’ equity

   $ 1,712,563           $ 1,656,210        

Net-interest income (taxable-equivalent basis) and effective interest rate differential

      $ 60,979        5.06      $ 58,253        4.98

Less: taxable-equivalent basis adjustment

        (3,022          (2,731  
  

 

 

    

 

 

   

 

 

   

 

 

    

 

 

   

 

 

 

Net-interest income

      $ 57,957           $ 55,522     
  

 

 

    

 

 

   

 

 

   

 

 

    

 

 

   

 

 

 

 

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The table below presents a summary of changes in interest income, interest expense, and the resulting net interest income on a taxable-equivalent basis for the quarterly periods presented. Because of numerous, simultaneous changes in volume and rate during the period, it is not possible to allocate precisely the changes between volumes and rates. In the following tables changes not due solely to volume or to rate have been allocated to these categories based on percentage changes in average volume and average rate as they compare to each other: (in thousands)

 

    

In Third Quarter of 2010 over Third

Quarter of 2009, Changes Due to

 
     Volume     Rate     Net Change  

Interest-earning assets

      

U.S. Treasury securities

   $ (15   $ (10   $ (25

Collateralized mortgage obligations

     382        (329     53   

Mortgage-backed securities

     (1     —          (1

Obligations of states & political subdivisions

     390        (123     267   

U.S. government agency obligations

     (101     (51     (152

Other securities

     (29     1        (28

Federal funds sold & interest bearing bank deposits

     (38     (3     (41

Loans, including non-accrual loans

     229        (26     203   
  

 

 

   

 

 

   

 

 

 

Total interest-earning assets

   $ 817      $ (541   $ 276   
  

 

 

   

 

 

   

 

 

 

Interest-bearing liabilities

      

Saving, N.O.W., & money market deposits

   $ 42      $ (149   $ (107

Time deposits

     (76     (323     (399

Other borrowings

     (236     36        (200
  

 

 

   

 

 

   

 

 

 

Total interest-bearing liabilities

   $ (270   $ (436   $ (706
  

 

 

   

 

 

   

 

 

 

Net change in net interest income (taxable-equivalent basis)

   $ 1,087      $ (105   $ 982   
  

 

 

   

 

 

   

 

 

 

The table below presents a summary of changes in interest income, interest expense, and the resulting net interest income on a taxable-equivalent basis for the nine month periods presented: (in thousands)

 

    

In First Nine Months of 2010 over First

Nine Months of 2009, Changes Due to

 
     Volume     Rate     Net Change  

Interest-earning assets

      

U.S. Treasury securities

   $ (47   $ (34   $ (81

Collateralized mortgage obligations

     1,882        (1,304     578   

Mortgage-backed securities

     (2     (1     (3

Obligations of states & political subdivisions

     1,081        (224     857   

U.S. government agency obligations

     (748     (442     (1,190

Other securities

     (41     27        (14

Federal funds sold & interest bearing bank deposits

     (29     (11     (40

Loans, including non-accrual loans

     1,592        (1,184     408   
  

 

 

   

 

 

   

 

 

 

Total interest-earning assets

   $ 3,688      $ (3,173   $ 515   
  

 

 

   

 

 

   

 

 

 

Interest-bearing liabilities

      

Saving, N.O.W., & money market deposits

   $ 161      $ (342   $ (181

Time deposits

     132        (1,089     (957

Federal funds purchased & repurchase agreements

     (64     (54     (118

Other borrowings

     (373     (582     (955
  

 

 

   

 

 

   

 

 

 

Total interest-bearing liabilities

   $ (144   $ (2,067   $ (2,211
  

 

 

   

 

 

   

 

 

 

Net change in net interest income (taxable-equivalent basis)

   $ 3,832      $ (1,106   $ 2,726   
  

 

 

   

 

 

   

 

 

 

Other Income

Other income decreased to $2,667,000 for the quarter compared to $2,766,000 the previous year, down 3.6 percent. Service charges on deposits were down 10.3 percent. Service charges, including commissions and fees other than for deposits, increased by 8.4 percent. Fiduciary fees were up 2.5 percent. Other operating income decreased by 17.9 percent, mainly attributable to a decrease in the sale of residential mortgage loans to the secondary market. Other income for the nine months ended September 30, 2010 was $7,797,000, down 6.7 percent from $8,353,000 for the comparable year to date period. Service charges on deposits were down 5.1 percent. Service charges, including commissions and fees other than for deposits, increased by 0.2 percent. Fiduciary fees were down 6.8 percent. Other operating income decreased by 28.9 percent, mainly attributable to a decrease in the sale of residential mortgage loans to the secondary market. Proceeds received in connection with sales of securities resulted in a net gain of $12,000 during the second quarter of 2010.

 

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Other Expense

Other expense for the third quarter of 2010 was $13,021,000, up 8.2 percent from $12,034,000 for the comparable period in 2009. FDIC assessments increased by $345,000, or 66.7 percent as a result of increased deposits and higher assessment rates. Other increases include employee compensation of 3.7 percent, net occupancy expense of 6.9 percent, and other operating expense of 14.6 percent. Other operating expense for the quarter increased primarily due to increased costs associated with information technology and appraisal fees. Equipment expense decreased by 12.8 percent.

Other expense for the first nine months of 2010 was $37,303,000, up 2.9 percent from $36,241,000 compared to the first nine months of 2009. Employee compensation increased 3.8 percent, net occupancy expense increased 5.0 percent, and other operating expense increased 4.4 percent. Other operating expense increased primarily due to increased professional fees associated with collections of delinquent loans, increased costs associated with information technology and appraisal fees. The increases were partially offset by a decrease in equipment expense of 8.3 percent and in FDIC assessments, which decreased by 5.1 percent as a result of a special assessment of approximately $800,000 charged by the FDIC in June 2009. Suffolk anticipates substantial additional expenses associated with meeting the requirements of the Agreement, both non-recurring over the next one to two years and permanent increases thereafter.

Capital Resources

Stockholders’ equity totaled $143,628,000 on September 30, 2010, an increase of 4.71 percent from $137,171,000 on December 31, 2009. This was the result of net income, as well as an increase in the appreciation in the market value of securities available for sale, offset by cash dividends declared. The ratio of equity to assets was 8.54 percent at September 30, 2010 and 8.1 percent at December 31, 2009, respectively.

The following table details amounts and ratios of Suffolk’s regulatory capital on a consolidated basis: (in thousands of dollars except ratios)

 

     Actual    

For capital

adequacy

   

To be well capitalized

under prompt corrective

action provisions

 
     Amount      Ratio     Amount      Ratio     Amount      Ratio  

As of September 30, 2010 (Restated)

               

Total Capital (to risk-weighted assets)

   $ 151,392         12.26   $ 98,770         8.00   $ 123,462         10.00

Tier 1 Capital (to risk-weighted assets)

     135,817         11.00     49,385         4.00     74,077         6.00

Tier 1 Capital (to average assets)

     135,817         8.03     67,661         4.00     84,577         5.00

As of December 31, 2009

               

Total Capital (to risk-weighted assets)

   $ 150,673         11.73   $ 102,760         8.00   $ 128,450         10.00

Tier 1 Capital (to risk-weighted assets)

     137,921         10.74     51,380         4.00     77,070         6.00

Tier 1 Capital (to average assets)

     137,921         8.21     67,196         4.00     83,996         5.00

At September 30, 2010, the Bank had a Tier 1 leverage ratio of 7.93 percent, a Tier 1 risk-based capital ratio of 10.88 percent, and a total risk-based capital ratio of 12.14 percent. The Bank exceeded the capital ratios required to be deemed well capitalized with respect to 12 CFR 6.4 as of September 30, 2010 and met all regulatory requirements applicable at that time. Subsequent to September 30, 2010, the Bank became subject to individual minimum capital ratios established by the OCC requiring the Bank to maintain Tier 1 capital ratio of at least equal to 8.00 percent of adjusted total assets, to maintain a Tier 1 capital ratio at least equal to 10.50 percent of risk-weighted assets, and to maintain a total risk based capital ratio at least equal to 12.00 percent of risk-weighted assets. 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.

Credit Risk

Suffolk makes loans based on its evaluation of the creditworthiness of the borrower. Even with careful underwriting, some loans may not be repaid as originally agreed. To provide for this possibility, Suffolk maintains an allowance for loan losses based on an analysis of the performance of the loans in its portfolio. The analysis includes subjective factors based on

 

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management’s judgment as well as quantitative evaluation. Estimates should produce an allowance that will provide for a range of losses. According to U.S. GAAP, a financial institution should record its best estimate. Appropriate factors contributing to the estimate may include changes in the composition of the institution’s assets, or potential economic slowdowns or downturns. Also important is the geographical or political environment in which the institution operates.

Suffolk’s management considers all of these factors when determining the provision for loan losses. As required by the Agreement with the OCC, Suffolk is in the process of establishing a program to improve credit risk management and implementing an asset diversification program. Please refer to the discussion of the allowance for loan losses below.

Suffolk has financial and performance letters of credit. Financial letters of credit require Suffolk to make payments if the customer’s financial condition deteriorates, as defined in the agreements. Performance letters of credit require Suffolk to make payments if the customer fails to perform certain non-financial contractual obligations. The maximum potential undiscounted amount of future payments of these letters of credit as of September 30, 2010 is $26,410,000 and they expire as follows: (in thousands)

 

2010

   $ 13,562   

2011

     12,252   

2012

     516   

2013

     —     

Thereafter

     80   
  

 

 

 
   $ 26,410   
  

 

 

 

Amounts due under these letters of credit would be reduced by any proceeds that Suffolk would be able to obtain in liquidating the collateral for the loans, which varies depending on the customer. The allowance for contingent liabilities includes a provision of $40,000 for losses based on the letters of credit outstanding as of September 30, 2010.

Critical Accounting Policies, Judgments and Estimates

Suffolk’s accounting and reporting policies conform to U.S. GAAP and general practices within the financial services industry. The preparation of the financial statements in conformity with U.S. GAAP requires management to make estimates and assumptions that affect the amounts reported in the financial statements and the accompanying notes. Actual results could differ from those estimates.

Allowance for Loan Losses

In August 2011, in consultation with the Audit Committee, Suffolk’s management determined it was not properly identifying loan losses in the period incurred. This was the result of deficiencies in Suffolk’s internal controls with respect to credit administration and credit risk management, primarily with regard to risk-rating as well as with respect to the timing and recognition of charge-offs, impaired loans, and classified loans. As a result, certain loans should have been considered impaired, charged-off, or classified. Consequently, Suffolk overstated loans, net; understated the allowance for loan losses; understated the provision for loan losses; overstated net income and earnings-per-common share; understated the deferred tax asset; and overstated the capital ratios. See Note 2 on page 6 for the tables that detail the restated financial statement line items and the regulatory capital ratios.

Suffolk considers the determination of the allowance for loan losses to involve a higher degree of judgment and complexity than its other significant accounting policies. Suffolk maintains an allowance for loan losses at a level that management believes will be adequate to absorb probable losses on existing loans that may become uncollectible based on evaluations of collectability. Suffolk’s underwriting standards generally require a loan-to-value ratio of 75 percent or less, and when applicable, a debt coverage ratio of at least 120 percent, at the time a loan is originated. Suffolk has not been directly affected by the increase in defaults of sub-prime mortgages as Suffolk does not originate, or hold in portfolio, sub-prime mortgages. The allowance for loan losses is determined by continuous analysis of the loan portfolio. That analysis includes changes in the size and composition of the portfolio, Suffolk’s own historical loan losses, current and anticipated economic trends, and details about individual loans. It also includes estimates of the actual value of collateral, other possible sources of repayment and estimates that are susceptible to significant changes due to changes in appraisal values of collateral, national and regional economic conditions and other factors. In assessing the adequacy of the allowance, Suffolk reviews its loan portfolio by separate categories which have similar risk and collateral characteristics; e.g. commercial loans, commercial real estate, construction loans, residential mortgages, home equity loans, and consumer loans. Management conducts a monthly analysis of the loan portfolio which evaluates any loan designated as having a high risk profile including but not limited to, loans classified as “Substandard” or “Doubtful” as defined by regulation, loans criticized internally or designated as “Special

 

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Mention,” delinquencies, expirations, overdrafts, loans to customers having experienced recent operating losses and loans identified by management as impaired. The analysis is performed to determine the amount of the allowance which would be adequate to absorb probable losses contained in the loan portfolio. The analytical process is regularly reviewed and adjustments may be made based on the assessments of internal and external influences on credit quality. As required by the Agreement with the OCC, Suffolk reviewed its allowance for loan losses policy which resulted in an increase to the allowance. During 2010, Suffolk experienced an increase in classified and criticized loans based on the current condition of borrowers. This was further noted in Suffolk’s review of the report of the Bank’s third-party loan reviewer.

Impaired loans, defined as loans for which management does not believe all principal and interest will be collected under contractual terms, are segregated and reviewed separately. Impaired loans secured by collateral are reviewed based on their collateral and the estimated time required to recover Suffolk’s investment in the loan as well as the cost of doing so, and the estimate of the recovery anticipated. Reserves are allocated to impaired loans based on this review. The allocated reserve is an estimation of losses specific to individual impaired loans. Allocated reserves are established based on an analysis of the most probable sources of repayment and liquidation of collateral. Reserves allocated to impaired loans were $6.7 million and $3.0 million as of September 30, 2010 and December 31, 2009, respectively. While every nonperforming loan is evaluated individually, not every loan requires an allocated reserve. Allocated reserves fluctuate based on changes in the underlying loans, anticipated sources of repayment, and charge-offs.

The following table summarizes impaired loans with and without valuation reserves by loan type: (in thousands)

 

     September 30, 2010 *      December 31, 2009  
     Impaired
Loans with
Valuation
Reserves
     Impaired
Loans
without
Valuation
Reserves
     Total
Impaired
Loans
     Total
Valuation
Reserves
     Impaired
Loans with
Valuation
Reserves
     Impaired
Loans
without
Valuation
Reserves
     Total
Impaired
Loans
     Total
Valuation
Reserves
 

Commercial, financial & agricultural loans

   $ 5,221       $ 10,289       $ 15,510       $ 3,209       $ 5,983       $ —         $ 5,983       $ 1,967   

Commercial real estate mortgages

     17,294         22,721         40,015         2,923         15,547         —           15,547         621   

Real estate construction loans

     4,829         23,650         28,479         573         10,774         —           10,774         407   

Residential mortgages (1st and 2nd liens)

     —           2,137         2,137         —           —           1,820         1,820         —     

Home equity loans

     —           371         371         —           —           65         65         —     

Consumer loans

     —           31         31         —           —           153         153         —     
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total

   $ 27,344       $ 59,199       $ 86,543       $ 6,705       $ 32,304       $ 2,038       $ 34,342       $ 2,995   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

 

* Restated

The following table summarizes information regarding impaired loans: (in thousands)

 

     September 30, 2010 *  

Average of individually impaired loans during the period

   $ 54,697   

 

* Restated

Collateral dependent loans are evaluated for impairment when a loan becomes ninety days past due or another impairment indicator is identified. At the time a loan secured by real estate is evaluated for impairment, an appraisal is ordered from an independent third party licensed appraiser for loans in excess of $250,000. Typically, it takes approximately 30-90 days to receive and review the appraisal on a commercial real estate mortgage. Once the updated appraisal is received, if the fair value less estimated costs to sell is less than the carrying amount of the loan, a reserve is created for the difference. We do not increase the value of any of our loans based upon an appraisal amount greater than our carrying amount. For collateral dependent loans that have not had a third party appraisal during the past twelve months, prior appraisals are discounted in value based upon the date of the appraisal. As of September 30, 2010, our impaired loans inclusive of previously recognized charge-off amounts total $53,643,000. Subsequent to charging off the difference, collateral dependent loans are deemed to be nonperforming impaired loans. As of September 30, 2010, there is one loan totaling $4,598,000 that has been restructured for which a partial charge-off has been recognized totaling $1,277,000. The terms of the restructured loan include a reduced interest rate. The loan is currently classified as non-accrual. Additional funds have been advanced for this loan, and a valuation reserve has been established for these advances.

At September 30, 2010, impaired loans totaling $59,199,000 have no associated valuation allowance. For these loans, an evaluation for impairment was completed with no measurement of impairment. The measurement is based upon the appraisal methodology described above for collateral dependent loans. For non-collateral dependent loans, measurement is based on the present value of future cash flows. As measuring impairment is an estimate which requires judgment, future results of operations may be negatively affected by outcomes different than those estimated.

 

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Suffolk evaluates classified and criticized loans that are not impaired by categorizing loans by type of risk and applying reserves based on loan type and corresponding risk. Suffolk also records reserves on Suffolk’s non-criticized and non-classified loan balances. This represents a general allowance for homogeneous loan pools where the loans are not individually evaluated for impairment, though rated according to loan product type and risk rating.

This amount is determined by applying historical loss factors to pools of loans within the portfolio having similar risk characteristics.

In addition, qualitative factors are considered for areas of concern that cannot be fully quantified in the allocation based on historical net charge-off ratios. Qualitative factors include:

 

   

Economic outlook

 

   

Trends in delinquency and problem loans

 

   

Changes in loan volume and nature of terms of loans

 

   

Effects of changes in lending policy

 

   

Experience, ability and depth of lending management and staff

 

   

Concentrations of credit

 

   

Board and Loan Review oversight

 

   

Changes in value of underlying collateral

 

   

Competition, regulation, and other external factors

For performing loans, an estimate of adequacy is made by applying the qualitative factors above specific to the portfolio to the period-end balances. Suffolk used a higher percentage factor for criticized and classified loans, given their potential for greater loss. Consideration is also given to the type and collateral of the loans with particular attention paid to commercial real estate construction loans, due to the inherent risk of this type of loan. Allocated and general reserves are available for any identified loss.

Delinquent, nonperforming (defined as loan past due 90 days or more and non-accrual loans), and classified loans have trended upward. These are primary factors in the determination of the allowance. At September 30, 2010, loans delinquent greater than 90 days and nonperforming loans totaled $32,062,000 as compared with $29,372,000 at December 31, 2009. When compared to total loans, nonperforming loans rose to 2.83 percent at September 30, 2010, up from 2.53 percent at December 31, 2009. Commercial mortgages and commercial real estate construction loans were primarily responsible for the increase. Non-performing loans include all non-accrual loans and loans 90 days or more delinquent.

The following table summarizes Suffolk’s non-performing loans by category: (in thousands of dollars except for ratios)

 

Non-performing Loans

 
     9/30/2010 *      % of
Total *
    Total
Loans
9/30/2010  *
     % of
Total Loans  *
    12/31/2009      % of
Total
    Total
Loans
12/31/2009
     % of
Total  Loans
 

Commercial, financial & agricultural

   $ 2,784         8.7   $ 250,182         1.11   $ 7,328         24.9   $ 259,565         2.82

Commercial real estate

     11,405         35.6     422,158         2.70     9,709         33.1     375,652         2.58

Real estate construction loans

     15,805         49.3     101,535         15.57     10,774         36.7     133,431         8.07

Residential mortgages (1st & 2nd liens)

     1,666         5.2     203,847         0.82     1,344         4.6     214,501         0.63

Home equity loans

     371         1.2     85,800         0.43     65         0.2     82,808         0.08

Consumer loans

     31         0.1     69,991         0.04     152         0.5     80,352         0.19

Other loans

     —           0.0     944         0.00     —           0.0     14,070         0.00
  

 

 

    

 

 

   

 

 

    

 

 

   

 

 

    

 

 

   

 

 

    

 

 

 

Total non-performing loans

   $ 32,062         100   $ 1,134,457         2.83   $ 29,372         100   $ 1,160,379         2.53
  

 

 

    

 

 

   

 

 

    

 

 

   

 

 

    

 

 

   

 

 

    

 

 

 

 

* Restated

 

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The following table details the collateral value securing non-performing loans: (in thousands)

 

    September 30, 2010 *     December 31, 2009  
    Principal Balance     Collateral Value (1)     Principal Balance     Collateral Value (1)  

Commercial, financial & agricultural loans

  $ 2,784      $ —        $ 7,328      $ —     

Commercial real estate mortgages

    11,405        23,957        9,709        22,145   

Real estate construction loans

    15,805        23,740        10,774        13,140   

Residential mortgages (1st and 2nd liens)

    1,666        13,319        1,344        3,772   

Home equity loans

    371        1,400        65        657   

Consumer loans

    31        —          152        —     
 

 

 

   

 

 

   

 

 

   

 

 

 

Total

  $ 32,062      $ 62,416      $ 29,372      $ 39,714   
 

 

 

   

 

 

   

 

 

   

 

 

 

 

* Restated
(1) Based on most recent appraisal

For non-performing loans, cash receipts are applied entirely against principal until the loan has been collected in full, after which time, any additional cash receipts are recognized as interest income. When, in management’s judgment, the borrower’s ability to make required interest and principal payments resumes and collectability is no longer in doubt, the loan is returned to accrual status. When interest accruals are suspended, accrued interest income is reversed and charged to earnings.

During the nine months ended September 30, 2010 and 2009, interest income totaling $2,556,000 and $785,000, respectively, was recognized on impaired loans. Cash basis interest income recognized on impaired loans during the periods was immaterial.

Included in nonperforming loans are restructured loans of $8,587,000. Subsequent to restructure, there has been $231,000 in advances funded on restructured loans outstanding as of September 30, 2010.

As of September 30, 2010 and December 31, 2009, we consider the restructured loans totaling $8.59 million and $10.31 million, respectively, to be impaired loans. The loans that have been restructured have been modified as to interest rate, due dates, or extension of the maturity date. Restructured loans are considered to be non-accrual loans, if at the time of restructuring the loan was deemed non-accrual. Once a sufficient amount of time has passed, generally six months, if the restructured loan has performed under the modified terms, the loan is returned to accrual status. In addition to the passage of time, we also consider the collateral value and the ability of the borrower to continue to make payments in accordance with the modified terms. During the three months ended September 30, 2010, there were no restructured loans returned to accrual status. During the three months ended September 30, 2010, there was one restructured loan charged off totaling $76,000. During the nine month period ended September 30, 2010, a restructured loan totaling $7,275,000, had $1,400,000 of the balance charged off during the quarter ended June 30, 2010 as a result of a new appraisal indicating the fair value less estimated costs to sell was less than the carrying amount of the loan.

As of both December 31, 2009 and September 30, 2010, we have not performed any commercial real estate (CRE) or other type of loan workouts whereby an existing loan was restructured into multiple new loans.

As of September 30, 2010, classified loans amounted to 19.88 percent of total loans, as compared with 3.48 percent at December 31, 2009. The increase is attributable to the prolonged national and regional economic slowdown which has increased the amount of time necessary to work out troubled loans.

Commercial mortgages and commercial real estate construction loans totaled $523,693,000 as of September 30, 2010, up from $509,083,000 as of December 31, 2009, representing 46.2 percent and 43.8 percent of the total loan portfolio, respectively. Commercial mortgages and commercial real estate construction loans consisted of the following as of September 30, 2010: 6 percent vacant land loans, 13 percent commercial construction loans, 25 percent for non-owner-occupied commercial mortgages and 56 percent for owner-occupied commercial mortgages. Commercial mortgages and commercial real estate construction loans consisted of the following as of December 31, 2009: 7 percent vacant land loans, 19 percent commercial construction loans, 25 percent for non-owner-occupied commercial mortgages and 49 percent for owner-occupied commercial mortgages. Commercial real estate construction loans were generally underwritten on the basis of reasonable ratios of loan-to-value, evaluations of projected cash flows, and commitments for permanent financing in place prior to granting an interim credit. Non-performing commercial mortgages and commercial real estate construction loans have increased to $27,210,000 at September 30, 2010, up from $20,483,000 at December 31, 2009. These loans have been evaluated for impairment and appropriate provisions have been made to recognize impaired balances.

 

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The following table presents information regarding real estate construction loans: (in thousands)

 

     Non-performing Real Estate Construction Loans  
     September 30, 2010 *     December 31, 2009  
     Balance
Outstanding
    Non-
performing
Balance
    Impaired
Balance  (1)
    Allowance
Allocation
    Balance
Outstanding
    Non-
performing
Balance
    Impaired
Balance  (1)
    Allowance
Allocation
 

Real estate construction loans

   $ 101,535      $ 15,805      $ 28,479      $ 3,555      $ 133,431      $ 10,774      $ 10,774      $ 1,258   

All loans

   $ 1,134,457      $ 32,062      $ 86,543      $ 26,659      $ 1,160,379      $ 29,372      $ 34,342      $ 12,333   

Real estate construction loans as % of all loans

     8.95     49.29     32.91     13.34     11.50     36.68     31.37     10.20

 

* Restated
(1) Includes non-performing loans

The following table presents nonperforming and collateral value information on real estate construction loans: (in thousands)

 

     September 30, 2010 *     December 31, 2009  
     Non-
performing
Balance
     Total
Collateral
Value
     Loan to  Value
Ratio
    Non-
performing
Balance
     Total
Collateral
Value
     Loan to  Value
Ratio
 

Real estate construction loans

   $ 15,805       $ 23,740         67   $ 10,774       $ 13,140         82

 

* Restated

Real estate construction loans as a percentage of the loan portfolio have decreased since December 31, 2009, however the nonperforming balance of real estate construction loans as a percentage of all nonperforming loans has increased during that time. Although the allowance has increased during that same period, it has not increased to the same extent as the increase in nonperforming loans. This is a result of the measurement of impairment, and because of the collateral value of the real estate construction portfolio, reserves were not required to the same level of increase as the nonperforming loans themselves.

Suffolk recorded a provision for loan losses for the third quarter of 2010 of $14,729,000. The total provision recorded for the first nine months of 2010 totaled $26,549,000, which represents an increase of $23,549,000 as compared to the first nine months of 2009. During the third quarter of 2010, Suffolk recorded $8,885,000 in net loan charge-offs compared to $132,000 for the third quarter of 2009. Suffolk believes that the allowance for loan losses of $26,659,000, or 2.35 percent of total loans at September 30, 2010, is adequate based on its review of overall credit quality indicators and ongoing loan monitoring processes.

 

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The following tables summarize the allowance for loan losses by category for the periods presented: (in thousands)

 

    Impaired Allocation
9/30/2010 *
    Remaining Allocation
9/30/2010 *
    Total Allocation
9/30/2010 *
    % of Total *  

Commercial, financial & agricultural loans

  $ 3,209      $ 12,494      $ 15,703        58.9

Commercial real estate mortgages

    2,923        1,929        5,030        18.9

Real estate construction loans

    573        3,160        3,555        13.3

Residential mortgages (1st and 2nd liens)

    —          753        753        2.8

Home equity loans

    —          832        832        3.1

Consumer loans

    —          786        786        3.0
 

 

 

   

 

 

   

 

 

   

 

 

 

Allowance for loan losses

  $ 6,705      $ 19,954      $ 26,659        100
 

 

 

   

 

 

   

 

 

   

 

 

 

 

* Restated

 

    Impaired  Allocation
12/31/2009
    Remaining  Allocation
12/31/2009
    Total  Allocation
12/31/2009
    % of Total  

Commercial, financial & agricultural loans

  $ 1,967      $ 3,559      $ 5,526        44.8

Commercial real estate mortgages

    621        3,023        3,644        29.5

Real estate construction loans

    407        851        1,258        10.2

Residential mortgages (1st and 2nd liens)

    —          1,154        1,154        9.4

Home equity loans

    —          280        280        2.3

Consumer loans

    —          471        471        3.8
 

 

 

   

 

 

   

 

 

   

 

 

 

Allowance for loan losses

  $ 2,995      $ 9,338      $ 12,333        100
 

 

 

   

 

 

   

 

 

   

 

 

 

The following tables summarize the activity in the allowance for loan losses for the periods presented: (in thousands)

 

     Nine months  ended
September 30, 2010
Restated
     Year Ended
December 31,  2009
 

Allowance for loan losses, Beginning

   $ 12,333       $ 9,051   

Loans charged-off:

     

Commercial, financial & agricultural loans

     7,717         806   

Commercial real estate mortgages

     230         —     

Real estate construction loans

     3,620         —     

Residential mortgages (1st and 2nd liens)

     492         —     

Home equity loans

     65         —     

Consumer loans

     286         404   

Other loans

     —           —     
  

 

 

    

 

 

 

Total Charge-offs

   $ 12,410       $ 1,210   
  

 

 

    

 

 

 

Loans recovered after being charged-off

     

Commercial, financial & agricultural loans

     62         41   

Commercial real estate mortgages

     —           —     

Real estate construction loans

     —           —     

Residential mortgages (1st and 2nd liens)

     —           —     

Home equity loans

     —           —     

Consumer loans

     74         176   

Other loans

     —           —     
  

 

 

    

 

 

 

Total recoveries

   $ 136       $ 217   
  

 

 

    

 

 

 

Net loans charged-off

     12,274         993   

Reclass to allowance for contingent liabilities

     51         —     

Provision for loan losses

     26,549         4,275   
  

 

 

    

 

 

 

Allowance for loan losses, Ending

   $ 26,659       $ 12,333   
  

 

 

    

 

 

 

 

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Suffolk believes the allowance is adequate to absorb inherent and known losses in the loan portfolio. However, the determination of the allowance is inherently subjective, as it requires estimates, all of which may be subject to significant change. When a loan, in full or in part, is deemed uncollectible, it is charged against the allowance. This happens when it is past due and the borrower has not shown the ability or intent to make the loan current, or the borrower does not have enough assets to pay the debt, or the value of the collateral is less than the balance of the loan and not likely to improve soon. In the future, the allowance for loan losses may change as a percentage of total loans. To the extent actual performance differs from management’s estimates, additional provisions for loan losses may be required that would reduce or may substantially reduce earnings in future periods, and no assurances can be given that Suffolk will not sustain loan losses, in any particular period, that are sizable in relation to the allowance for loan losses.

Additional analysis of charged off loans for the quarter ended September 30, 2010 is provided below: (in thousands)

 

     September 30, 2010 *         
     Nonperforming
Loans
     Impaired Loans      Restructured Loans      Total  

Commercial, financial & agricultural loans

   $ 58       $ 6,292       $ —         $ 6,350   

Commercial real estate mortgages

     —           72         —           72   

Real estate construction loans

     —           2,043         —           2,043   

Residential mortgages (1st and 2nd liens)

     248         —           —           248   

Home equity loans

     —           —           —           —     

Consumer loans

     192         —           —           192   
  

 

 

    

 

 

    

 

 

    

 

 

 

Total Charge-offs

   $ 498       $ 8,407       $ —         $ 8,905   
  

 

 

    

 

 

    

 

 

    

 

 

 

 

* Restated

Net charge-offs in the third quarter 2010 were $9.0 million compared to $132,000 of net charge-offs in the third quarter of 2009. The increased charge-offs were realized in all of our loan categories. This increase in charge-offs reflects the deterioration of economic conditions and resulting failure of businesses, devaluation of assets, and negative impact on customers’ ability to service debt. For impaired collateral dependent loans, which include commercial real estate mortgages and real estate construction loans, charge-offs were the result of new appraisals indicating a collateral deficiency after considering costs to sell, and were therefore charged off.

Deferred Tax Assets and Liabilities

Suffolk recognizes deferred tax assets and liabilities. Deferred income taxes occur when income taxes are allocated through time. Some items are temporary, resulting from differences in the timing of a transaction under generally accepted accounting principles, and for the computation of income tax. Examples would include the future tax effects of temporary differences for such items as deferred compensation and the provision for loan losses. Estimates of deferred tax assets are based upon evidence available to management that future realization is more likely than not. If management determines that Suffolk may be unable to realize all or part of net deferred tax assets in the future, a direct charge to income tax expense may be required to reduce the recorded value of the net deferred tax asset to the amount that management expects to realize. At September 30, 2010, Suffolk believes the deferred tax asset is fully realizable.

Investment Securities

Suffolk evaluates unrealized losses on securities to determine if any reduction in the fair value is other than temporary. This amount will continue to be dependent on market conditions, the occurrence of certain events or changes in circumstances of the issuer of the security, and Suffolk’s intent and ability to hold the impaired investment at the time the valuation is made. If management determines that impairment in the investment’s value is other than temporary, earnings would be charged.

 

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Item 3 - Quantitative and Qualitative Disclosures about Market Risk

Market Risk

Suffolk originates and invests in interest-earning assets and solicits interest-bearing deposit accounts. Suffolk’s operations are subject to market risk resulting from fluctuations in interest rates to the extent that there is a difference between the amounts of interest-earning assets and interest-bearing liabilities that are prepaid, withdrawn, mature, or re-priced in any given period of time. Suffolk’s earnings or the net value of its portfolio (the present value of expected cash flows from liabilities) will change when interest rates change. The principal objective of Suffolk’s asset/liability management program is to maximize net interest income while keeping risks acceptable. These risks include both the effect of changes in interest rates, and risks to liquidity. The program also provides guidance to management in funding Suffolk’s investment in loans and securities. Suffolk’s exposure to interest-rate risk has not changed substantially since December 31, 2009.

Business Risks and Uncertainties

This report contains some statements that look to the future. These may include remarks about Suffolk Bancorp, the banking industry, the economy in general, expectations of the business environment in which Suffolk operates, projections of future performance, and potential future credit experience. These forward-looking statements are based upon current management expectations, and may, therefore, involve risks and uncertainties that cannot be predicted or quantified and are beyond Suffolk’s control and are subject to a variety of uncertainties that could cause future results to vary materially from Suffolk’s historical performance, or from current expectations. Factors affecting Suffolk include particularly, but are not limited to: changes in interest rates; increases or decreases in retail and commercial economic activity in Suffolk’s market area; variations in the ability and propensity of consumers and businesses to borrow, repay, or deposit money, or to use other banking and financial services; results of regulatory examinations; any failure by us to comply with our written agreement with the OCC or the individual minimum capital ratios for the Bank established by the OCC; the cost of compliance with the Agreement; failure by Suffolk to restore effective internal controls over financial reporting; and the potential that net charge-offs are higher than expected. Further, it could take Suffolk longer than anticipated to implement its strategic plans to increase revenue and manage non-interest expense, or it may not be possible to implement those plans at all. Finally, new and unanticipated legislation, regulation, or accounting standards may require Suffolk to change its practices in ways that materially change the results of operations.

Item 4 - Controls and Procedures

Suffolk’s Chief Executive Officer who is also Acting Chief Financial Officer (the “Certifying Officer”) evaluated the effectiveness of Suffolk’s disclosure controls and procedures (as defined in Rules 13a-15(e) of the Securities Exchange Act of 1934) as of September 30, 2010 in connection with the filing of the initial Form 10-Q for that period.

In connection with the restatement of Suffolk’s financial statements for the three and nine months ended September 30, 2010, management re-evaluated the effectiveness of its disclosure controls and procedures. Based on that re-evaluation, management, including Suffolk’s Certifying Officer, has concluded that, due to the material weaknesses in internal control over financial reporting described below, Suffolk’s disclosure controls and procedures were not effective as of September 30, 2010.

Suffolk’s management is responsible for establishing and maintaining adequate internal control over financial reporting, as such term is defined in Rule 13a-15(f) under the Exchange Act.

Because of their inherent limitations, systems of internal control over financial reporting may not prevent or detect misstatements. Therefore, even those systems determined to be effective can only provide reasonable assurance with respect to financial statement preparation and presentation.

A “material weakness” in internal control over financial reporting is a deficiency, or a combination of deficiencies, in internal control over financial reporting, such that there is a reasonable possibility that a material misstatement of a company’s annual or interim financial statements will not be prevented or detected in a timely basis by Suffolk’s internal controls.

Allowance for Loan and Lease Losses

Estimating the allowance for loan losses requires credit administration staff to identify and evaluate borrowers’ ability to repay their obligations through periodic evaluation and reevaluation of cash flow and/or collateral, and, when necessary, making provision for the amount deemed being likely not to be repaid. Suffolk identified deficiencies within the credit

 

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administration function which compromised the operational effectiveness of the internal controls, particularly in making timely reevaluations of credit and/or collateral. This led to management’s determination that there was a material weakness in internal control over financial reporting in estimating the allowance for loan losses.

Financial Reporting Staffing Resources

Management concluded that a material weakness exists due to insufficient staffing resources that are in dedicated permanent positions within the accounting function with sufficient skills and industry knowledge of Generally Accepted Accounting Principles in the United States (“US GAAP”) and regulatory accounting, which resulted in insufficient documentation and monitoring over financial reporting, including preparing financial statements and disclosures. Among other factors identified, approximately six months have passed since the prior Chief Financial Officer resigned as of June 24, 2011 and Suffolk has yet to fill this position. Suffolk immediately engaged an interim accounting consultant to assist with financial reporting in the meantime; however, the individual is not an officer of Suffolk. Suffolk’s President and Chief Executive Officer was appointed as Acting Chief Financial Officer until a permanent Chief Financial Officer is hired, representing a significant concentration of authority in one individual.

Interdepartmental Communications

A material weakness exists due to insufficient communications at the interdepartmental levels. There was inconsistent exchange of important financial information between Suffolk’s accounting and operating functions that led to errors in classifying loans as performing loans when the loans were non-performing. That was one factor resulting in the allowance for loan and lease losses to be understated as of September 30, 2010 and December 31, 2010, as described above at “Allowance for Loan and Lease Losses.”

Governance and Management Accountability

The Board of Directors is responsible for competent and effective oversight and leadership of the Company’s management and to ensure accountability of management. The material weaknesses related to the allowance for loan and lease losses, financial reporting staffing resources and interdepartmental communications, as well as delays in processes surrounding the completion of restated and current financial statements, and the untimely correction of deficiencies previously identified by regulators, are reflective of a material weakness in the Board of Directors as it relates to the foregoing matters.

Suffolk has implemented certain changes in its internal controls as of the date of this report to address the material weaknesses. Specifically, subsequent to September 30, 2010, management took the following steps to remediate the material weaknesses set forth above:

Allowance for Loan and Lease Losses

 

  1. Hired a new Chief Lending Officer during the second quarter of 2011.

 

  2. Improved staff by hiring a new loan administrator, additional underwriting staff and a loan workout specialist.

 

  3. Reorganized the credit department to ensure appropriate separation of duties and developed expanded training for Suffolk’s lenders.

 

  4. Hired a senior credit officer to run a newly created separate loan review and workout department.

 

  5. Changed Suffolk’s credit policy to require identification of concentrations of risk, analysis of our customer’s global cash flows, reappraisal and re-evaluation of collateral, more accurate and timely credit-risk rating procedures and improved underwriting processes and standards.

 

  6. Incorporated the results of a systematic re-appraisal of commercial real estate which secures loans in excess of $1 million.

 

  7. Engaged qualified outside consultants to assist in re-evaluating risk ratings.

 

  8. Improved the processes for identifying loans and the determination of the amount of impairment.

 

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  9. Augmented Suffolk’s credit policy to govern loan workout.

 

  10. Implemented a new procedure to ensure that OREO was accounted for in accordance with US GAAP.

Financial Reporting Staffing Resources

 

  11. Initiated a search for a qualified Chief Financial Officer with sufficient knowledge of US GAAP, regulatory accounting and the banking industry, and the skills to effectively implement that knowledge.

 

  12. Engaged a qualified consultant in financial reporting and the function of the Chief Financial Officer to assist the Acting Chief Financial Officer in maintaining and improving controls.

 

  13. Increased oversight of the financial reporting process through the Audit Committee and the Compliance Committee, the latter of which meets at least monthly or more often.

 

  14. Created and filled the new position of Treasurer to further relieve the Chief Financial Officer of day-to-day duties in asset liability management, investment portfolio management and additional treasury functions.

 

  15. Enhanced the procedures to ensure that all reconciliations of all departments are completed and reviewed to ensure accuracy.

 

  16. Complied individual policies into comprehensive written policies and procedures for the accounting function which will include specific policies, procedures and controls for financial reporting.

 

  17. Increased automation of the accounting and financial reporting process to free staff resources to focus on financial reporting.

Interdepartmental Communications

 

  18. Established a process for both credit and finance staff to review the computation of specific impairment allowances under ASC 310-10 – Receivables – Impairment of a Loan and establishing enhanced reporting from core systems available directly to personnel in accounting and finance.

Governance and Management Accountability

 

  19. Formed a Compliance Committee of the Board to oversee compliance and, later, to respond to the Formal Agreement.

 

  20. Implemented procedures to track all regulatory compliance through structured matrices.

 

  21. Engaged qualified independent consultants to assist with compliance with the Formal Agreement, including an assessment of key management roles.

 

  22. Outsourced the internal audit function to a qualified risk management firm to provide greater independence and depth to the function.

 

  23. Appointed a Vice Chairman of the Board to provide daily oversight of management on behalf of the full Board and to communicate back to the Board.

 

  24. Engaged a qualified independent consultant to advise the Board on various regulatory, strategic and operational issues.

Suffolk cannot determine the impact of the remediation steps at this time.

There has been no change in Suffolk’s internal controls over financial reporting that occurred during the third quarter of 2010 that materially affected, or is reasonably likely to materially affect, Suffolk’s internal control over financial reporting.

 

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Part II

Item 1 - Legal Proceedings

On July 11, 2011 a shareholder derivative action, Robert J. Levy v. J. Gordon Huszagh, et al., No. 11 Civ. 3321 (JS), was filed in the U.S. District Court for the Eastern District of New York against the directors of Suffolk and a former officer of Suffolk. Suffolk was named as a nominal defendant. The complaint seeks damages against the individual defendants in an unspecified amount, and alleges that the individual defendants breached their fiduciary duties by making improper statements regarding the sufficiency of Suffolk’s allowance for loan losses and loan portfolio credit quality, and by failing to establish sufficient allowances for loan losses and to establish effective credit risk management policies. On September 30, 2011, Suffolk and the directors filed a motion to dismiss the complaint.

On October 28, 2011, a separate shareholder derivative action, Susan Forbush v. Edgar F. Goodale, et al., No. 33538/11, was filed in the Supreme Court of the State of New York for the County of Suffolk, against the directors of Suffolk and a former officer of Suffolk. Suffolk was named as a nominal defendant. The complaint asserts claims that are substantially similar to those asserted in the Levy action.

On October 20, 2011, a putative shareholder class action, James E. Fisher v. Suffolk Bancorp, et al., No. 11 Civ. 5114 (SJ), was filed in the U.S. District Court for the Eastern District of New York against Suffolk, its chief executive officer, and a former chief financial officer of Suffolk. The complaint alleges that the defendants violated Sections 10(b) and 20(a) of the Securities Exchange Act of 1934 by knowingly or recklessly making false statements about, or failing to disclose accurate information about, Suffolk’s financial results and condition, loan loss reserves, impaired assets, internal and disclosure controls, and banking practices. The complaint seeks damages in an unspecified amount on behalf of purchasers of Suffolk’s common stock between March 12, 2010 and August 10, 2011.

Suffolk has been informed that the SEC’s New York regional office is conducting an informal inquiry to determine whether there have been violations of the federal securities laws in connection with Suffolk’s financial reporting. The SEC has not asserted that any federal securities law violation has occurred. Suffolk believes it is in compliance with all federal securities laws and believes it has cooperated fully with the SEC’s informal inquiry. Although the ultimate outcome of the informal inquiry cannot be ascertained at this time, based upon information that presently is available to it, Suffolk does not believe that the informal inquiry, when resolved, will have a material adverse effect on Suffolk’s results of operations or financial condition.

The foregoing matters are in their preliminary phases and it is not possible to ascertain whether there is a reasonable possibility of a loss from these matters. Therefore, we have concluded that an amount for a loss contingency is not to be accrued or disclosed at this time. Suffolk believes that it has substantial defenses to the claims filed against it in these lawsuits and, to the extent that these actions proceed, Suffolk intends to defend itself vigorously.

Item 1A - Risk Factors

There are no material changes from any of the risk factors previously disclosed in Suffolk’s 2009 Form 10-K in response to Part I, Item 1A other than the addition of the following risk factors:

Our results may be adversely affected if we continue to suffer higher than expected losses on our loans or are required to further increase our allowance for loan losses.

We assume credit risk from the possibility that we will suffer losses because borrowers, guarantors, and related parties fail to perform under the terms of their loans. We try to minimize and monitor this risk by adopting and implementing what we believe are effective underwriting and credit policies and procedures, including how we establish and review the allowance for loan losses. The allowance for loan losses is determined by continuous analysis of the loan portfolio and the analytical process is regularly reviewed and adjustments may be made based on the assessments of internal and external influences on credit quality. Those policies and procedures may still not prevent unexpected losses that could adversely affect our results. Weak economic conditions could adversely impact the ability of borrowers to repay outstanding loans or the value of collateral securing those loans. In addition, deterioration in economic conditions affecting borrowers, new information regarding existing loans, identification of additional problem loans, changes in regulation and regulatory interpretation and other factors, both within and outside of our control, may require an increase in the allowance for loan losses. See the section captioned “Allowance for Loan Losses” in Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations located elsewhere in this report for further discussion related to our loan portfolio and our process for determining the appropriate level of the allowance for loan losses. As required by the Agreement with the OCC, Suffolk is in the process of reviewing its allowance for loan losses policy which may result in an increase to the allowance.

 

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Recent financial reforms and related regulations may affect our results of operations, financial condition or liquidity.

The Dodd-Frank Wall Street Reform and Consumer Protection Act

The Dodd-Frank Wall Street Reform and Consumer Protection Act (the “Dodd-Frank Act”), signed into law on July 21, 2010, makes extensive changes to the laws regulating financial services firms. The Dodd-Frank Act also requires significant rulemaking and mandates multiple studies which could result in additional legislative or regulatory action. Under the Dodd-Frank Act federal banking regulatory agencies are required to draft and implement enhanced supervision, examination and capital standards for depository institutions and their holding companies. The enhanced requirements include, among other things, changes to capital, leverage and liquidity standards and numerous other requirements. The Dodd-Frank Act authorizes various new assessments and fees, expands supervision and oversight authority over non-bank subsidiaries, increases the standards for certain covered transactions with affiliates and requires the establishment of minimum leverage and risk-based capital requirements for insured depository institutions. The Dodd-Frank Act also establishes a new federal Consumer Financial Protection Bureau with broad authority and permits states to adopt stricter consumer protection laws and enforce consumer protection rules issued by the Consumer Financial Protection Bureau. At this time, it is difficult to predict the extent to which the Dodd-Frank Act or the resulting regulations will impact Suffolk’s business. However, compliance with these new laws and regulations will likely result in additional costs, and these additional costs may adversely impact our results of operations, financial condition or liquidity.

Failure to comply with the Bank’s written agreement with the OCC may result in our being subjected to further regulatory enforcement actions.

On October 25, 2010, the Bank, following discussion with the OCC, entered into a formal agreement (the “Agreement”) with the OCC. The Agreement requires the Bank to take certain actions, including a review of management, the establishment of a three-year strategic plan and capital program, and the establishment of programs related to internal audit, maintaining an adequate allowance for loan losses, real property appraisal, credit risk management, credit concentrations, Bank Secrecy Act compliance and information technology. While subject to the Agreement, Suffolk expects that its and the Bank’s management and board of directors will be required to focus a substantial amount of time on complying with its terms. There also is no guarantee that the Bank will be able to fully comply with the Agreement. If the Bank fails to comply with the terms of the Agreement, it could be subject to further regulatory enforcement actions.

Further increases to our allowance for loan losses would negatively impact our capital levels causing the Bank to fail to be in compliance with the three individual minimum capital ratios set by the OCC

Subsequent to September 30, 2010, the Bank became subject to individual minimum capital ratios established by the OCC requiring the Bank to maintain Tier 1 capital ratio of at least equal to 8.00 percent of adjusted total assets, to maintain a Tier 1 capital ratio at least equal to 10.50 percent of risk-weighted assets, and to maintain a total risk based capital ratio at least equal to 12.00 percent of risk-weighted assets. At September 30, 2010, the Bank had a Tier 1 leverage ratio of 7.93 percent, a Tier 1 risk-based capital ratio of 10.88 percent, and a total risk-based capital ratio of 12.14 percent. However, the Bank exceeded the capital ratios required to be deemed well capitalized with respect to 12 CFR 6.4 as of September 30, 2010 after taking into effect the restatement and met all regulatory requirements applicable at that time. Further increases to Suffolk’s allowance for loan losses, however, would negatively impact the Bank’s capital levels and make it difficult to maintain the capital levels directed by the OCC. If the Bank fails to maintain the required capital levels, it could be subject to further regulatory enforcement actions.

A failure to restore and maintain effective internal controls over financial reporting and disclosure controls and procedures could have a material adverse effect on our results of operation or financial condition.

During April of 2011, management identified possible deficiencies and/or weaknesses in Suffolk’s internal controls related to the design and implementation of policies to promptly identify problem loans and to quantify the elements of risk in problem loans. After conducting an internal review, management determined that there were material weaknesses related to the allowance for loan and lease losses, financial reporting staffing resources, interdepartmental communications and governance and management accountability. See Part I, Item 4 – Controls and Procedures. Suffolk has incurred costs and implemented certain changes in its internal controls over financial reporting and disclosure controls and procedures to address these material weaknesses. It is too early to determine the impact of these remediation steps and Suffolk has not yet determined that it has restored effective internal controls over financial reporting and disclosure controls and procedures. It is possible

 

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that additional deficiencies or weaknesses could be identified A failure to restore and maintain effective internal controls over financial reporting and disclosure controls and procedures could have a material adverse effect on our results of operation or financial condition.

Item 2 - Unregistered Sales of Equity Securities and Use of Proceeds

The following table presents information about repurchases of common stock:

 

     For the
last 12
months
     For the three months ended  
      Sept. 30,
2010
     Jun. 30,
2010
     Mar. 31,
2010
     Dec.31,
2009
 

Average price per share of quarterly repurchases

   $ 2.50       $ —         $ —         $ 2.50       $ —     

Aggregate cost of quarterly repurchases

   $ 13,200       $ —         $ —         $ 13,200       $ —     
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Repurchases of common stock

              

Treasury stock, beginning balance

     3,996,878         4,002,158         4,002,158         3,996,878         3,996,878   

Repurchases (1)

     5,280         —           —           5,280         —     
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Treasury stock, ending balance

     4,002,158         4,002,158         4,002,158         4,002,158         3,996,878   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

 

(1) Shares repurchased in payment of exercised employee incentive stock options. No shares were repurchased in market transactions.

Item 6 - Exhibits

CERTIFICATION OF PERIODIC REPORT - Exhibit 31.1

CERTIFICATION OF PERIODIC REPORT - Exhibit 31.2

CERTIFICATION OF PERIODIC REPORT - Exhibit 32.1

CERTIFICATION OF PERIODIC REPORT - Exhibit 32.2

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.

 

  SUFFOLK BANCORP
Date: December 20, 2011    

/s/ J. Gordon Huszagh

    J. Gordon Huszagh
    President & Chief Executive Officer
Date: December 20, 2011    

/s/ J. Gordon Huszagh

    J. Gordon Huszagh
    Acting Chief Financial Officer

 

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