-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, A7kGP84N+bKYPDUK+VRweHSEwOmNccpXfWuWTicG602EIJ3EBajO3Nuvhvm/g0h7 ZiAQPWPXa5nBLdSOT6z6Ag== 0001214659-06-000583.txt : 20060310 0001214659-06-000583.hdr.sgml : 20060310 20060310171014 ACCESSION NUMBER: 0001214659-06-000583 CONFORMED SUBMISSION TYPE: 10-K PUBLIC DOCUMENT COUNT: 7 CONFORMED PERIOD OF REPORT: 20051231 FILED AS OF DATE: 20060310 DATE AS OF CHANGE: 20060310 FILER: COMPANY DATA: COMPANY CONFORMED NAME: 1ST CONSTITUTION BANCORP CENTRAL INDEX KEY: 0001141807 STANDARD INDUSTRIAL CLASSIFICATION: SAVINGS INSTITUTION, FEDERALLY CHARTERED [6035] IRS NUMBER: 223665653 STATE OF INCORPORATION: NJ FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: 10-K SEC ACT: 1934 Act SEC FILE NUMBER: 000-32891 FILM NUMBER: 06680124 BUSINESS ADDRESS: STREET 1: 2650 ROUTE 130 STREET 2: BOX 634 CITY: CRANBURY STATE: NJ ZIP: 08512 BUSINESS PHONE: 6096554500 MAIL ADDRESS: STREET 1: 2650 ROUTE 130 STREET 2: BOX 634 CITY: CRANBURY STATE: NJ ZIP: 08512 10-K 1 f396110k.htm FOR PERIOD ENDING DECEMBER 31, 2005

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, DC 20549
 


FORM 10-K
 

(Mark One)

x ANNUAL REPORT UNDER SECTION 13 OR 15 (d) OF THE SECURITIES EXCHANGE ACT OF 1934
   

 

For the fiscal year ended December 31, 2005

   

o

TRANSITION REPORT UNDER SECTION 13 OR 15 (d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from                to               

Commission file Number: 000-32891
 

1ST CONSTITUTION BANCORP

(Exact Name of Registrant as Specified in Its Charter)
 

 

New Jersey    22-3665653
(State or Other Jurisdiction of
Incorporation or Organization)		   (IRS. Employer Identification No.)

2650 Route 130, P.O. Box 634, Cranbury, NJ 08512
(Address of Principal Executive Offices, including Zip Code)


 

(609) 655-4500

(Registrant’s telephone number, including area code)


SECURITIES REGISTERED PURSUANT TO SECTION 12(b) OF THE ACT:

 
None

 

SECURITIES REGISTERED PURSUANT TO SECTION 12(g) OF THE ACT:

 
Common Stock, No Par Value, and Related Stock Purchase Rights
(Title of Class)

Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.   Yes o No x

Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or 15(d) of the Act.   Yes o No x

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 o

 

 

  

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K. o

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer. See definition of “accelerated filer and large accelerated filer” in Rule 12b-2 of the Exchange Act. (Check one):
 

 

Large accelerated filer o

Accelerated filer o

 Non-accelerated filer x

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).   Yes o No x

The aggregate market value of the registrant’s common stock held by non-affiliates of the registrant, computed by reference to the price at which the common stock was last sold, or the average bid and asked price of such common stock, as of the last business day of the registrant’s most recently completed second quarter, is $57,045,025.

As of March 1, 2006, 3,436,966 shares of the registrant’s common stock were outstanding.

Portions of the registrant’s definitive Proxy Statement for its 2006 Annual Meeting of Shareholders are incorporated by reference into Part III of this report.

 

 


 

FORM 10-K

TABLE OF CONTENTS

PART I

 
Item 1.    Business  1 
Item 1A.   Risk Factors  10
Item 1B.   Unresolved Staff Comments  12
Item 2.    Properties  12 
Item 3.    Legal Proceedings  13 
Item 4.    Submission of Matters to a Vote of Security Holders  13 
 
    PART II  
 
Item 5.    Market for Registrant’s Common Equity, Related Shareholder Matters and 
Issuer Purchases of Equity Securities  		13
Item 6.    Selected Financial Data  15 
Item 7.    Management’s Discussion and Analysis of Financial Condition and Results of Operation  15 
Item 7A.   Quantitative and Qualitative Disclosures About Market Risk  34
Item 8.    Financial Statements and Supplementary Data  34 
Item 9.    Changes in and Disagreements with Accountants on Accounting and Financial Disclosure  34 
Item 9A.   Controls and Procedures  35 
Item 9B.   Other Information  35 
 

  PART III
 
Item 10.    Directors and Executive Officers of the Registrant  35 
Item 11.    Executive Compensation  35 
Item 12.    Security Ownership of Certain Beneficial Owners and Management and Related Shareholder Matters  35 
Item 13.    Certain Relationships and Related Transactions  35 
Item 14.    Principal Accountant Fees and Services  35 
 
    PART IV  
 
Item 15.    Exhibits and Financial Statement Schedules  36 
 
SIGNATURES  40 

 

 

 

 

 

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PART I

Item 1. Business.

1st Constitution Bancorp

1st Constitution Bancorp (the "Company") is a bank holding company registered under the Bank Holding Company Act of 1956, as amended. The Company was organized under the laws of the State of New Jersey in February 1999 for the purpose of acquiring all of the issued and outstanding stock of 1st Constitution Bank (the "Bank") and thereby enabling the Bank to operate within a bank holding company structure. The Company became an active bank holding company on July 1, 1999. The Bank is a wholly-owned subsidiary of the Company. Other than its investment in the Bank, the Company currently conducts no other significant business activities.

As of December 31, 2005, the Company, on a consolidated basis, had total assets of approximately $372.5 million, total deposits of approximately $305.8 million, total gross loans of approximately $240.0 million and total shareholders' equity of approximately $29.8 million.

The main office of the Company and the Bank is located at 2650 Route 130 North, Cranbury, New Jersey 08512, and the telephone number is (609) 655-4500.

1st Constitution Bank

The Bank, a commercial bank formed under the laws of the State of New Jersey, engages in the business of commercial and retail banking. As a community bank, the Bank offers a wide range of services (including demand, savings and time deposits and commercial and consumer/installment loans) to individuals, small businesses and not-for-profit organizations principally in Middlesex, Mercer and Somerset Counties, New Jersey. The Bank conducts its operations through its main office located in Cranbury, New Jersey, and operates eight additional branch offices in downtown Cranbury, Hamilton Square, Jamesburg, Montgomery, Perth Amboy, Plainsboro, West Windsor, and Princeton, New Jersey and a loan production office in Fort Lee, New Jersey. The Bank's deposits are insured up to applicable legal limits by the Federal Deposit Insurance Corporation ("FDIC").

Management efforts focus on positioning the Bank to meet the financial needs of the communities in Middlesex, Mercer and Somerset Counties and to provide financial services to individuals, families, institutions and small businesses. To achieve this goal, the Bank is focusing its efforts on:

- personal service;

- expansion of its branch network;

- innovative product offerings; and

- technological advances and e-commerce.

Personal Service

The Bank provides a wide range of commercial and consumer banking services to individuals, families, institutions and small businesses in central New Jersey. The Bank's focus is to understand the needs of the community and the customers and tailor products, services and advice to meet those needs. The Bank seeks to provide a high level of personalized banking services, emphasizing quick and flexible responses to customer demands.

 

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Expansion of Branch Banking

The Bank continually evaluates opportunities for branch bank expansion, either mini branches or full service banks, to continue to grow and meet the needs of the community. During the second quarter of 2004, the Bank opened new branch offices in Jamesburg, Middlesex County, and West Windsor, Mercer County, New Jersey. During the third quarter of 2004, the Bank relocated the interim Perth Amboy branch office to its new permanent location in Perth Amboy, New Jersey. The Bank has received New Jersey Department of Banking and Insurance and FDIC approval to relocate its Plainsboro branch office from 10 Schalks Crossing Road to 11 Schalks Crossing Road and to open a new branch office to be located at 180 Main Street, Fort Lee, Bergen County. The Company currently anticipates that the relocation of the Plainsboro branch office and the opening of the new branch office in Fort Lee will both occur in the third quarter of 2006.

Innovative Product Offerings

During April 2005, the Bank introduced "1st Choice Super Savings", a new high yield savings account product. With a minimum balance of $25,000 to avoid monthly service charges, customers earn a premium market yield. By the end of 2005, this product had attracted over $18.0 million in new deposit balances.

Technological Advances and e-Commerce

The Bank recognizes that customers want to receive service via their most convenient delivery channel, be it the traditional branch office, by telephone, ATM, or the internet. For this reason, the Bank continues to enhance its e-commerce capabilities. At www.1stconstitution.com, customers have easy access to online banking, including account access, and to the Bank's bill payment system. Consumers can apply online for loans and interact with senior management through the e-mail system. Business customers have access to cash management information and transaction capability through the Bank's online Business Express product offering. This overall expansion in electronic banking offers the Bank's customers another means to access the Bank's services easily and at their own convenience.

Competition

The Bank experiences substantial competition in attracting and retaining deposits and in making loans. In attracting deposits and borrowers, the Bank competes with commercial banks, savings banks, and savings and loan associations, as well as regional and national insurance companies and non-bank financial institutions, regulated small loan companies and local credit unions, regional and national issuers of money market funds and corporate and government borrowers. Within the direct market area of the Bank, there are a significant number of offices of competing financial institutions. In New Jersey generally, and in the Bank's local market specifically, large commercial banks, as well as savings banks and savings and loan associations, including Provident Savings Bank and Hudson City Savings Bank, hold a dominant market share and there has been significant merger activity in the last few years, creating even larger competitors.

Locally, the Bank's most direct competitors include Bank of America, PNC Bank, Wachovia, and Sovereign Bank. The Bank is at a competitive disadvantage compared with these larger national and regional commercial and savings banks. By virtue of their larger capital, asset size or reserves, many of such institutions have substantially greater lending limits (ceilings on the amount of credit a bank may provide to a single customer that are linked to the institution's capital) and other resources than the Bank. Many such institutions are empowered to offer a wider range of services, including trust services, than the Bank and, in some cases, have lower funding costs (the price a bank must pay for deposits and other borrowed monies used to make loans to customers) than the Bank. In addition to having established deposit bases and loan portfolios, these institutions, particularly large national and regional commercial and savings banks, have the financial ability to finance extensive advertising campaigns and to allocate considerable resources to locations and products perceived as profitable.

 

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In addition, non-bank financial institutions offer services that compete for deposits with the Bank. For example, brokerage firms and insurance companies offer such instruments as short-term money market funds, corporate and government securities funds, mutual funds and annuities. It is expected that competition in these areas will continue to increase. Some of these competitors are not subject to the same degree of regulation and supervision as the Company and the Bank and therefore may be able to offer customers more attractive products than the Bank.

However, management of the Bank believes that loans to small and mid-sized businesses and professionals, which represent the main commercial loan business of the Bank, are not always of primary importance to the larger banking institutions. The Bank competes for this segment of the market by providing responsive personalized services, local decision-making, and knowledge of its customers and their businesses.

Lending Activities

The Bank's lending activities include both commercial and consumer loans. Loan originations are derived from a number of sources including real estate broker referrals, mortgage loan companies, direct solicitation by the Bank's loan officers, existing depositors and borrowers, builders, attorneys, walk-in customers and, in some instances, other lenders. The Bank has established disciplined and systematic procedures for approving and monitoring loans that vary depending on the size and nature of the loan.

Commercial Lending

The Bank offers a variety of commercial loan services including term loans, lines of credit, and loans secured by equipment and receivables. A broad range of short-to-medium term commercial loans, both secured and unsecured, are made available to businesses for working capital (including inventory and receivables), business expansion (including acquisition and development of real estate and improvements), and the purchase of equipment and machinery. The Bank also makes construction loans to real estate developers for the acquisition, development and construction of residential subdivisions.

Commercial loans are granted based on the borrower's ability to generate cash flow to support its debt obligations and other cash related expenses. A borrower's ability to repay commercial loans is substantially dependent on the success of the business itself and on the quality of its management. As a general practice, the Bank takes as collateral a security interest in any available real estate, equipment, inventory, receivables or other personal property of its borrowers, although occasionally the Bank makes commercial loans on an unsecured basis. Generally, the Bank requires personal guaranties of its commercial loans to offset the risks associated with such loans.

Residential Consumer Lending

A portion of the Bank's lending activities consists of the origination of fixed and adjustable rate residential first mortgage loans secured by owner-occupied property located in the Bank's primary market areas. Home mortgage lending is unique in that a broad geographic territory may be serviced by originators working from strategically placed offices either within the Bank's traditional banking facilities or from affordable storefront locations in commercial buildings. The Bank also offers construction loans, second mortgage home improvement loans and home equity lines of credit.

The Bank finances the construction of individual, owner-occupied houses on the basis of written underwriting and construction loan management guidelines. First mortgage construction loans are made to contractors on both a pre-sold and a "speculation" basis. Such loans are also made to qualified individual borrowers and are generally supported by a take-out commitment from a permanent lender. The Bank makes residential construction loans to individuals who intend to erect owner occupied housing on a purchased parcel of real estate. The construction phase of these loans has certain risks, including the viability of the contractor, the contractor's ability to complete the project and changes in interest rates.

 

3

 


 

In most cases, the Bank will sell its mortgage loans with terms of 15 years or more in the secondary market. The sale to the secondary market allows the Bank to hedge against the interest rate risks related to such lending operations. This brokerage arrangement allows the Bank to accommodate its clients' demands while eliminating the interest rate risk for the 15- to 30- year period generally associated with such loans.

The Bank in most cases requires borrowers to obtain and maintain title, fire, and extended casualty insurance, and, where required by applicable regulations, flood insurance. The Bank maintains its own errors and omissions insurance policy to protect against loss in the event of failure of a mortgagor to pay premiums on fire and other hazard insurance policies. Mortgage loans originated by the Bank customarily include a "due on sale" clause, which gives the Bank the right to declare a loan immediately due and payable in certain circumstances, including, without limitation, upon the sale or other disposition by the borrower of the real property subject to a mortgage. In general, the Bank enforces due on sale clauses. Borrowers are typically permitted to refinance or repay loans at their option without penalty.

Non-Residential Consumer Lending

Non-residential consumer loans made by the Bank include loans for automobiles, recreation vehicles, and boats, as well as personal loans (secured and unsecured) and deposit account secured loans. The Bank also conducts various indirect lending activities through established retail companies in its market areas. Non-residential consumer loans are attractive to the Bank because they typically have a shorter term and carry higher interest rates than are charged on other types of loans. Non-residential consumer loans, however, do pose additional risk of collectibility when compared to traditional types of loans, such as residential mortgage loans granted by commercial banks.

Consumer loans are granted based on employment and financial information solicited from prospective borrowers as well as credit records collected from various reporting agencies. Stability of the borrower, willingness to pay and credit history are the primary factors to be considered. The availability of collateral is also a factor considered in making such a loan. The Bank seeks collateral that can be assigned and has good marketability with a clearly adequate margin of value. The geographic area of the borrower is another consideration, with preference given to borrowers in the Bank's primary market areas.

Supervision and Regulation

Banking is a complex, highly regulated industry. The primary goals of the bank regulatory scheme are to maintain a safe and sound banking system and to facilitate the conduct of monetary policy. In furtherance of those goals, Congress has created several largely autonomous regulatory agencies and enacted a myriad of legislation that governs banks, bank holding companies and the banking industry. This regulatory framework is intended primarily for the protection of depositors and not for the protection of the Company's shareholders. Descriptions of, and references to, the statutes and regulations below are brief summaries thereof, and do not purport to be complete. The descriptions are qualified in their entirety by reference to the specific statutes and regulations discussed.

State and Federal Regulations

The Company is a bank holding company within the meaning of the Bank Holding Company Act of 1956, as amended (the "BHCA"). As a bank holding company, the Company is subject to inspection, examination and supervision by the Board of Governors of the Federal Reserve System (the "Federal Reserve Board") and is required to file with the Federal Reserve Board an annual report and such additional information as the Federal Reserve Board may require pursuant to the BHCA. The Federal Reserve Board may also make examinations of the Company and its subsidiaries. The Company is subject to capital standards similar to, but separate from, those applicable to the Bank.

Under the BHCA, bank holding companies that are not financial holding companies generally may not acquire the ownership or control of more than 5% of the voting shares, or substantially all the assets, of any company, including a bank or another bank holding company, without the Federal Reserve Board's prior approval. The Company has not applied to become a financial holding company but did obtain such approval to acquire the shares of the Bank. A bank holding company that does not qualify as a financial holding company is generally limited in the types of activities in which it may engage to those that the Federal Reserve Board had recognized as permissible for bank holding companies prior to the date of enactment of the Gramm-Leach-Bliley Financial Services Modernization Act of 1999. For example, a holding company and its banking subsidiary are prohibited from engaging in certain tie-in arrangements in connection with any extension of credit or lease or sale of any property or the furnishing of services. At present, the Company does not engage in any significant activity other than owning the Bank.

 

4

 


 

In addition to federal bank holding company regulation, the Company is registered as a bank holding company with the New Jersey Department of Banking and Insurance (the "Department"). The Company is required to file with the Department copies of the reports it files with the federal banking and securities regulators.

Capital Adequacy

The Company is required to comply with minimum capital adequacy standards established by the Federal Reserve Board. There are two basic measures of capital adequacy for bank holding companies and the depository institutions that they own: a risk based measure and a leverage measure. All applicable capital standards must be satisfied for a bank holding company to be considered in compliance.

The Federal Deposit Insurance Corporation Improvement Act of 1991 ("FDICIA") required each federal banking agency to revise its risk-based capital standards to ensure that those standards take adequate account of interest rate risk, concentration of credit risk and the risks of non-traditional activities. In addition, pursuant to FDICIA, each federal banking agency has promulgated regulations, specifying the levels at which a bank would be considered "well capitalized," "adequately capitalized," "undercapitalized," "significantly undercapitalized," or "critically undercapitalized," and to take certain mandatory and discretionary supervisory actions based on the capital level of the institution.

The regulations implementing these provisions of FDICIA provide that a bank will be classified as "well capitalized" if it (i) has a total risk-based capital ratio of at least 10.0 percent, (ii) has a Tier 1 risk-based capital ratio of at least 6.0 percent, (iii) has a Tier 1 leverage ratio of at least 5.0 percent, and (iv) meets certain other requirements. A bank will be classified as "adequately capitalized" if it (i) has a total risk-based capital ratio of at least 8.0 percent, (ii) has a Tier 1 risk-based capital ratio of at least 4.0 percent, (iii) has a Tier 1 leverage ratio of (a) at least 4.0 percent, or (b) at least 3.0 percent if the institution was rated 1 in its most recent examination, and (iv) does not meet the definition of "well capitalized." A bank will be classified as "undercapitalized" if it (i) has a total risk-based capital ratio of less than 8.0 percent, (ii) has a Tier 1 risk-based capital ratio of less than 4.0 percent, or (iii) has a Tier 1 leverage ratio of (a) less than 4.0 percent, or (b) less than 3.0 percent if the institution was rated 1 in its most recent examination. A bank will be classified as "significantly undercapitalized" if it (i) has a total risk-based capital ratio of less than 6.0 percent, (ii) has a Tier 1 risk-based capital ratio of less than 3.0 percent, or (iii) has a Tier 1 leverage ratio of less than 3.0 percent. An institution will be classified as "critically undercapitalized" if it has a tangible equity to total assets ratio that is equal to or less than 2.0 percent. An insured depository institution may be deemed to be in a lower capitalization category if it receives an unsatisfactory examination.

As of December 31, 2005, the Bank's capital ratios exceed the requirements to be considered a well capitalized institution under these regulations.

The risk-based capital guidelines for bank holding companies such as the Company currently require a minimum ratio of total capital to risk-weighted assets (including off-balance sheet activities, such as standby letters of credit) of 8%. At least half of the total capital is required to be Tier 1 capital, consisting principally of common shareholders' equity, non-cumulative perpetual preferred stock, a limited amount of cumulative perpetual preferred stock and minority interest in the equity accounts of consolidated subsidiaries, less goodwill. The remainder of the total capital (Tier 2 capital) may consist of a limited amount of subordinated debt and intermediate-term preferred stock, certain hybrid capital instruments and other debt securities, perpetual preferred stock and a limited amount of the general loan loss allowance. At December 31, 2005, the Company maintained a Tier 1 capital ratio of 12.47% and total qualifying capital ratio of 13.30%.

 

 In addition to the risk-based capital guidelines, the federal banking regulators established minimum leverage ratio (Tier 1 capital to total assets) guidelines for bank holding companies. These guidelines provide for a minimum leverage ratio of 3% for those bank holding companies which have the highest regulatory examination ratings and are not contemplating or experiencing significant growth or expansion. All other bank holding companies are required to maintain a leverage ratio of at least 1% to 2% above the 3% stated minimum. The Company's leverage ratio at December 31, 2005 was 9.76%.
 

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Management has determined that the 1st Constitution Capital Trust I (the "Trust") qualifies as a variable interest entity under FASB Interpretation 46, "Consolidation of Variable Interest Entities" ("FIN 46"). The Trust issued mandatorily redeemable preferred stock to investors and loaned the proceeds to the Company. The Trust holds, as its sole asset, subordinated debentures issued by the Company in 2002. Prior to December 31, 2003, the Trust was included in the Company's consolidated balance sheet and statements of income. Subsequent to the issuance of FIN 46, the FASB issued a revised interpretation, FIN 46(R), the provisions of which were required to be applied to certain variable interest entities, including the Trust, by March 31, 2004. The Company adopted the provisions under FIN 46 and accordingly deconsolidated the Trust as of December 31, 2003.

In March 2005, the Federal Reserve Board adopted a final rule that would continue to allow the inclusion of trust preferred securities of the kind issued by the Trust in Tier 1 capital, but with stricter quantitative limits. Under the final rule, after a five-year transition period, the aggregate amount of trust preferred securities and certain other capital elements would be limited to 25% of Tier 1 capital elements, net of goodwill. The amount of trust preferred securities and certain other elements in excess of the limit could be included in Tier 2 capital, subject to restrictions. Based on the final rule, the Company expects to include all of its $5.2 million in trust preferred securities in Tier 1 capital. Management has evaluated the effects of the final rule and does not anticipate a material impact on its capital ratios by the end of the transition period.

Restrictions on Dividends

The primary source of cash to pay dividends, if any, to the Company's shareholders and to meet the Company's obligations is dividends paid to the Company by the Bank. Dividend payments by the Bank to the Company are subject to the New Jersey Banking Act of 1948 (the "Banking Act") and the Federal Deposit Insurance Act (the "FDIA"). Under the Banking Act and the FDIA, the Bank may not pay any dividends if after paying the dividend, it would be undercapitalized under applicable capital requirements. In addition to these explicit limitations, the federal regulatory agencies are authorized to prohibit a banking subsidiary or bank holding company from engaging in an unsafe or unsound banking practice. Depending upon the circumstances, the agencies could take the position that paying a dividend would constitute an unsafe or unsound banking practice.

It is the policy of the Federal Reserve Board that bank holding companies should pay cash dividends on common stock only out of income available over the immediately preceding year and only if prospective earnings retention is consistent with the organization's expected future needs and financial condition. The policy provides that bank holding companies should not maintain a level of cash dividend that undermines the bank holding company's ability to serve as a source of strength to its banking subsidiary. A bank holding company may not pay dividends when it is insolvent.

The Company has never paid a cash dividend and the Company's Board of Directors has no plans to pay a cash dividend in the foreseeable future. The Bank paid a stock dividend every year from 1993 to 1999, when it was acquired by the Company. The Company has paid a 5% stock dividend every year since its formation in 1999. The Company also declared a two-for-one stock split on January 20, 2005 and paid February 28, 2005 to shareholders of record on February 10, 2005.

Priority on Liquidation

The Company is a legal entity separate and distinct from the Bank. The rights of the Company as the sole shareholder of the Bank, and therefore the rights of the Company's creditors and shareholders, to participate in the distributions and earnings of the Bank when the Bank is not in bankruptcy, are subject to various state and federal law restrictions as discussed above under the heading "Restrictions of Dividends." In the event of a liquidation or other resolution of an insured depository institution such as the Bank, the claims of depositors and other general or subordinated creditors are entitled to a priority of payment over the claims of holders of an obligation of the institution to its shareholders (the Company) or any shareholder or creditor of the Company. The claims on the Bank by creditors include obligations in respect of federal funds purchased and certain other borrowings, as well as deposit liabilities.

 

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Financial Institution Legislation

The Gramm-Leach-Bliley Financial Modernization Act of 1999 (the "Modernization Act") became effective in early 2000. The Modernization Act:

 

•

allows bank holding companies meeting management, capital and Community Reinvestment Act standards to engage in a substantially broader range of non-banking activities than is permissible for a bank holding company, including insurance underwriting and making merchant banking investments in commercial and financial companies; if a bank holding company elects to become a financial holding company, it files a certification, effective in 30 days, and thereafter may engage in certain financial activities without further approvals;

 

•

allows banks to establish subsidiaries to engage in certain activities which a financial holding company could engage in, if the bank meets certain management, capital and Community Reinvestment Act standards;

 

•

allows insurers and other financial services companies to acquire banks and removes various restrictions that currently apply to bank holding company ownership of securities firms and mutual fund advisory companies; and establishes the overall regulatory structure applicable to financial holding companies that also engage in insurance and securities operations.

The Modernization Act modified other financial laws, including laws related to financial privacy and community reinvestment.

The Modernization Act also amends the BHCA and the Bank Merger Act to require the federal banking agencies to consider the effectiveness of a financial institution's anti-money laundering activities when reviewing an application under these acts.

Additional proposals to change the laws and regulations governing the banking and financial services industry are frequently introduced in Congress, in the state legislatures and before the various bank regulatory agencies. The likelihood and timing of any such changes and the impact such changes might have on the Company cannot be determined at this time.

The Sarbanes-Oxley Act of 2002 ("Sarbanes-Oxley Act"), which became law on July 30, 2002, added new legal requirements affecting corporate governance, accounting and corporate reporting for companies with publicly traded securities.

The Sarbanes-Oxley Act provides for, among other things:

 

•

a prohibition on personal loans made or arranged by the issuer to its directors and executive officers (except for loans made by a bank subject to Regulation O);

 

•

independence requirements for audit committee members;

 

•

independence requirements for outside auditors;

 

•

certification of financial statements and reports on Forms 10-K, 10-KSB, 10-Q, and 10-QSB by the chief executive officer and the chief financial officer;

 

•

the forfeiture of bonuses or other incentive-based compensation and profits from the sale of an issuer's securities by directors and senior officers in the twelve month period following initial publication of any financial statements that later require restatement due to corporate misconduct;

 

•

disclosure of off-balance sheet transactions;

 

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•

two-business day filing requirements for insiders filing Forms 4;

 

•

disclosure of a code of ethics for financial officers and filing a Form 8-K for a change or waiver of such code;

 

•

"real time" filing of periodic reports;

 

•

posting of certain SEC filings and other information on the company website;

 

•

the reporting of securities violations "up the ladder" by both in-house and outside attorneys;

 

•

restrictions on the use of non-GAAP financial measures;

 

•

the formation of a public accounting oversight board; and

 

•

various increased criminal penalties for violations of securities laws.

Each of the national stock exchanges, including the Nasdaq Stock Market where the Company's common stock is listed, have implemented new corporate governance rules, including rules strengthening director independence requirements for boards, and the adoption of charters for the nominating, corporate governance, and audit committees. The rule changes are intended to, among other things, make the board of directors independent of management and allow shareholders to more easily and efficiently monitor the performance of companies and directors. These increased burdens have increased the Company's legal and accounting fees and the amount of time that the Board of Directors and management must devote to corporate governance issues.

Effective August 29, 2002, as directed by Section 302(a) of Sarbanes-Oxley, the Company's chief executive officer and chief financial officer are each required to certify that the Company's Quarterly and Annual Reports do not contain any untrue statement of a material fact. The rules have several requirements, including having these officers certify that: they are responsible for establishing, maintaining and regularly evaluating the effectiveness of the Company's internal controls; they have made certain disclosures to the Company's auditors and the audit committee of the Board of Directors about the Company's internal controls; and they have included information in the Company's Quarterly and Annual Reports about their evaluation and whether there have been significant changes in the Company's internal controls or in other factors that could significantly affect internal controls subsequent to the evaluation.

As part of the USA Patriot Act, signed into law on October 26, 2001, Congress adopted the International Money Laundering Abatement and Financial Anti-Terrorism Act of 2001 (the "Act"). The Act authorizes the Secretary of the Treasury, in consultation with the heads of other government agencies, to adopt special measures applicable to financial institutions such as banks, bank holding companies, broker-dealers and insurance companies. Among its other provisions, the Act requires each financial institution: (i) to establish an anti-money laundering program; (ii) to establish due diligence policies, procedures and controls that are reasonably designed to detect and report instances of money laundering in United States private banking accounts and correspondent accounts maintained for non-United States persons or their representatives; and (iii) to avoid establishing, maintaining, administering, or managing correspondent accounts in the United States for, or on behalf of, a foreign shell bank that does not have a physical presence in any country. In addition, the Act expands the circumstances under which funds in a bank account may be forfeited and requires covered financial institutions to respond under certain circumstances to requests for information from federal banking agencies within 120 hours.

The Department of Treasury has issued regulations implementing the due diligence requirements. These regulations require minimum standards to verify customer identity and maintain accurate records, encourages cooperation among financial institutions, federal banking agencies, and law enforcement authorities regarding possible money laundering or terrorist activities, prohibits the anonymous use of "concentration accounts," and requires all covered financial institutions to have in place an anti-money laundering compliance program.

 

8

 


 

The Bank, a New Jersey-chartered commercial bank, is subject to supervision and examination by the New Jersey Department of Banking and Insurance. The Bank is also subject to regulation by the FDIC, which is its principal federal bank regulator.

The Bank must comply with various requirements and restrictions under federal and state law, including the maintenance of reserves against deposits, restrictions on the types and amounts of loans that may be granted and the interest that may be charged thereon, limitations on the types of investments that may be made and the services that may be offered, and restrictions on dividends as described in the preceding section. Consumer laws and regulations also affect the operations of the Bank. In addition to the impact of regulation, commercial banks are affected significantly by the actions of the Federal Reserve Board which influence the money supply and credit availability in the national economy.

Community Reinvestment Act

Under the Community Reinvestment Act ("CRA"), as implemented by FDIC regulations, a bank has a continuing and affirmative obligation, consistent with its safe and sound operation, to help meet the credit needs of its entire community, including low- and moderate-income neighborhoods. CRA does not establish specific lending requirements or programs for financial institutions nor does it limit an institution's discretion to develop the types of products and services that it believes are best suited to its particular community, consistent with CRA. CRA requires the FDIC to assess an institution's record of meeting the credit needs of its community and to take such record into account in its evaluation of certain applications by the applicable institution. The CRA requires public disclosure of an institution's CRA rating and requires that the FDIC provide a written evaluation of an institution's CRA performance utilizing a four-tiered descriptive rating system. An institution's CRA rating is considered in determining whether to grant charters, branches and other deposit facilities, relocations, mergers, consolidations and acquisitions. Performance less than satisfactory may be the basis for denying an application. At its last CRA examination, the Bank was rated "satisfactory" under CRA.

Insurance of Deposits

The Bank's deposits are insured up to a maximum of $100,000 per depositor under the Bank Insurance Fund ("BIF"). The FDICIA is applicable to depository institutions and deposit insurance. The FDICIA requires the FDIC to establish a risk-based assessment system for all insured depository institutions. Under this legislation, the FDIC is required to establish an insurance premium assessment system based upon: (i) the probability that the insurance fund will incur a loss with respect to the institution, (ii) the likely amount of the loss, and (iii) the revenue needs of the insurance fund. In compliance with this mandate, the FDIC has developed a matrix that sets the assessment premium for a particular institution in accordance with its capital level and overall rating by the primary regulator. Under the matrix as currently in effect, the assessment rate ranges from 0 to 27 basis points of assessed deposits. The Bank is also subject to a quarterly FICO assessment.

Employees

The Company has two paid employees. Banking operations are conducted by the Bank, and as of December 31, 2005, the Bank had 79 full-time employees and 10 part-time employees. Neither the Bank's nor the Company's employees are represented by any collective bargaining group. The Bank and the Company each considers its relations with such employees to be good.

Forward Looking Statements

When used in this and in future filings by the Company with the Securities and Exchange Commission, in the Company's press releases and in oral statements made with the approval of an authorized executive officer of the Company, the words or phrases "will," "will likely result," "could," "anticipates," "believes," "continues," "expects," "plans," "will continue," "is anticipated," "estimated," "project" or "outlook" or similar expressions (including confirmations by an authorized executive officer of the Company of any such expressions made by a third party with respect to the Company) are intended to identify forward-looking statements. The Company wishes to caution readers not to place undue reliance on any such forward-looking statements, each of which speak only as of the date made. Such statements are subject to certain risks and uncertainties that could cause actual results to differ materially from historical earnings and those presently anticipated or projected.

 

9

 


 

Factors that may cause actual results to differ from those results expressed or implied, include, but are not limited to, those listed below under "Risk Factors" the overall economy and the interest rate environment; the ability of customers to repay their obligations; the adequacy of the allowance for loan losses; competition; significant changes in accounting, tax or regulatory practices and requirements; and technological changes. Although management has taken certain steps to mitigate any negative effect of the aforementioned items, significant unfavorable changes could severely impact the assumptions used and have an adverse effect on profitability. Such risks and other aspects of the Company's business and operations are described in "Business", "Risk Factors" and "Management's Discussion and Analysis of Financial Condition and Results of Operation." The Company has no obligation to publicly release the result of any revisions which may be made to any forward-looking statements to reflect anticipated or unanticipated events or circumstances occurring after the date of such statements.

Item 1A. Risk Factors.

The common stock of the Company is speculative in nature and involves a significant degree of risk. The risk factors below are not listed in order of importance.

The Company faces significant competition.

The Company faces significant competition from many other banks, savings institutions and other financial institutions which have branch offices or otherwise operate in the Company's market area. Non-bank financial institutions, such as securities brokerage firms, insurance companies and money market funds, engage in activities which compete directly with traditional bank business which has also led to greater competition. Many of these competitors have substantially greater financial resources than the Company, including larger capital bases that allow them to attract customers seeking larger loans than the Company is able to accommodate and the ability to aggressively advertise their products. There can be no assurance that the Company and the Bank will be able to successfully compete with these entities in the future. See "BUSINESS -- Competition."

The Company's Business is Affected by Economic Conditions and Related Uncertainties.

Commercial banking is affected, directly and indirectly, by local, domestic, and international economic and political conditions, and by government monetary and fiscal policies. Conditions such as inflation, recession, unemployment, volatile interest rates, tight money supply, scarce natural resources, real estate values, international conflicts and other factors beyond the control of the Company may adversely affect the potential profitability of the Company. A downtrend in several areas, such as real estate, construction and consumer spending, could have a material adverse impact on the Company's ability to maintain or increase profitability.

The Company Is Subject To Interest Rate Risk.

The Company's earnings are largely dependent upon its net interest income. Net interest income is the difference between interest income earned on interest-earning assets such as loans and securities and interest expense paid on interest-bearing liabilities such as deposits and borrowed funds. Interest rates are highly sensitive to many factors that are beyond the Company's control, including general economic conditions and policies of various governmental and regulatory agencies and, in particular, the Board of Governors of the Federal Reserve System. Changes in monetary policy, including changes in interest rates, could influence not only the interest the Company receives on loans and securities and the amount of interest it pays on deposits and borrowings, but such changes could also affect (i) the Company's ability to originate loans and obtain deposits, (ii) the fair value of the Company's financial assets and liabilities, and (iii) the average duration of the Company's mortgage-backed securities portfolio. If the interest rates paid on deposits and other borrowings increase at a faster rate than the interest rates received on loans and other investments, the Company's net interest income, and therefore earnings, could be adversely affected. Earnings could also be adversely affected if the interest rates received on loans and other investments fall more quickly than the interest rates paid on deposits and other borrowings.

 

10

 


 

Although management believes it has implemented effective asset and liability management strategies to reduce the potential effects of changes in interest rates on the Company's results of operations, any substantial, unexpected, prolonged change in market interest rates could have a material adverse effect on the Company's financial condition and results of operations.

The Company is subject to risks associated with speculative construction lending.

The risks associated with speculative construction lending include the borrower's inability to complete the construction process on time and within budget, the sale of the project within projected absorption periods, the economic risks associated with real estate collateral, and the potential of a rising interest rate environment. Such loans may include financing the development and/or construction of residential subdivisions. This activity may involve financing land purchase, infrastructure development (i.e. roads, utilities, etc.), as well as construction of residences or multi-family dwellings for subsequent sale by developer/builder. Because the sale of developed properties is integral to the success of developer business, loan repayment may be especially subject to the volatility of real estate market values. Management has established underwriting and monitoring criteria to minimize the inherent risks of speculative commercial real estate construction lending. Further, management concentrates lending efforts with developers demonstrating successful performance on marketable projects within the Bank's lending areas.

Federal and State Government Regulation Impact the Company's Operations.

The operations of the Company and the Bank are heavily regulated and will be affected by present and future legislation and by the policies established from time to time by various federal and state regulatory authorities. In particular, the monetary policies of the Federal Reserve Board have had a significant effect on the operating results of banks in the past and are expected to continue to do so in the future. Among the instruments of monetary policy used by the Federal Reserve Board to implement its objectives is changes in the discount rate charged on bank borrowings. It is not possible to predict what changes, if any, will be made to the monetary policies of the Federal Reserve Board or to existing federal and state legislation or the effect that such changes may have on the future business and earnings prospects of the Company.

The Company and the Bank are subject to examination, supervision and comprehensive regulation by various federal and state agencies. Compliance with the rules and regulations of these agencies may be costly and may limit growth and restrict certain activities, including payment of dividends, investments, loans and interest rate charges, interest rates paid on deposits, and locations of offices. The Bank is also subject to capitalization guidelines set forth in federal legislation. See "BUSINESS -- Supervision and Regulation."

The laws and regulations applicable to the banking industry could change at any time, and we cannot predict the impact of these changes on our business and profitability. Because government regulation greatly effects the business and financial results of all commercial banks and bank holding companies, the cost of compliance could adversely affect the Company's ability to operate profitably.

If economic conditions deteriorate, particularly in the Bank's market area, our results of operations and financial condition could be adversely affected as borrowers' ability to repay loans declines and the value of the collateral securing our loans decreases.

Our financial results may be adversely affected by changes in prevailing economic conditions, particularly in the Bank's market area, including decreases in real estate values, changes in interest rates which may cause a decrease in interest rate spreads, adverse employment conditions, the monetary and fiscal policies of the federal government and other significant external events.

Decreases in local real estate values would adversely affect the value of property used as collateral for our loans. Adverse changes in the economy also may have a negative effect on the ability of our borrowers to make timely repayments of their loans, which would have an adverse impact on our earnings.

 

11

 


 

If our allowance for loan losses is not sufficient to cover actual loan losses, our earnings could decrease.

We make various assumptions and judgments about the collectibility of our loan portfolio, including the creditworthiness of our borrowers and the value of the real estate and other assets serving as collateral for the repayment of many of our loans. In determining the amount of the allowance for loan losses, we review our loans and our loss and delinquency experience, and we evaluate economic conditions. If our assumptions are incorrect, our allowance for loan losses may not be sufficient to cover losses inherent in our loan portfolio, resulting in additions to our allowance. Material additions to our allowance would materially decrease our net income.

In addition, bank regulators periodically review our allowance for loan losses and may require us to increase our provision for loan losses or recognize further loan charge-offs. Any increase in our allowance for loan losses or loan charge-offs as required by these regulatory authorities might have a material adverse effect on our financial condition and results of operations.

Item 1B. Unresolved Staff Comments

Not Applicable.

Item 2. Properties.

General

The Company's and the Bank's principal office in Cranbury, New Jersey (the "Principal Office"), which it occupies under a lease that expires in December 2010, provides for an aggregate monthly rental of $16,134, subject to annual rental increases plus real estate taxes and certain common space charges allocated by the landlord. This lease grants the Bank two additional five-year renewal periods. The Bank also has the right of first refusal to purchase the premises of which the Principal Office is a part on the same terms and conditions as contained in any bona fide offer for the premises. In 2003, the Bank entered into a five-year lease for an additional 1,900 square feet of office space in this building for an aggregate monthly rental of $2,137 per month, subject to annual rental increases. This lease grants the Bank two additional five-year renewal periods.

The Bank leases approximately 2,400 square feet for its branch office in Montgomery Township, New Jersey for an aggregate monthly rental of $5,050. This lease expires on September 30, 2007.

In September 2005, the Bank exercised its right of first refusal option granted under the existing lease agreement and purchased the land and building comprising its branch office in downtown Cranbury, New Jersey. The Bank had previously leased this 3,780 square feet branch office for an aggregate monthly rental of $3,819 per month.

In December 2005, the Bank elected to exercise its option for the early termination of the lease for its branch located in Plainsboro, New Jersey. The Bank has applied for and received regulatory agency approval to relocate this branch into the Plainsboro Village Center which is currently in the final stages of construction. The Bank entered into a 15 year lease for approximately 2,500 square feet with two drive-through lanes in the multi-tenant retail/office building. The Bank has two five year renewal options for this space. The aggregate monthly payment for this lease is $7,381, with annual escalations.

The Bank entered into a lease for the branch located in Hamilton Square, New Jersey in April 1999. This lease expires in July 2014 and provides for a rental of approximately 4,170 square feet. The Bank has two five-year renewal options for this space. The aggregate monthly rental payment for this lease is $9,401, with annual escalations.

In January 2004, the Bank entered into a two-year lease for a new Loan Production Office in Fort Lee, New Jersey. The lease provides for the rental of 1,567 square feet with an aggregate monthly rental of $2,873 in the first year and $2,938 in the second year. In December 2005, the Bank entered into a lease to house a de novo branch plus the loan production office in Fort Lee, New Jersey. The Bank has applied for and received regulatory agency approval to relocate the loan production office and establish a de novo branch. This lease expires in February 2014 and provides for the rental of 3,100 square feet on the ground floor plus 800 square feet in the basement. The aggregate monthly rental payment for this lease is $6,458, with annual escalations.

 

12

 


 

In June 2004, the Bank commenced the lease for the West Windsor, New Jersey branch. The lease expires in July 2019 and provides for a rental of approximately 3,000 square feet. The lease provides for three five-year renewal options for this space. The aggregate monthly rental payment for this lease is $2,083, with annual escalations.

In August 2004, the Bank commenced the lease for the Perth Amboy, New Jersey branch. This lease expires in August 2019 and provides for a rental of approximately 3,000 square feet The lease provides for two seven and one-half year renewal options for this space. The aggregate monthly rental payment for this lease is $6,250, with annual escalations.

In June 2004, the Bank completed the construction and renovation project associated with opening a branch office in Jamesburg, New Jersey. The Bank purchased the site at 1 Harrison Street in 2002.

Management believes the foregoing facilities are suitable for the Company's and the Bank's present and projected operations.

Item 3. Legal Proceedings.

None.

Item 4. Submission of Matters to a Vote of Security Holders.

No matters were submitted to a vote of the Company's shareholders during the fourth quarter of the fiscal year ended December 31, 2005.

PART II

Item 5. Market for Registrant's Common Equity, Related Shareholder Matters and Issuer Purchases of Equity Securities.

The common stock of the Company trades on the NASDAQ National Market System under the trading symbol "FCCY". The following are the high and low sales prices per share for 2005 and 2004, as reported on the Nasdaq National Market System.
 

 

 

2005

 

2004

 

 

 

High

 

Low

 

High

 

Low

 

First Quarter

 

$19.50

 

$15.14

(1)

$15.30

 

$13.70

(1)

Second Quarter

 

$19.27

 

$15.89

(1)

15.19

 

13.87

(1)

Third Quarter

 

$19.87

 

$16.69

(1)

14.83

 

13.76

(1)

Fourth Quarter

 

$19.95

 

$15.88

(1)

16.97

 

14.58

(1)

 

(1) Prices have been retroactively adjusted for the 5% stock dividend declared December 15, 2005 and paid January 31, 2006 to shareholders of record on January 17, 2006 and for the two-for-one stock split declared January 20, 2005 and paid February 28, 2005 to shareholders of record on February 10, 2005.

As of March 6, 2006, there were approximately 330 holders of the Company's common stock.

The Company paid a 5% stock dividend on January 31, 2006 and January 31, 2005. The Company declared a two-for-one stock split on January 20, 2005, which was paid February 28, 2005 to shareholders of record on February 10, 2005. The Company has never paid a cash dividend and there are no plans to pay a cash dividend at this time. The Company will retain its earnings in order to provide capital for growth of the Bank.

 

13

 


 

Issuer Purchases of Equity Securities

On March 12, 2001, the Company announced that the Board of Directors authorized a stock repurchase program allowing for the repurchase of a limited number of the Company's shares at management's discretion on the open market. On July 21, 2005, the Board of Directors terminated the stock repurchase program and authorized a new common stock repurchase program under which the Company may purchase in open market or privately negotiated transactions up to 5% of its common shares outstanding on that date. The Company undertook these repurchase programs in an effort to increase shareholder value. The following table provides common stock repurchases made by or on behalf of the Company during the three months ended December 31, 2005.

Issuer Purchases of Equity Securities (1)

 

 

 

 

Period

 

 

Total Number of Shares Purchased

 

 

Average Price Paid Per Share

 

Total Number of Shares Purchased As Part of Publicly Announced Plan or Program

Maximum Number of Shares That May Yet be Purchased Under the Plan or Program

 

Beginning

 

Ending

 

 

 

 

October 1, 2005

October 31, 2005

362

$18.82

362

163,909

November 1, 2005

November 30, 2005

248

$19.49

248

163,661

December 1, 2005

December 31, 2005

- -

- -

- -

163,661

 

Total

 

610

 

$19.09

 

610

 

163,661

 ________________________

(1)

The Company's common stock repurchase program covers a maximum of 165,350 shares of common stock of the Company, representing 5% of the outstanding common stock of the Company on July 21, 2005.

 

 

 

 

 

 

 

 

 

 

14

 


  

Item 6. Selected Financial Data.

The following selected financial data should be read in conjunction with the Company's Consolidated Financial Statements and the accompanying notes presented elsewhere herein.

 

 

 

 

 

 

 

For years ended December 31

2005

2004

2003

2002

2001

Five Year Compounded Growth Rate

 

 

 

 

 

 

 

Highlights

 

 

 

 

 

 

Net income

$4,560,127

$3,837,714

$3,228,500

$2,687,322

$2,152,001

21.4%

Return on average assets

1.31%

1.22%

1.18%

1.06%

1.03%

 

Return on average equity

16.49%

15.54%

14.85%

14.09%

13.17%

 

Net interest margin

4.78%

4.25%

3.94%

3.87%

4.04%

 

 

 

 

 

 

 

 

Income Statement Data

 

 

 

 

 

 

Net interest income

$15,299,893

$12,470,773

$10,012,780

$9,209,044

$8,054,847

16.4%

Provision for loan losses

405,000

240,000

240,000

240,000

300,000

 

Non-interest income

2,646,861

2,557,242

2,401,349

1,525,526

1,186,582

 

Non-interest expenses

10,887,225

8,989,961

7,168,722

6,287,881

5,552,291

 

 

 

 

 

 

 

 

Balance Sheet Data at December 31

 

 

 

 

 

Total Assets

$372,495,466

$335,830,440

$293,483,174

$273,862,343

$232,800,734

15.5%

Total Deposits

305,809,467

276,887,033

245,353,724

224,149,464

193,882,067

17.3%

Total Gross Loans

240,014,349

210,653,051

163,950,306

151,049,736

124,937,483

16.8%

Shareholders' Equity

29,796,867

26,790,384

23,585,256

20,994,842

17,432,944

14.4%

Intangible Assets

- -

- -

- -

- -

- -

 

Allowance for Loan Losses

2,361,375

2,005,169

1,786,632

1,669,882

1,414,495

15.8%

 

 

 

 

 

 

 

Share Information (1)

 

 

 

 

 

 

Earnings per share - Basic

$1.32

$1.11

$0.94

$0.79

$0.63

21.4%

Earnings per share - Diluted

$1.27

$1.08

$0.89

$0.75

$0.61

20.5%

Book value per share

$8.67

$7.72

$6.84

$6.16

$5.13

14.9%

Average diluted shares

outstanding

 

3,588,558

 

3,584,217

 

3,609,140

 

3,592,741

 

3,530,552

 

 

 

 

 

 

 

 

 

Capital Ratios

 

 

 

 

 

 

Total capital to risk-weighted

assets

 

13.30%

 

13.99%

 

14.94%

 

14.75%

 

12.82%

 

Tier 1 capital to risk-weighted

assets

 

12.47%

 

13.17%

 

14.06%

 

13.84%

 

11.86%

 

Tier 1 capital to average assets

9.76%

10.16%

9.74%

9.64%

7.57%

 

 

 

 

 

 

 

 

 

(1) All share information has been restated for the effect of a 5% stock dividend declared on December 15, 2005 and paid on January 31, 2006 to shareholders of record on January 17, 2006.

Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operation.

This discussion should be read in conjunction with the consolidated financial statements, notes and tables included elsewhere in this report. Throughout the following sections, the "Company" refers to 1ST Constitution Bancorp and its wholly owned subsidiaries, 1ST Constitution Bank and 1ST Constitution Capital Trust I, the "Bank" refers to 1ST Constitution Bank, and the "Trust" refers to 1ST Constitution Capital I. The purpose of this discussion and analysis is to assist in the understanding and evaluation of the Company's financial condition, changes in financial condition and results of operations.

 

15

 


 

Executive Summary

The Company reported net income for the 12 months ended December 31, 2005 of $4,560,127, an increase of 18.8% from the $3,837,714 reported for the 12 months ended December 31, 2004. Diluted net income per share was $1.27 in 2005 compared to $1.08 reported in 2004. Basic net income per share in 2005 was $1.32 as compared to the $1.11 reported in 2004. The Company has achieved a five-year compounded growth rate for net income of 21.4% over the 2000-2005 period. All share information has been restated for the effect of a 5% stock dividend declared on December 15, 2005 and paid on January 31, 2006 to shareholders of record on January 17, 2006.

Key performance ratios continued to improve in 2005 as compared to the prior year. Return on average assets ("ROA") and return on average equity ("ROE") were 1.31% and 16.49%, respectively, in 2005, compared to 1.22% and 15.54%, respectively, in 2004.

The Company's record earnings for 2005 reflect continuing momentum across a broad range of product and service offerings. Increased lending activity, coupled with increases in deposits through branch network expansion and secondary market loan sales volume, fueled both the record earnings and balance sheet growth.

The Company's net interest income for 2005 was $15,299,893, an increase of 22.7% from the $12,470,773 reported for 2004. The net interest margin for 2005 was 4.78% compared to 4.25% reported for 2004. During 2004, a rising interest rate environment evolved during the latter half of the year and continued throughout the year 2005, resulting in lesser levels of loan prepayments for loans securitizing mortgage backed securities in the Company's Available for Sale and Held to Maturity portfolios. As a result, net amortization of premiums expense decreased by $210,661, or 60.2%, to $139,507 for the year ended December 31, 2005 compared to $350,168 for the year ended December 31, 2004.

The Federal Reserve Bank's Open Market Committee ("FOMC") held eight meetings in 2004 and held eight meetings in 2005. Beginning with the June 30, 2004 meeting, the FOMC increased short-term interest rates by 25 basis points and continued with a series of thirteen consecutive 25 basis point increases in each of the subsequent meetings. The immediate benefit of these interest rate increases to the Company's investment security purchases and floating rate assets resulted in an 83 basis point increase in the yield on total interest-earning assets for 2005. In addition, management's ability to lag the interest rate increases on deposits coupled with a tight discipline in deposit pricing resulted in an increase of 53 basis points in the Company's net interest margin for the year ended December 31, 2005 when compared to the year ended December 31, 2004. Management expects the FOMC to continue its program of increasing the targeted Federal Funds rate in early 2006 and has continued to structure the Company's balance sheet in an asset sensitive position in order to continue to benefit from this rising market rate environment.

During 2005, the Company has increased its core deposits base as a result of the branch expansion program undertaken throughout 2004. In 2004, the Company increased the number of branch offices in its target markets and introduced its products and services to an expanded geographic region. In January 2004, a new loan production office was opened in Fort Lee (Bergen County), New Jersey. During June 2004, new branch offices were opened in Jamesburg (Middlesex County) and West Windsor (Mercer County), New Jersey. In August 2004, the Perth Amboy (Middlesex County), New Jersey branch office was relocated to its new permanent location. This 2004 expansion program resulted in significant incremental non-interest expenses as a result of branch leases, facilities maintenance, and personnel staffing. Non-interest expense increased by $1,897,264, or 21.1%, to $10,887,225 in 2005 from $8,989,961 in 2004. Management believes the Company will continue to realize strategic benefits of this network expansion through increased deposits and new customer relationships.

Driven by construction loan growth, the Bank's loan portfolio increased 16.4% in 2005 from 2004. At December 31, 2005, total loans outstanding (including loans held for sale) reached $256,772,083 compared to $220,580,932 at December 31, 2004. Asset quality remained strong in 2005, as illustrated by the ratio of nonperforming loans to total loans of 0.32% in 2005 and 0.50% in 2004. The allowance for loan losses totaled $2,361,375, or 0.98% of total loans, covering over 283.36% of the balance of total nonperforming loans. The Bank's deposit base increased by 10.4% in 2005 from $276,887,033 at December 31, 2004 to $305,809,467 at

 

16

 


 

 

December 31, 2005. Management strategically priced deposit products to be competitive with other financial institutions with branch locations in its market yet still maintain a strong net interest margin to support earnings growth.

Management believes that the Company has positioned itself for continued success with the combination of a strong capital base, a commitment to provide exceptional customer service, and a commitment to maintain the technology necessary to provide its customers with easy access to the financial products and services offered by the Bank.

Critical Accounting Policies and Estimates

"Management's Discussion and Analysis of Financial Condition and Results of Operation" is based upon the Company's consolidated financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States of America. The preparation of these financial statements requires the Company to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses. Note 1 to the Company's Consolidated Financial Statements for the year ended December 31, 2005 contains a summary of the Company's significant accounting policies. Management believes the Company's policy with respect to the methodology for the determination of the allowance for loan losses involves a higher degree of complexity and requires management to make difficult and subjective judgments which often require assumptions or estimates about highly uncertain matters. Changes in these judgments, assumptions or estimates could materially impact results of operations. This critical policy and its application is periodically reviewed with the Audit Committee and the Board of Directors. The provision for loan losses is based upon management's evaluation of the adequacy of the allowance, including an assessment of known and inherent risks in the portfolio, giving consideration to the size and composition of the loan portfolio, actual loan loss experience, level of delinquencies, detailed analysis of individual loans for which full collectibility may not be assured, the existence and estimated net realizable value of any underlying collateral and guarantees securing the loans, and current economic and market conditions. Although management uses the best information available to it, the level of the allowance for loan losses remains an estimate which is subject to significant judgment and short-term change. Various regulatory agencies, as an integral part of their examination process, periodically review the Company's allowance for loan losses. Such agencies may require the Company to make additional provisions for loan losses based upon information available to them at the time of their examination. Furthermore, the majority of the Company's loans are secured by real estate in the State of New Jersey. Accordingly, the collectibility of a substantial portion of the carrying value of the Company's loan portfolio is susceptible to changes in local market conditions and may be adversely affected should real estate values decline or the Central New Jersey area experience an adverse economic shock. Future adjustments to the allowance for loan losses may be necessary due to economic, operating, regulatory and other conditions beyond the Company's control.

Results of Operations

The Company reported record earnings of $4,560,127, or $1.27 per share (diluted), for the year ended December 31, 2005 compared to $3,837,714, or $1.08 per share (diluted), in 2004. Net income and diluted earnings per share grew 18.8% and 17.6%, respectively, in 2005. The Company posted net income of $3,228,500 or $0.89 per share (diluted) in 2003. All share information ahs been restated for the effect of a 5% stock dividend declared on December 15, 2005 and paid on January 31, 2006 to shareholders of record on January 17, 2006.

Net Interest Income

Net interest income, the Company's largest and most significant component of operating income, is the difference between interest and fees earned on loans and other earning assets, and interest paid on deposits and borrowed funds. This component represented 85.2% of the Company's net revenues in 2005. Net interest income also depends upon the relative amount of interest earning assets, interest-bearing liabilities, and the interest rate earned or paid on them.

The following tables set forth the Company's consolidated average balances of assets and liabilities and shareholders' equity as well as interest income and expense on related items, and the Company's average yield or rate for the years ended December 31, 2005, 2004 and 2003. The average rates are derived by dividing interest income and expense by the average balance of assets and liabilities, respectively.

 

17

 

 

 

Average Balance Sheets with Resultant Interest and Rates

 

(yields on a tax-equivalent basis)

 

2005

 

2004

 

2003

 

 

Average

 

Average

 

Average

 

Average

 

Average

 

Average

 

 

Balance

Interest

Rate

 

Balance

Interest

Rate

 

Balance

Interest

Rate

 

 

 

 

 

 

 

 

 

 

 

 

 

Assets:

 

 

 

 

 

 

 

 

 

 

 

 

Federal Funds Sold/Short-Term

Investments

 

$850,741

$27,181

3.19%

 

$976,584

$10,977

1.12%

 

$3,044,985

$29,458

0.97%

Investment Securities:

 

 

 

 

 

 

 

 

 

 

 

 

U.S. Treasury Bonds

 

0

0

- -

 

0

0

- -

 

0

0

- -

Collateralized Mortgage

Obligations / Mortgage

Backed Securities

 

75,758,305

3,017,885

3.98%

 

87,636,728

3,196,936

3.65%

 

76,837,624

2,619,813

3.41%

Obligations of States and

Political Subdivisions (4)

 

18,975,766

978,099

5.15%

 

10,132,976

571,410

5.64%

 

8,058,436

461,411

5.73%

 

 

 

 

 

 

 

 

 

 

 

 

 

Total

 

94,734,071

3,995,984

4.22%

 

97,769,704

3,768,346

3.85%

 

84,896,060

3,081,224

3.63%

 

 

 

 

 

 

 

 

 

 

 

 

 

Loan Portfolio:

 

 

 

 

 

 

 

 

 

 

 

 

Commercial

 

36,519,005

2,758,112

7.55%

 

27,656,123

2,149,021

7.75%

 

38,410,951

2,768,004

7.21%

Installment

 

2,394,026

200,020

8.35%

 

3,255,459

264,074

8.09%

 

8,947,398

675,344

7.55%

Commercial Mortgages and

Construction Wholesale

 

147,297,238

10,766,296

7.31%

 

125,877,374

7,644,898

6.07%

 

90,701,292

5,567,060

6.14%

Residential Mortgages and

Construction Retail

 

13,436,207

890,510

6.63%

 

14,518,615

945,843

6.51%

 

23,133,308

1,276,368

5.52%

All Other Loans

 

31,772,196

3,007,190

9.46%

 

27,144,851

2,418,231

8.91%

 

8,998,670

1,138,986

12.66%

Total (1)

 

231,418,672

17,622,128

7.61%

 

198,452,422

13,422,067

6.76%

 

170,191,619

11,425,762

6.71%

 

 

 

 

 

 

 

 

 

 

 

 

 

Total Interest-Earning Assets

 

327,003,484

21,645,293

6.62%

 

297,197,710

17,201,390

5.79%

 

258,132,664

14,536,444

5.63%

 

 

 

 

 

 

 

 

 

 

 

 

 

Allowance for Loan Losses

 

(2,177,263)

 

 

 

(1,909,294)

 

 

 

(1,769,585)

 

 

Cash and Due From Banks

 

9,130,543

 

 

 

7,853,303

 

 

 

8,678,793

 

 

Other Assets

 

12,893,312

 

 

 

10,815,249

 

 

 

8,906,063

 

 

Total Assets

 

$346,850,076

  

 

 

$313,957,968

 

 

 

   $273,947,935

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Liabilities and Shareholders' Equity:

 

 

 

 

 

 

 

 

 

 

 

 

Interest-Bearing Liabilities:

 

 

 

 

 

 

 

 

 

 

 

 

Money Market and NOW

Accounts

 

$101,189,352

$1,211,901

1.20%

 

$96,113,368

$986,531

1.02%

 

$76,435,477

$752,547

0.98%

Savings Accounts

 

33,671,684

409,397

1.22%

 

26,890,218

136,530

0.51%

 

21,684,139

155,221

0.72%

Certificates of Deposit

 

77,183,169

2,383,392

3.09%

 

74,136,634

1,917,353

2.58%

 

63,182,395

1,751,582

2.77%

Certificates of Deposit of

$100,000 and Over

 

9,771,290

309,159

3.16%

 

10,156,576

260,109

2.55%

 

18,287,421

503,905

2.76%

Other Borrowed Funds

 

31,143,663

1,363,507

4.38%

 

24,812,983

981,689

3.95%

 

23,985,934

952,910

3.97%

Trust Preferred Securities

 

5,000,000

350,823

7.02%

 

5,000,000

263,083

5.33%

 

5,000,000

257,852

5.16%

 

 

 

 

 

 

 

 

 

 

 

 

 

Total Interest-Bearing Liabilities

 

257,959,158

6,028,179

2.34%

 

237,109,779

4,545,295

1.91%

 

208,575,366

4,374,017

2.10%

 

 

 

 

 

 

 

 

 

 

 

 

 

Net Interest Spread (2)

 

 

 

4.28%

 

 

 

3.86%

 

 

 

3.53%

 

 

 

 

 

 

 

 

 

 

 

 

 

Non-interest Bearing

Demand Deposits

 

57,792,902

 

 

 

49,622,127

 

 

 

41,318,131

 

 

Other Liabilities

 

3,447,534

 

 

 

2,536,002

 

 

 

2,310,536

 

 

Total Liabilities

 

319,199,594

 

 

 

289,267,908

 

 

 

252,204,033

 

 

Shareholders' Equity

 

27,650,482

 

 

 

24,690,060

 

 

 

21,743,902

 

 

Total Liabilities and Shareholders' Equity

 

$346,850,076

 

 

 

$313,957,968

 

 

 

$273,947,935

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Net Interest Margin (3)

 

 

$15,617,114

4.78%

 

 

$12,656,095

4.25%

 

 

$10,162,427

3.94%

 

 

(1)

Loan origination fees are considered an adjustment to interest income. For the purpose of calculating loan yields, average loan balances include nonaccrual loans with no related interest income.
(2)

The interest rate spread is the difference between the average yield on interest earning assets and the average rate paid on interest bearing liabilities.
(3)

The net interest margin is equal to net interest income divided by average interest earning assets.
(4) Tax equivalent basis.

 

 

18

 


 

Changes in net interest income and margin result from the interaction between the volume and composition of interest earning assets, interest bearing liabilities, related yields, and associated funding costs. The Rate/Volume Table demonstrates the impact on net interest income of changes in the volume of interest earning assets and interest bearing liabilities and changes in interest rates earned and paid.

The Company's net interest income increased on a tax equivalent basis by $2,961,019, or 23.4%, to $15,617,114 in 2005, from the $12,656,095 reported in 2004. As indicated in the Rate/Volume Table, the principal factor contributing to the 2005 increase in net interest income was an increase in the interest income of $2,380,579, resulting from increased balances in the loan portfolio components. This was partially offset by an increase in interest expense resulting from increases in the rates paid on deposit components.

The Company's net interest income increased by $2,493,669, or 24.5%, to $12,656,095 in 2004, from the $10,162,427 reported in 2003. As indicated in the Rate/Volume Table, the principal factor contributing to the 2004 increase in net interest income was an increase in the interest income of $1,963,469, resulting from increased balances in the loan portfolio components. This was partially offset by an increase in interest expense resulting from increases in deposits components.
 

Rate/Volume Table

 

Amount of Increase (Decrease)

 

 

Year Ended December 31,

2005 versus 2004

 

Year Ended December 31,

2004 versus 2003

 

 

Due to Change in:

 

Due to Change in:

(Tax-equivalent basis)

 

Volume

 

Rate

 

Total

 

Volume

 

Rate

 

Total

 

 

 

 

 

 

 

 

 

 

 

 

 

Interest Income:

 

 

 

 

 

 

 

 

 

 

 

 

Loans:

 

 

 

 

 

 

 

 

 

 

 

 

Commercial

 

$664,403

 

($55,312)

 

$609,091

 

($775,423)

 

$156,440

 

($618,983)

Installment

 

(69,690)

 

5,636

 

(64,054)

 

(459,586)

 

48,316

 

(411,270)

Commercial Mortgages and Construction- Wholesale

 

1,430,352

 

1,691,046

 

3,121,398

 

2,141,328

 

(63,491)

 

2,077,838

Residential Mortgages and Construction- Retail

 

(70,464)

 

15,131

 

(55,333)

 

(559,545)

 

229,020

 

(330,525)

All Other Loans

 

425,978

 

162,981

 

588,959

 

1,616,696

 

(337,450)

 

1,279,245

Total loans

 

2,380,579

 

1,819,482

 

4,200,061

 

1,963,469

 

32,836

 

1,996,304

Investment Securities :

 

 

 

 

 

 

 

 

 

 

 

 

 

Collat. Mortg. Obligations / Mortg. Backed Securities

 

(450,907)

 

271,856

 

(179,051)

 

381,290

 

195,832

 

577,123

States and political subdivisions

 

477,537

 

(70,848)

 

406,689

 

117,251

 

(7,253)

 

109,999

Total Investment Securities

 

26,630

 

201,008

 

227,638

 

498,542

 

188,580

 

687,122

Federal Funds Sold / Short-Term Investments

 

(4,011)

 

20,215

 

16,204

 

(23,048)

 

4,567

 

(18,481)

Total Interest Income

 

2,403,198

 

2,040,705

 

4,443,903

 

2,438,963

 

225,983

 

2,664,945

 

 

 

 

 

 

 

 

 

 

 

 

 

Interest Expense :

 

 

 

 

 

 

 

 

 

 

 

 

Money Market and NOW Accounts

 

51,775

 

173,595

 

$225,370

 

203,409

 

30,574

 

233,984

Savings Accounts

 

58,265

 

214,602

 

272,867

 

37,484

 

(56,175)

 

(18,691)

Certificates of Deposit

 

83,271

 

382,768

 

466,039

 

285,817

 

(120,047)

 

165,771

Certificates of Deposit of $100,000 And Over

 

(9,825)

 

58,875

 

49,050

 

(205,392)

 

(38,404)

 

(243,796)

Other Borrowed Funds

 

262,592

 

119,226

 

381,818

 

33,576

 

(4,797)

 

28,779

Trust Preferred Securities

 

- -

 

 

87,740

 

87,740

 

0

 

5,231

 

5,231

Total interest expense

 

446,078

 

1,036,806

 

1,482,884

 

354,893

 

(183,617)

 

171,277

 

Net Interest Income

 

$1,957,120

 

$1,003,900

 

$2,961,019

 

$2,084,069

 

$409,600

 

$2,493,668
                         

 

Average interest earning assets increased by $29,805,774, or 10.0%, to $327,003,484 in 2005 from $297,198,710 in 2004, consisting primarily of an increase in 2005 of $32,966,250 in loans partially offset by a decrease of $3,035,633 in investment securities compared to 2004. Led by commercial mortgages and construction loans, the Bank's average loan portfolio grew by 16.6% and loan yields averaged 7.61% in 2005, 85 basis points higher than in 2004. This increase was primarily the result of 2005 loan growth at floating yields amid the increasing interest rate environment that continued during the year. The Bank's average investment securities portfolio decreased 3.1%, and the yield on that portfolio increased 37 basis points in 2005 compared to 2004, primarily as a result of the reduced level of premium amortization on mortgage-backed securities due to the rising rate environment that continued throughout the year 2005. Net premium amortization for 2005 was

 

19

 


  

$139,507 compared to $350,168 for 2004. Overall, the yield on interest earning assets increased 83 basis points to 6.62% in 2005 from 5.79% in 2004.

Average interest earning assets increased by $39,065,046, or 15.1%, to $297,197,710 in 2004 from $258,132,644 in 2003, with increases in 2004 of $28,260,803 in loans and $12,873,644 in investment securities compared to 2003. Led by commercial mortgages and construction loans, the Bank's average loan portfolio grew by 16.6%, and loan yields averaged 6.76%, in 2004, 5 basis points higher than 2003. This increase was primarily the result of 2004 loan growth at floating yields amid the increasing interest rate environment that evolved during the latter part of the year. The Bank's average investment securities portfolio grew 15.2%, and the yield on that portfolio increased 22 basis points, in 2004 compared to 2003, primarily as a result of the reduced level of premium amortization on mortgage-backed securities due to the rising rate environment that evolved during the latter portion of 2004. Net premium amortization for 2004 was $350,168 compared to $1,190,853 for 2003. Overall, the yield on interest earnings assets increased 16 basis points to 5.79% in 2004 from 5.63% in 2003.

Interest expense increased by $1,482,884, or 32.6%, to $6,028,179 for 2005, from $4,545,295 for 2004. This increase in interest expense is principally attributable to higher levels of interest-bearing liabilities priced at a higher market interest rate level. Savings accounts increased on average by $6,781,466 in 2005 as compared to 2004, contributing to the funding of loan portfolio growth. The cost on these deposits increased 71 basis points in 2005 from 2004. Average interest bearing liabilities rose 8.8% in 2005 from 2004. The cost of total interest-bearing liabilities increased 43 basis points to 2.34% in 2005 from 1.91% in 2004.

Interest expense increased by $171,278, or 3.9%, to $4,545,295 for 2004, from $4,374,017 for 2003. This increase in interest expense is principally attributable to higher levels of interest-bearing liabilities priced at a higher market interest rate level. Money market and NOW accounts increased on average by $19,677,891 in 2004 as compared to 2003, contributing to the funding of loan portfolio growth. The cost on these deposits increased 4 basis points in 2004 from 2003. Average interest bearing liabilities rose 13.7% in 2004 from 2003. The cost of total interest-bearing liabilities decreased 19 basis points to 1.91% in 2004 from 2.10% in 2003.

Average non-interest bearing demand deposits increased by $8,170,775, or 16.5%, to $57,792,902 in 2005 from $49,622,127 in 2004. Expansion of the branch network and the resulting new business relationships have generated most of this increase. Throughout the comparative periods, increases in average non-interest bearing deposits contributed to the increases in net interest income.

Non-Interest Income

Non-interest income increased by $89,618, or 3.5%, to $2,646,861 in 2005 from $2,557,242 in 2004. Non-interest income in 2004 increased by $155,893, or 6.5%, from a total of $2,401,349 for 2003.

Service charges on deposit accounts represent a significant source of non-interest income. Service charge revenues increased by $175,610, or 34.1%, to $690,104 in 2005 from $514,494 in 2004. Service charge revenue totaled $559,698 in 2003. This component of non-interest income represented 26.1%, 20.1%, and 23.3% of the total non-interest income in 2005, 2004, and 2003, respectively. Service charge income increased in 2005 principally due to management's actions to restructure service charges and fees based on the results of a comparative study of market fees performed in early 2005. During 2005, new fees were assessed on accounts overdrawn for drawing on uncollected funds plus a new fee for processing incoming wire transfers was initiated. Service charge income decreased in 2004 as a result of the Bank waiving service charges on new accounts during the period of branch expansion, and a decreasing number of accounts subject to service charges. Management continues to utilize a strategy of requiring compensating balances from its commercial customers. Those who meet balance requirements are not assessed service charges.

Gain on sale of loans held for sale increased by $70,861, or 5.2%, to $1,444,521 for 2005, from $1,373,660 for 2004. Gain on sale of loans held for sale totaled $1,284,913 in 2003. Market interest rates on 30-year fixed rate mortgages fell consistently during 2004, and into the first half of 2005. Consumer refinance of home loans, which, along with a strong housing market, led to the Bank achieving high levels in mortgage origination volumes and mortgage loan sale gains, as newly-originated loans were sold at higher than normal spreads due to the consistently lower level of market interest rates. The rising rate environment that evolved during late 2004 and continued throughout 2005 has not significantly impacted the mortgage market and resultant secondary loan sales as long term rates have not increased at the same pace as short term rates.

 

20

 

 

Non-interest income also includes income from bank-owned life insurance ("BOLI") which amounted to $235,430 for 2005 compared to $312,496 for 2004. The Bank purchased $6.0 million in tax-free BOLI assets in 2002 and $2.0 million in 2005, which partially offset the cost of employee benefit plans and reduced the overall effective tax rate. The Bank also generates non-interest income from a variety of fee-based services. These include safe deposit rentals, wire transfer service fees and Automated Teller Machine fees for non-customers. Deposit and service fee charges are reviewed and adjusted as needed from time to time by management to reflect current costs incurred by the Bank to offer the products or services and prices charged by competitor financial institutions amid the Bank's competitive market.

The Company recorded net losses on sales of securities available for sale of $271,871 in 2005 versus net gains on sales of $27,545 in 2004. These portfolio transactions in 2005 and 2004 were primarily the result of modest portfolio restructurings. Their purpose was to improve the Company's longer-term interest rate risk position.

Non-Interest Expenses

Non-interest expenses increased by $1,897,264, or 21.1%, to $10,887,225 in 2005, from $8,989,961 in 2004. Non-interest expenses in 2004 increased 25.4% to $8,989,961 from $7,168,722 in 2003. The largest increase in non-interest expenses in 2005 compared to 2004 was in salaries and employees benefits. To a lesser extent, occupancy, and other non-interest expenses also reflect increases for the comparable periods. The largest increase in non-interest expenses in 2004 compared to 2003 was in salaries and employee benefits and, to a lesser extent, other non-interest expenses, as indicated in the table below. The following table presents the major components of non-interest expenses for the years 2003 through 2005.
 

Non-interest Expenses

 

2005

2004

2003

Salaries and employee benefits

$5,894,200

$4,955,587

$3,979,655

Occupancy expense

1,365,930

1,071,463

818,545

Equipment expense

491,735

464,928

434,933

Marketing

292,352

274,095

225,860

Date processing services

623,001

636,076

498,081

Regulatory, professional and other fees

1,102,691

542,001

548,440

Office expense

401,490

462,586

312,055

All other expenses

715,826

583,225

351,153

Total

$10,887,225

$8,989,961

$7,168,722

 

 

 

 

 

Salaries and employee benefits, which represent the largest portion of non-interest expenses, increased by $938,613, or 18.9%, to $5,894,200 in 2005 compared to $4,955,587 in 2004. The 2005 increase is primarily due to (a) increased staffing levels for all of 2005 as a result of the opening of three new branch locations plus a new loan production office during 2004 plus (b) normal employee salary increases. These expenses increased in 2004 by $975,932, or 24.5%, over the $3,979,655 reported for 2003.      The increase in the level of salaries and employee benefits for 2004 versus 2003 reflects the increase in staffing levels due to the branch expansion program plus normal salary increases. Salaries and employee benefits as a percentage of average assets were 1.70% in 2005, 1.58% in 2004 and 1.45% in 2003. As the result of the adoption by the Company as of January 1, 2006 of Financial Accounting Standards Board Statement No. 123(R), Share Based Payment, management expects the expenses for employees will increase in 2006. See "Recent Accounting Pronouncements".

For 2005, occupancy expense increased by $294,467, or 27.5%, to $1,365,930 from $1,071,463 for 2004. The increase in occupancy expense for 2005 compared to 2004 was a result of the 2004 branch expansion program which included new office space rentals, maintenance, and other related expenses. The increase in occupancy expense in 2004 compared to 2003 was due primarily to contractual rent increases at most of the Bank's branch offices.

 

21

 

  

The occupancy expense component of total non-interest expense as a percentage of average assets was 0.39% in 2005, 0.34% in 2004 and 0.30% in 2003, respectively.

Regulatory, professional and other fees increased by $560,690, or 103.4%, to $1,102,691 in 2005 compared to $542,001 in 2004 as the Company incurred increased legal, independent accountant and consultant fees primarily as a result of new compliance requirements contained in Section 404 of the Sarbanes - Oxley Act.

The Bank's ratio of non-interest expense to average assets was 3.14% for 2005 compared to 2.86% for 2004 and 2.62% for 2003.

An important industry productivity measure is the efficiency ratio. The efficiency ratio is calculated by dividing total operating expenses by net interest income and other income. An increase in the efficiency ratio indicates that more resources are being utilized to generate the same or greater volume of income, while a decrease would indicate a more efficient allocation of resources. The Bank's efficiency ratio increased modestly in 2005 to 60.7% compared to 59.8% in 2004 and 57.7% in 2003.

Financial Condition

Cash and Cash Equivalents

At December 31, 2005, cash and cash equivalents totaled $12,137,750 compared to $7,924,409 at December 31, 2004. Cash and cash equivalents at December 31, 2005 consisted of cash and due from banks of $9,394,929 and federal funds sold/short-term investments of $2,742,821. The corresponding balances at December 31, 2004 were $7,898,395 and $26,014, respectively. The higher balances of cash and cash equivalents at December 31, 2005 were primarily due to late December 2005 interest-bearing deposits balances raised to fund loan growth and manage the Bank's liquidity position.

Securities

The Bank's investment securities portfolio amounted to $90,995,028, or 24.4% of total assets at December 31, 2005, compared to $97,755,786, or 29.1% of total assets at December 31, 2004. On an average balance basis, the investment securities portfolio represented 29.0% and 32.9% of average interest-earning assets for the years ended December 31, 2005 and 2004, respectively. The average yield earned on the portfolio was 4.22% in 2005, an increase of 37 basis points from 3.85% earned in 2004.

Securities available for sale are investments that may be sold in response to changing market and interest rate conditions or for other business purposes. Securities available for sale consist primarily of U.S. Government and Federal agency securities as well as mortgage-backed securities. Activity in this portfolio is undertaken primarily to manage liquidity and interest rate risk and to take advantage of market conditions that create economically more attractive returns. At December 31, 2005, available-for-sale securities amounted to $69,236,658, a decrease of $16,351,991 from December 31, 2004. The Company recorded net losses on sales of securities available for sale of $271,871 in 2005 versus net gains on sales of $27,545 in 2004.

Proceeds from maturities and prepayments of securities available for sale amounted to $17,074,576 in 2005 and $29,011,317 in 2004. At December 31, 2005, the portfolio had net unrealized losses of $1,274,157, compared to net unrealized losses of $170,875 at December 31, 2004. These unrealized gains and losses are reflected net of tax in shareholders' equity as other comprehensive income (loss).

Securities held to maturity, which are carried at amortized historical cost, are investments for which there is the positive intent and ability to hold to maturity. The held-to-maturity portfolio consists primarily of obligations of states and political subdivisions. At December 31, 2005, securities held to maturity were $21,758,370, an increase of $9,591,233 from $12,167,137 at December 31, 2004. The market value of the held-to-maturity portfolio at December 31, 2005 was $21,521,026, resulting in a net unrealized loss of $237,344.

 

22

 

 

The amortized cost, estimated market value and weighted average yield of debt securities at December 31, 2005, by contractual maturity, are shown below. Expected maturities will differ from contractual maturities because borrowers may have the right to call or prepay obligations with or without call or prepayment penalties. Federal Home Loan Bank stock is included in "Held to maturity - Due in one year or less."
 

 

 

 

Amortized

Cost

 

Estimated

Market

Value

 

Weighted

Average

Yield*

Available for sale-

 

 

 

 

 

 

Due in one year or less

 

$4,620,617

 

$4,611,487

 

2.56%

Due after one year through five years

 

14,657,111

 

14,359,729

 

3.91%

Due after five years through ten years

 

15,131,245

 

14,905,727

 

4.73%

Due after ten years

 

36,101,843

 

35,359,715

 

4.95%

 

 

 

 

 

 

 

Total

 

$70,510,816

 

$69,236,658

 

4.53%

 

 

 

 

 

 

 

Held to maturity-

 

 

 

 

 

 

Due in one year or less

 

$4,180,681

 

$4,168,393

 

2.24%

Due after one year through five years

 

3,067,600

 

3,087,895

 

5.52%

Due after five years through ten years

 

3,248,929

 

3,215,590

 

5.38%

Due after ten years

 

11,261,161

 

11,049,148

 

5.62%

 

 

 

 

 

 

 

Total

 

$21,758,371

 

$21,521,026

 

4.92%

* computed on a tax equivalent basis.

Loans

The loan portfolio, which represents the Bank's largest asset, is a significant source of both interest and fee income. Elements of the loan portfolio are subject to differing levels of credit and interest rate risk. The Bank's primary lending focus continues to be construction loans, commercial loans, owner-occupied commercial mortgage loans and tenanted commercial real estate loans. Total loans averaged $231,418,672 during 2005, an increase of $32,966,250, or 16.6%, compared to an average of $198,452,422 in 2004. Growth in the average loan portfolio balance was generated primarily by an increase of $21,419,864, or 17.0%, in commercial mortgage and construction wholesale loans. At December 31, 2005, total loans amounted to $240,014,349 compared to $210,653,051 at December 31, 2004, an increase of $29,361,298, or 13.9%. The average yield earned on the loan portfolio was 7.61% in 2005 compared to 6.76% in 2004, an increase of 85 basis points. This increase is primarily due to the rising interest rate environment that evolved during the last half of 2004 and continued throughout 2005.

The following table represents the components of the loan portfolio for the dates indicated.
 

 

December 31,

 

2005

2004

2003

2002

2001

 

Amount

%

Amount

%

Amount

%

Amount

%

Amount

%

Construction loans

$109,862,614

46%

$88,027,024

42%

$56,971,265

35%

$32,342,880

21%

$29,385,096

24%

Residential real estate loans

 

8,602,975

 

4%

 

9,815,366

 

5%

 

8,059,032

 

5%

 

9,032,228

 

6%

 

11,634,097

 

9%

Commercial and commercial real estate loans

 

104,448,196

 

43%

 

96,021,077

 

46%

 

83,840,831

 

51%

 

89,415,759

 

59%

 

62,442,753

 

50%

Loans to individuals

16,441,994

7%

16,002,619

7%

13,236,895

8%

14,851,742

10%

15,587,772

12%

Lease financing

21,073

0%

74,543

0%

1,054,198

1%

4,773,528

4%

5,717,826

5%

All other loans

637,497

0%

712,422

0%

788,085

0%

642,599

0%

169,939

0%

 

 

 

 

 

 

 

 

 

 

 

Total

$240,014,349

100%

$210,653,051

100%

$163,950,306

100%

$151,049,736

100%

$124,937,483

100%

 

 

 

 

 

 

 

 

 

 

 
                     

 

The rising interest rate environment that existed throughout 2005, especially the rising average prime rate, and competitive loan pricing resulted in the increased portfolio components discussed in the following paragraphs.

 

23

 


 

Commercial loans averaged $36,519,005 for 2005, an increase of $8,861,882, or 32.0%, compared to $27,656,123 for 2004. Commercial loans consist primarily of loans to small and middle market businesses and are typically working capital loans used to finance inventory, receivables or equipment needs. These loans are generally secured by business assets of the commercial borrower. The average yield on the commercial loan portfolio decreased 20 basis points to 7.55% in 2005 from 7.75% in 2004.

Commercial mortgages and construction wholesale loans averaged $147,297,238 for 2005, an increase of $21,419,864, or 17.0%, compared to $125,877,374 for 2004. Generally, these loans represent owner-occupied or investment properties and usually complement a broader commercial relationship between the bank and the borrower. Construction loans are structured to provide for advances only after work is completed and inspected by qualified professionals. The average yield on the commercial mortgages and construction wholesale loan portfolio increased 124 basis points to 7.31% for 2005 from 6.07% for 2004.

Residential mortgages and construction retail loans averaged $13,436,207 for 2005, a decrease of $1,082,408, or 7.5%, compared to $14,518,615 for 2004. These loans consist primarily of residential mortgage loans, home equity loans and business loans secured by residential real estate. The average yield on this portfolio increased 12 basis points to 6.63% for 2005 from 6.51% for 2004.

The following table provides information concerning the interest rate sensitivity of the Bank's commercial and commercial real estate loans and construction loans at December 31, 2005.

   

Maturity Range

  

 

 

Type

Within

One
Year

  

After One But

Within

Five Years

  

After

Five

Years

  

 

Total

Commercial & Commercial real estate

$20,314,514

  

$25,946,870

  

$58,186,812

  

$104,448,196

Construction Loans

87,006,197

  

22,856,417

  

                    -

  

109,862,614

Total

$107,320,711

  

$48,803,287

  

$58,186,812

  

$214,310,810

 

 

  

 

  

 

  

 

Fixed rate loans

$2,793,963

  

$18,190,392

  

$6,074,785

  

$27,059,139

Floating rate loans

104,526,748

  

30,612,895

  

52,112,028

  

187,251,671

 

Total

 

$107,320,711

  

 

$48,803,287

  

 

$58,186,812

  

 

$214,310,810
               

 

Non-Performing Assets

Non-performing assets consist of non-performing loans and other real estate owned. Non-performing loans are composed of (1) loans on a non-accrual basis, (2) loans which are contractually past due 90 days or more as to interest and principal payments but have not been classified as non-accrual, and (3) loans whose terms have been restructured to provide a reduction or deferral of interest on principal because of a deterioration in the financial position of the borrower.

The Bank's policy with regard to non-accrual loans is that generally, loans are placed on a non-accrual status when they are 90 days past due unless these loans are well secured and in the process of collection or, regardless of the past due status of the loan, when management determines that the complete recovery of principal or interest is in doubt. Consumer loans are generally charged off after they become 120 days past due. Subsequent payments on loans in non-accrual status are credited to income only if collection of principal is not in doubt.

 

24

 


 

 Non-performing loans decreased by $279,182, or 25.1%, to $833,359 at December 31, 2005, from $1,112,541 at December 31, 2004. This decrease is primarily due to a decrease of $216,261 in non-accrual loans to $833,150 at December 31, 2005 compared to $1,049,411 at December 31, 2004. Management believes that the borrowing relationships representing the balance of non-performing loans at December 31, 2005 are well collateralized and present minor risk of financial loss to the Company. The table below sets forth non-performing assets and risk elements in the Bank's portfolio by type for the years indicated. As the table demonstrates, loan quality and ratios remain strong. This was accomplished through quality loan underwriting, a proactive approach to loan monitoring and aggressive workout strategies.

Non-performing assets decreased by $279,182, or 25.1%, to $833,359 at December 31, 2005 from $1,112,541 at December 31, 2004. Non-performing assets represented 0.22% of total assets at December 31, 2005 and 0.33% at December 31, 2004. Non-performing loans as a percentage of total loans were 0.32% at December 31, 2005, compared to 0.50% at December 31, 2004.

The Bank had no loans classified as restructured loans or potential problem loans at December 31, 2005 and 2004.

At December 31, 2005, the Bank had $209 in loans that were 90 days or more past due but still accruing interest income compared to $63,130 of loans in this category of non-performing loans at December 31, 2004. Management's decision to accrue income on these loans was based on the level of collateral and the status of collection efforts.
 

Non-Performing Assets and Loans

 

 

 

 

 

 

2005

2004

2003

2002

2001

Non-Performing loans:

 

 

 

 

 

Loans 90 days or more past due and still accruing

$209

$63,130

$0

$2,156

$0

Non-accrual loans

833,150

1,049,411

330,783

156,156

618,102

Total non-performing loans

833,359

1,112,541

330,783

158,312

618,102

Other real estate owned

0

0

8,971

9,492

0

Total non-performing assets

$833,359

$1,112,541

$339,754

$167,804

$618,102

 

 

 

 

 

 

Non-performing loans to total loans

0.32%

0.50%

0.20%

0.10%

0.49%

Non-performing assets to total assets

0.22%

0.33%

0.12%

0.06%

0.28%

 

Management takes a proactive approach in addressing delinquent loans. The Company's President meets weekly with all loan officers to review the status of credits past-due ten days or more. An action plan is discussed for each of the loans to determine the steps necessary to induce the borrower to cure the delinquency and restore the loan to a current status. Also, delinquency notices are system generated when loans are five days past-due and again at fifteen days past-due.

In most cases, the Company's collateral is real estate and when the collateral is foreclosed upon, the real estate is carried at the lower of fair market value less estimated selling costs, or at cost. The amount, if any, by which the recorded amount of the loan exceeds the fair market value of the asset is a loss which is charged to the allowance for loan losses at the time of foreclosure or repossession. Resolution of a past-due loan can be delayed if the borrower files a bankruptcy petition because collection action cannot be continued unless the Company first obtains relief from the automatic stay provided by the bankruptcy code.

 

Allowance for Loan Losses and Related Provision

The allowance for loan losses is maintained at a level sufficient to absorb estimated credit losses in the loan portfolio as of the date of the financial statements. The allowance for loan losses is a valuation reserve available for losses incurred or inherent in the loan portfolio and other extensions of credit. The determination of the adequacy of the allowance for loan losses is a critical accounting policy of the Company.

 

25

 

  

The Company's primary lending emphasis is the origination of commercial and commercial real estate loans including construction loans. Based on the composition of the loan portfolio, the primary risks inherent in it are deteriorating credit quality, increases in interest rates, a decline in the economy, and a decline in New Jersey real estate market values. Any one or a combination of these events may adversely affect the loan portfolio and may result in increased delinquencies, loan losses and increased future provision levels.

All, or part, of the principal balance of commercial and commercial real estate loans, and construction loans are charged off to the allowance as soon as it is determined that the repayment of all, or part, of the principal balance is highly unlikely. Consumer loans are generally charged off no later than 120 days past due on a contractual basis, earlier in the event of bankruptcy, or if there is an amount deemed uncollectible. Because all identified losses are immediately charged off, no portion of the allowance for loan and lease losses is restricted to any individual loan or groups of loans, and the entire allowance is available to absorb any and all loan and lease losses.

Management reviews the adequacy of the allowance on at least a quarterly basis to ensure that the provision for loan and lease losses has been charged against earnings in an amount necessary to maintain the allowance at a level that is adequate based on management's assessment of probable estimated losses. The Company's methodology for assessing the adequacy of the allowance for loan and lease losses consists of several key elements. These elements include a specific reserve for doubtful or high risk loans, an allocated reserve, and an unallocated portion. The Company consistently applies the following comprehensive methodology.

During the quarterly review of the allowance for loan and lease losses, the Company considers a variety of factors that include:

  • General economic conditions.

  • Trends in charge-offs.

  • Trends and levels of delinquent loans.

  • Trends and levels of non-performing loans, including loans over 90 days delinquent.

  • Trends in volume and terms of loans.

  • Levels of allowance for specific classified loans.

  • Credit concentrations.

The specific reserve for high risk loans is established for specific commercial loans, commercial real estate loans, and construction loans which have been identified by management as being high risk loan assets. These high risk loans are assigned a doubtful risk rating grade because the loan has not performed according to payment terms and there is reason to believe that repayment of the loan principal in whole, or part, is unlikely. The specific portion of the allowance is the total amount of potential unconfirmed losses for these individual doubtful loans. To assist in determining the fair value of loan collateral, the Company often utilizes independent third party qualified appraisal firms which in turn employ their own criteria and assumptions that may include occupancy rates, rental rates, and property expenses, among others.

The second category of reserves consists of the allocated portion of the allowance. The allocated portion of the allowance is determined by taking pools of loans outstanding that have similar characteristics and applying historical loss experience for each pool. This estimate represents the potential unconfirmed losses within the portfolio. Individual loan pools are created for commercial and commercial real estate loans, construction loans, and for the various types of loans to individuals. The historical estimation for each loan pool is then adjusted to account for current conditions, current loan portfolio performance, loan policy or management changes, or any other factor which may cause future losses to deviate from historical levels.

The Company also maintains an unallocated allowance. The unallocated allowance is used to cover any factors or conditions which may cause a potential loan loss but are not specifically identifiable. It is prudent to maintain an unallocated portion of the allowance because no matter how detailed an analysis of potential loan losses is performed, these estimates by definition lack precision. Management must make estimates using assumptions and information which is often subjective and changing rapidly. At December 31, 2005, management believed that the allowance for loan losses and nonperforming loans was adequate.

 

26

 

 

The table below presents, for the years indicated, an analysis of the allowance for loan losses and other related data.
 

Allowance for Loan Losses

 

 

 

 

 

 

 

 

 

 

 

 

2005

 

2004

 

2003

 

2002

 

2001

Balance, beginning of period

 

$2,005,169

 

$1,786,632

 

$1,669,882

 

$1,414,495

 

$1,132,555

 

 

 

 

 

 

 

 

 

 

 

Provision charged to operating expenses

 

405,000

 

240,000

 

240,000

 

240,000

 

300,000

 

 

 

 

 

 

 

 

 

 

 

Loans charged off:

 

 

 

 

 

 

 

 

 

 

Construction loans

 

- -

 

- -

 

- -

 

- -

 

- -

Residential real estate loans

 

- -

 

- -

 

- -

 

- -

 

- -

Commercial and commercial real estate loans

 

(39,150)

 

(17,070)

 

(115,698)

 

(7,034)

 

(20,297)

Loans to individuals

 

(13,653)

 

(5,203)

 

(7,968)

 

(1,148)

 

(676)

Lease financing

 

- -

 

- -

 

- -

 

- -

 

- -

All other loans

 

- -

 

- -

 

- -

 

- -

 

- -

 

 

(52,803)

 

(22,273)

 

(123,666)

 

(8,182)

 

(20,973)

Recoveries:

 

 

 

 

 

 

 

 

 

 

Construction loans

 

- -

 

- -

 

- -

 

- -

 

- -

Residential real estate loans

 

- -

 

- -

 

- -

 

- -

 

- -

Commercial and commercial real estate loans

 

1,498

 

750

 

 

 

20,296

 

 

Loans to individuals

 

2,511

 

60

 

416

 

3,273

 

2,913

Lease financing

 

- -

 

- -

 

- -

 

- -

 

- -

All other loans

 

- -

 

- -

 

- -

 

- -

 

- -

 

 

4,009

 

810

 

416

 

23,569

 

2,913

Net (charge offs) / recoveries

 

(48,794)

 

(21,463)

 

(123,250)

 

15,387

 

(18,060)

 

 

 

 

 

 

 

 

 

 

 

Balance, end of period

 

$2,361,375

 

$2,005,169

 

$1,786,632

 

$1,669,882

 

$1,414,495

 

 

 

 

 

 

 

 

 

 

 

Loans:

 

 

 

 

 

 

 

 

 

 

At year end

 

$256,772,083

 

$220,580,932

 

$163,950,306

 

$151,049,736

 

$124,937,483

Average during the year

 

231,418,672

 

198,452,422

 

170,191,619

 

145,159,286

 

123,944,552

Net (charge offs) recoveries to average loans outstanding

 

(0.02%)

 

(0.01%)

 

(0.07%)

 

0.01%

 

(0.01%)

 

 

 

 

 

 

 

 

 

 

 

Allowance for loan losses to:

 

 

 

 

 

 

 

 

 

 

Total loans at year end

 

0.92%

 

0.91%

 

1.09%

 

1.11%

 

1.13%

Non-performing loans

 

283.36%

 

180.23%

 

540.12%

 

270.16%

 

228.84%

 

At December 31, 2005, the allowance for loan losses was $2,361,375 compared to $2,005,169 at December 31, 2004, an increase of $356,206, or 17.8%. The ratio of the allowance for loan losses to total loans at December 31, 2005 and 2004 was 0.92% and 0.91%, respectively. The allowance for loan losses as a percentage of non-performing loans was 283.36% at December 31, 2005, compared to 180.23% at December 31, 2004. Management believes the quality of the loan portfolio remains strong and that the allowance for loan losses is adequate in relation to credit risk exposure levels.

The provision for loan losses was $405,000 and $240,000, respectively, for the years ended December 31, 2005 and 2004. Management considers a complete review of the following specific factors in determining the provision for loan losses: historical losses by loan category, non-accrual loans, problem loans as identified through internal classifications, collateral values, and the growth and size of the portfolio. In addition to these factors, management takes into consideration current economic conditions and local real estate market conditions. The increase in the provision for the year ended December 31, 2005 was primarily due growth of the loan portfolio and increased watch list loans. Management believes the quality of the loan portfolio remains sound, the determination of the provision for loan losses amount was primarily due to the manageable balances in non-accrual loans and management's assessment of economic conditions in the Bank's marketplace. Net charge offs/recoveries amounted to a net charge off of $48,794 in 2005 compared to a net charge off of $21,463 in 2004.

 

27

 

 

The following table describes the allocation of the allowance for loan losses among the various categories of loans and certain other information as of the dates indicated. The allocation is made for analytical purposes and is not necessarily indicative of the categories in which future losses may occur. The total allowance is available to absorb losses from any segment of loans.
 

 

Allocation of the Allowance for Loan Losses

 

 

 

 

 

 

 

 

 

 

 

 

December 31, 2005

December 31, 2004

December 31, 2003

December 31, 2002

December 31, 2001

 

 

 

Amount

% of loans in each category to total loans

 

 

Amount

% of loans in each category to total loans

 

 

Amount

% of loans in each category to total loans

 

 

Amount

% of loans in each category to total loans

 

 

Amount

% of loans in each category to total loans

Balance at end of period applicable to:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Domestic:

 

 

 

 

 

 

 

 

 

 

Commercial and commercial real estate

 

$1,393,211

 

43%

 

$1,183,050

 

46%

 

$1,054,113

 

52%

 

$985,230

 

60%

 

$707,248

 

51%

Construction

578,537

46%

491,266

41%

375,193

34%

350,675

21%

325,334

23%

Residential real estate

141,683

4%

120,310

5%

107,198

5%

100,193

6%

127,305

9%

Loans to individuals

236,138

7%

200,517

8%

178,663

8%

166,988

10%

169,739

12%

Lease financing

4,723

0%

4,010

0%

53,599

1%

50,096

3%

70,725

5%

Unallocated

7,084

0%

6,016

0%

17,866

0%

16,699

0%

14,144

0%

 

 

 

 

 

 

 

 

 

 

 

 

$2,361,375

100%

$2,005,169

100%

$1,786,632

100%

$1,669,882

100%

$1,414,495

100%
                     

 

Deposits

Deposits, which include demand deposits (interest bearing and non-interest bearing), savings and time deposits, are a fundamental and cost-effective source of funding. The Bank offers a variety of products designed to attract and retain customers, with the Bank's primary focus being on building and expanding long-term relationships. Deposits in 2005 averaged $279,608,397, an increase of $22,689,474, or 8.8%, compared to $256,918,923 for 2004. At December 31, 2005, total deposits were $305,809,467, an increase of $28,922,434, or 10.4%, from $276,887,033 at December 31, 2004. The average rate paid on the Bank's interest-bearing deposit balances for 2005 was 1.94%, increasing from the 1.59% average rate for 2004.

The significant contributor to the level of deposit growth in the year ended December 31, 2005 were non-interest bearing demand deposits, which increased by $11,892,221, or 23.4%, to $62,686,802 at December 31, 2005 from $50,794,581 at December 31, 2004. Interest bearing demand deposits, which include interest-bearing checking, money market and the Bank's premier money market product, 1ST Choice accounts, also increased by $5,075,984, or 5.3%, to an average of $101,189,352 in 2005 from an average of $96,113,368 in 2004. The average cost of interest bearing demand deposits increased 18 basis points to 1.20% in 2005 compared to 1.02% in 2004.

Savings accounts increased by $22,236,528, or 81.4%, to $49,547,438 at December 31, 2005 from $27,310,910 at December 31, 2004. The average balance of savings accounts for 2005 increased by $6,781,466 to $33,671,684 compared to an average balance of $26,890,218 for 2004. During April 2005, the Bank introduced 1ST Choice Super Savings, a new high yield savings account. By the end of the year 2005, this product had attracted over $18.0 million in new deposit balances.

Average non-interest bearing demand deposits increased by $8,170,775, or 16.5%, to $57,792,902 for 2005 from $49,622,127 for 2004. At December 31, 2005, non-interest bearing demand deposits totaled $62,686,802, an increase of 23.4% compared to $50,794,581 at December 31, 2004. Non-interest bearing demand deposits represent a stable, interest-free source of funds. Growth in business and personal checking accounts through the Bank's marketing programs generated most of the current year increase.

Time deposits consists primarily of retail certificates of deposit and certificates of deposit of $100,000 and over. Time deposits at December 31, 2005 were $91,095,333, an increase of $2,395,876, or 2.7%, from $88,699,457 at December 31, 2004. The retail certificates of deposit component of time deposits increased by $3,046,535, or 4.1%, to an average of $77,183,169 for 2005 from an average of $74,136,634 for 2004. The average cost of these deposits increased by 51 basis points to 3.09% for 2005 from 2.58% for 2004.

 

28

 

  

Certificates of deposit of $100,000 and over decreased by $385,286, or 3.8%, to an average of $9,771,290 for 2005 from an average of $10,156,576 for 2004. The average cost for these deposits increased by 61 basis points to 3.16% for 2005 compared to 2.55% for 2004. Certificates of deposit of $100,000 and over are a less stable funding source and are used primarily as an alternative to other sources of borrowed funds.

The following table illustrates the components of average total deposits for the past three years.
 

 

 

Average Deposit Balances

 

 

2005

 

2004

 

2003

 

 

 

 

Average

Balance

Percentage

of Total

 

Average

Balance

Percentage of Total

 

Average

Balance

Percentage of Total

Non-interest bearing demand

deposits

 

$57,792,902

20.67%

 

$49,622,127

19.31%

 

$41,318,131

18.70%

Money market and NOW accounts

 

101,189,352

36.19%

 

96,113,368

37.41%

 

76,435,477

34.60%

Savings deposits

 

33,671,684

12.04%

 

26,890,218

10.46%

 

21,684,139

9.82%

Certificates of deposit of $100,000

or more

 

9,771,290

3.49%

 

10,156,576

3.95%

 

18,287,421

8.28%

Other time deposits

 

77,183,169

27.60%

 

74,136,634

28.87%

 

63,182,395

28.60%

Total

 

$279,608,397

100.00%

 

$256,918,923

100.00%

 

$220,907,563

100.00%

 

 

 

Other Borrowings

Other borrowings are mainly comprised of Federal Home Loan Bank ("FHLB") borrowings and overnight funds purchased. These borrowings are primarily used to fund asset growth not supported by deposit generation. The average balance of other borrowed funds increased by $6,330,680, or 25.5%, to $31,143,663 for 2005 from the average balance of $24,812,983 for 2004. This increase is primarily due to the fact that loan portfolio growth exceeded deposit growth. The average cost of other borrowed funds increased 43 basis points to 4.38% for 2005 compared to 3.95% for 2004.

The balance of other borrowings was $28,500,000 at December 31, 2005, consisting of long-term FHLB borrowings of $23,500,000 and overnight funds purchased of $5,000,000. The balance of other borrowings at December 31, 2004 consisted of FHLB borrowings of $15,500,000 and overnight funds purchased of $9,700,000. The average cost of other borrowed funds decreased 2 basis points to 3.95% for 2004 compared with 3.97% for 2003.

During 2000, the Bank purchased three ten-year fixed rate convertible advances from the FHLB. These advances, in the amounts of $2,500,000, $5,000,000, and $5,000,000 bear interest at the rates of 5.50%, 5.34%, and 5.06%, respectively. These advances are convertible quarterly at the option of the FHLB.

These advances are fully secured by marketable securities and qualifying one-to-four family mortgage loans.

Securities sold under agreements to repurchase are summarized as follows:

 

 

2005

2004

2003

Balance outstanding at year end

- -

- -

$1,921,015

Weighted average interest rate at year end

- -

1.27%

1.15%

Average daily balance outstanding during year

- -

$1,674,172

$2,290,866

Weighted average interest rate during year

- -

1.28%

1.46%

Highest month-end outstanding balance

- -

$1,941,042

$2,562,549

 

 

29

 


 

Shareholders' Equity and Dividends

Shareholders' equity increased by $3,006,483, or 11.2%, to $29,796,867 at December 31, 2005, from $26,790,384 at December 31, 2004. Book value per common share increased by $0.95, or 12.3%, to $8.67 at December 31, 2005 from $7.72 at December 31, 2004. The increase in shareholders' equity and book value per share resulted primarily from net income of $4,560,127, less the effect of stock buybacks and the unrealized holding loss on securities held for resale.

During the period January 1, 2000 - December 31, 2005, the Company achieved a five year compounded growth rate for shareholders' equity of 14.4%. The Company's book value per share has also increased over this period at a compounded growth rate of 14.9%. In lieu of cash dividends, the Company (and its predecessor the Bank) has declared a stock dividend every year since 1992 and has paid such dividends every year since 1993. A 5% stock dividend was declared in each of the years 2005, 2004 and 2003. The Company also declared a two-for-one stock split on January 20, 2005 and paid February 28, 2005 to shareholders of record on February 10, 2005.

The Company's common stock is quoted on the NASDAQ National Market System under the symbol "FCCY".

The Company and the Bank are subject to various regulatory capital requirements administered by the Federal Reserve Board and the Federal Deposit Insurance Corporation. For information on regulatory capital, see Note 15 of the Notes to Consolidated Financial Statements.

Off-Balance Sheet Arrangements and Contractual Obligations

Off-Balance Sheet Arrangements

The following table shows the amounts and expected maturities of significant commitments as of December 31, 2005. Further discussion of these commitments is included in Note 13 to the Consolidated Financial Statements.
 

 

One Year

or Less

One to

Three Years

Three to

Five Years

Over Five

Years

 

Total

Standby letters of credit

$3,848,473

$0

$0

$0

$3,848,473

 

 

 

 

 

 

Commitments to sell residential loans

$16,757,734

$0

$0

$0

$16,757,734

 

Contractual Obligations

The following table shows the significant contractual obligations of the Company by expected payment period as of December 31, 2005. Further discussion of these commitments is included in Note 13 to the Consolidated Financial Statements.

 

 

Contractual Obligation

 

Total

Less Than One Year

One to Three Years

Three to Five Years

Over Five Years

Long-term debt obligations

$15,500,000

$0

$0

$3,000,000

$12,500,000

Operating lease obligation

$6,320,296

$676,981

$1,881,677

$618,811

$3,052,827

Purchase obligations

$820,000

$605,000

$215,000

$0

$0

Certificates of deposit

$91,095,333

$66,082,431

$17,215,316

$7,797,586

$0

 

Long-term debt obligations includes fixed term borrowings from the Federal Home Loan Bank. The borrowings have defined terms and under certain circumstances are callable at the option of the lender. Operating leases represent obligations entered into by the Company for the use of land and premises. The leases generally have escalation terms based upon certain defined indices. Purchase obligations represent legally binding and enforceable agreements to purchase goods and services from third parties and consists primarily of contractual obligations under data processing service agreements.

 

30

 


  

The Company also has commitments and obligations under its employee benefit plans as described in Note 11 to the Consolidated Financial Statements.

Liquidity

Liquidity measures the ability to satisfy current and future cash flow needs as they become due.

Liquidity management refers to the Company's ability to support asset growth while satisfying the borrowing needs and deposit withdrawal requirements of customers. In addition to maintaining liquid assets, factors such as capital position, profitability, asset quality and availability of funding affect a bank's ability to meet its liquidity needs. On the asset side, liquid funds are maintained in the form of cash and cash equivalents, federal funds sold, investment securities held to maturity maturing within one year, securities available for sale and loans held for sale. Additional asset-based liquidity is derived from scheduled loan repayments as well as investment repayments of principal and interest from mortgage-backed securities. On the liability side, the primary source of liquidity is the ability to generate core deposits. Short-term borrowings are used as supplemental funding sources when growth in the core deposit base does not keep pace with that of earnings assets.

The Bank has established a borrowing relationship with the FHLB and its correspondent banks which further supports and enhances liquidity.

The Consolidated Statements of Cash Flows present the changes in cash from operating, investing and financing activities. At December 31, 2005, the balance of cash and cash equivalents was $12,137,750.

Net cash provided by operating activities decreased by $9,512,080, or 98.6%, to $133,562 for 2005 from $9,645,642 for 2004. The primary source of funds is net income from operations adjusted for provision for loan losses, depreciation expenses, and net amortization of premiums on securities. During 2005, a lower sales volume of loans held for sale resulted in less cash proceeds realized from this operating activity.

Net cash used in investing activities decreased by $28,454,689, or 51.4%, to $26,910,068 for 2005 from $55,364,757 for 2004. The decrease in cash usage for 2005 compared to 2004 resulted from decreases in loans and purchases of securities.

Net cash provided by financing activities increased by $7,950,791, or 20.4%, to $30,989,847 for 2005 from $38,940,638 for 2004. The cash provided in 2005 resulted primarily from the increase in total deposits.

The securities portfolios are also a source of liquidity, providing cash flows from maturities and periodic repayments of principal. During 2005, prepayments and maturities of investment securities totaled $17,434,749. Another source of liquidity is the loan portfolio, which provides a flow of payments and maturities.
 

 Interest Rate Sensitivity Analysis

The largest component of the Bank's total income is net interest income, and the majority of the Bank's financial instruments are composed of interest rate-sensitive assets and liabilities with various terms and maturities. The primary objective of management is to maximize net interest income while minimizing interest rate risk. Interest rate risk is derived from timing differences in the repricing of assets and liabilities, loan prepayments, deposit withdrawals, and differences in lending and funding rates. Management actively seeks to monitor and control the mix of interest rate-sensitive assets and interest rate-sensitive liabilities.

 

 

31

 

The following tables set forth certain information relating to the Bank's financial instruments that are sensitive to changes in interest rates, categorized by expected maturity or repricing and the fair value of such instruments at December 31, 2005.

 


Interest Rate Sensitivity Analysis At December 31, 2005

Total Within One Year

One Year To

Two Years

Non-interest

Sensitive and

Over Two Years

Total

($ in thousands)

Interest Sensitivity Period

 

30 Day

90 Day

180 Day

365 Day

Earning Assets:

 

 

 

 

 

 

 

 

 

Total Investment Securities

$740

$9,199

$1,804

$4,671

$16,414

$13,325

$61,256

$90,995

 

Loans

154,085

4,826

5,050

8,393

172,354

16,740

50,920

240,014

 

Other Interest-earning assets

19,747

- -

- -

- -

19,747

- -

21,739

41,486

 

174,572

14,025

6,854

13,064

208,515

30,065

133,915

372,495

 

 

 

 

 

 

 

 

 

Source of Funds:

 

 

 

 

 

 

 

 

 

Savings and time deposits

32,338

15,126

17,657

29,475

94,596

28,345

29,551

152,492

 

Other interest-bearing liabilities

76,067

- -

5,000

- -

81,067

2,640

48,424

124,131

 

Non-interest-bearing sources

- -

- -

- -

- -

- -

- -

95,872

95,872

 

108,405

15,126

22,657

29,475

175,663

30,985

173,847

372,495

 

 

 

 

 

 

 

 

 

Asset (Liability Sensitivity Gap:

 

 

 

 

 

 

 

 

Period Gap

$67,167

($1,101)

($15,803)

($16,411)

$32,852

($920)

($31,932)

$0

 

Cumulative Gap

$67,167

$65,066

$49,263

$32,852

$32,852

$31,932

 

 

 

Cumulative Gap to Total Assets

17.8%

17.5%

13.2%

8.8%

8.8%

8.6%

 

 

 

 

 

 

 

 

 

 

 

 

 

The Bank continually evaluates interest rate risk management opportunities, including the use of derivative financial instruments. Management believes that hedging instruments currently available are not cost-effective, and therefore has focused its efforts on increasing the Bank's spread by attracting lower-costing retail deposits.

In addition to utilizing the gap ratio for interest rate risk assessment, management utilizes simulation analysis whereby the model estimates the variance in net income with a change in interest rates of plus or minus 200 basis points over 12 and 24 month periods. Given recent simulations, net interest income would be within policy guidelines regardless of the direction of market rates.

Recent Accounting Pronouncements

FASB Statement No. 123 (revised 2004), Share-Based Payment. Statement 123(R) addresses the accounting for share-based payment transactions in which an enterprise receives employee services in exchange for (a) equity instruments of the enterprise or (b) liabilities that are based on the fair value of the enterprise's equity instruments or that may be settled by the issuance of such equity instruments. Statement 123(R) requires an entity to recognize the grant-date fair-value of stock options and other equity-based compensation issued to employees in the income statement. The revised Statement generally requires that an entity account for those transactions using the fair-value-based method; and eliminates an entity's ability to account for share-based compensation transactions using the intrinsic value method of accounting in APB Opinion No. 25, Accounting for Stock Issued to Employees, which was permitted under Statement 123, as originally issued. The revised Statement requires entities to disclose information about the nature of the share-based payment transactions and the effects of those transactions on the financial statements. Statement 123(R) is effective for the Company beginning January 1, 2006. The Company anticipates using the modified prospective transition method with the adoption of this standard. The Company is assessing the impact of adopting the new pronouncement and is currently unable to estimate its impact on its consolidated financial statements.

In March 2005, the SEC issued Staff Accounting Bulletin No. 107 ("SAB 107"), which provides guidance on the interaction between Statement 123(R) and certain SEC rules and regulations. SAB 107 was issued to assist issuers in their initial implementation of Statement 123(R) and to enhance the information received by investors and other users of the financial statements.

 

32

 


 

In March 2005 the FASB issued Interpretation No. 47, "Accounting for Conditional Asset Retirement Obligations" (FIN 47). FIN 47 requires an entity to recognize a liability for the fair value of a legal obligation to perform asset-retirement activities that are conditional on a future event if the amount can be reasonably estimated. The Interpretation provides guidance to evaluate whether fair value is reasonably estimable. FIN 47 is effective no later than the end of fiscal years ending after December 15, 2005. FIN 47 is not expected to have a material impact on the Company's financial position or results of operations.

In May 2005, the FASB issued SFAS No. 154, "Accounting Changes and Error Corrections," which replaces APB Opinion No. 20, "Accounting Changes," and SFAS No. 3, "Reporting Accounting Changes in Interim Financial Statements," and changes the requirements for the accounting for and reporting of a change in accounting principle. SFAS No. 154 applies to all voluntary changes in accounting principle and to changes required by an accounting pronouncement when the pronouncement does not include specific transition provisions. SFAS No. 154 requires retrospective application of changes in accounting principle to prior periods' financial statements unless it is impracticable to determine either the period-specific effects or the cumulative effect of the change. APB Opinion No. 20 previously required that most voluntary changes in accounting principle be recognized by including the cumulative effect of the change in net income for the period of the change in accounting principle. SFAS No. 154 carries forward without change the guidance contained in APB Opinion No. 20 for reporting the correction of an error in previously issued financial statements and a change in accounting estimate. SFAS No. 154 also carries forward the guidance in APB Opinion No. 20 requiring justification of a change in accounting principle on the basis of preferability. SFAS No. 154 is effective for accounting changes and corrections of errors made in fiscal years beginning after December 15, 2005, with early adoption permitted. Our adoption of SFAS No. 154 will not have an impact on our financial condition or results of operations.

In November 2005, the FASB issued FASB Staff Position (FSP) FAS 115-1 and FAS 124-1, "The Meaning of Other-Than-Temporary Impairment and Its Application to Certain Investments." This FSP provides guidance on determining if an investment is considered to be impaired, if the impairment is other-than-temporary and the measurement of an impairment loss. It also includes accounting considerations subsequent to the recognition of an other-than-temporary impairment and requires certain disclosures about unrealized losses that have not been recognized as other-than-temporary impairments. The guidance in this FSP amends Statement 115, Accounting for Certain Investments in Debt and Equity Securities, and is effective for reporting periods beginning after December 15, 2005.  The Company is currently accounting for investments in accordance with this guidance, and therefore, the adoption of this FSP will not have a material impact on the Company's results of operations or financial position.

In July 2005, the FASB issued an Exposure Draft of a proposed Interpretation, "Accounting for Uncertain Tax Positions". The proposed Interpretation clarifies the accounting for uncertain tax positions in accordance with FASB Statement No. 109, "Accounting for Income Taxes". The proposed Interpretation requires that a tax position meet a "probable recognition threshold" for the benefit of the uncertain tax position to be recognized in the financial statements. A tax position that fails to meet the probable recognition threshold will result in either a reduction of a current or deferred tax asset or receivable, or recording a current or deferred tax liability. The proposed Interpretation also provides guidance on measurement, de-recognition of tax benefits, classification, interim period accounting disclosure, and transition requirements in accounting for uncertain tax positions. The proposed Interpretation has a 60-day comment period and is scheduled to be effective for all companies as of the first fiscal year ending after December 15, 2005. The Company is assessing the impact of adopting the new pronouncement and is currently unable to estimate its impact on its consolidated financial statements.

 

33

 


  

Item 7A. Quantitative and Qualitative Disclosures About Market Risk.

Market Risk Analysis

To measure the impacts of longer-term asset and liability mismatches beyond two years, the Company utilizes Modified Duration of Equity and Economic Value of Portfolio Equity ("EVPE") models. The modified duration of equity measures the potential price risk of equity to changes in interest rates. A longer modified duration of equity indicates a greater degree of risk to rising interest rates. Because of balance sheet optionality, an EVPE analysis is also used to dynamically model the present value of asset and liability cash flows, with rates ranging up or down 200 basis points. The economic value of equity is likely to be different as interest rates change. Results falling outside prescribed ranges require action by Management. At December 31, 2005 and 2004, the Company's variance in the economic value equity as a percentage of assets with an instantaneous and sustained parallel shift of 200 basis points is within the negative 3% guideline, as shown in the tables below.

The market capitalization of the Company should not be equated to the EVPE, which only deals with the valuation of balance sheet cash flows using conservative assumptions. Calculated core deposit premiums may be less than what is available in an outright sale. The model does not consider potential premiums on floating rate loan sales, the impact of overhead expense, non-interest income, taxes, industry market price multiples and other factors reflected in the market capitalization of a company.

Market Risk Analysis

December 31, 2005

 

Change in Interest Rates

 

Flat

 

- -200bp

 

+200bp

Economic Value of Portfolio Equity

$44,923,000

$43,305,000

$42,049,000

Change

 

($1,617,000)

($2,873,000)

Change as a % of assets

 

(-0.43%)

(-0.77%)

 

December 31, 2004

 

Change in Interest Rates

 

Flat

 

- -200bp

 

+200bp

Economic Value of Portfolio Equity

$38,221,000

$34,681,000

$35,641,000

Change

 

($3,540,000)

($2,580,000)

Change as a % of assets

 

(-1.05%)

(-0.77%)

 

Item 8. Financial Statements and Supplementary Data.

Reference is made to Item 15(a)(1) and (2) to page F-1 for a list of financial statements and supplementary data required to be filed pursuant to this Item 8. The information required by this Item 8 is provided on pages F-1 through F-23 hereof.

Item 9. Changes In and Disagreements with Accountants on Accounting and Financial Disclosure.

Not applicable.

 

34

 

  

Item 9A. Controls and Procedures.

The Company's Chief Executive Officer and Chief Financial Officer, with the assistance of other members of the Company's management, have evaluated the effectiveness of the Company's disclosure controls and procedures as of the end of the period covered by this Annual Report on Form 10-K. Based on such evaluation, the Company's Chief Executive Officer and Chief Financial Officers have concluded that the Company's disclosure controls and procedures are effective.

The Company's Chief Executive Officer and Chief Financial Officer have also concluded that there have not been any changes in the Company's internal control over financial reporting during the quarter ended December 31, 2005 that have materially affected, or are reasonably likely to materially affect, the Company's internal control over financial reporting.

Because the Company is not an "Accelerated Filer" as defined in Rule 12b-2 of the Exchange Act, the Company is not required to file Management's annual report on internal control over financial reporting and the Attestation report of the registered public accounting firm required by Item 308(a) and (b) of Regulation S-K promulgated under the Securities Act of 1933, as amended, until the Company's first fiscal year ending on or after July 15, 2007.       The Company currently expects to file these reports pursuant to Items 308(a) and (b) at such time as the Company is required to do so.

Item 9B. Other Information.

None.

PART III

Item 10. Directors and Executive Officers of the Registrant.

The information required by this item is incorporated by reference to the Company's Proxy Statement for its 2006 Annual Meeting of Shareholders under the caption "Directors and Executive Officers."

Item 11. Executive Compensation.

The information required by this item is incorporated by reference to the Company's Proxy Statement for its 2006 Annual Meeting of Shareholders under the caption "Executive Compensation."

Item 12. Security Ownership of Certain Beneficial Owners and Management and Related Shareholder Matters.

The information required by this item is incorporated by reference from the Company's Proxy Statement for its 2006 Annual Meeting of Shareholders under the captions "Stock Ownership of Management and Principal Shareholders" and "Equity Compensation Plan Information."

Item 13. Certain Relationships and Related Transactions.

This information required by this item is incorporated by reference from the Company's Proxy Statement for its 2006 Annual Meeting of Shareholders under the caption "Certain Transactions With Management."

Item 14. Principal Accountant Fees and Services.

The information regarding principal accounting fees and services and the Company's pre-approval policies and procedures for audit and non-audit services provided by the Company's independent accountants is incorporated by reference to the Company's Proxy Statement for its 2006 Annual Meeting of Shareholders under the caption "Principal Accountant Fees and Services."

 

35

  

PART IV

Item 15. Exhibits and Financial Statement Schedules.

 

(a)

Financial Statements and Financial Statement Schedules

The following documents are filed as part of this report:

 

1.

Financial Statements of 1st Constitution Bancorp.

 

 

Consolidated Balance Sheet - December 31, 2005 and 2004.

Consolidated Statements of Income - Years Ended December 31, 2005, 2004 and 2003.

 

Consolidated Statements of Changes in Shareholders' Equity -
Years Ended December 31, 2005, 2004 and 2003.

Consolidated Statements of Cash Flows - years Ended December 31, 2005, 2004, and 2003.

 

Notes to Consolidated Financial Statements

 

 

Report of Independent Registered Public Accounting Firm - Grant Thornton LLP

 

Report of Independent Registered Public Accounting Firm - KPMG LLP

 

These statements are incorporated by reference to the Company's Annual Report to Shareholders for the year ended December 31, 2005.

 

2.

All schedules are omitted because either they are inapplicable or not required, or because the information required therein is included in the Consolidated Financial Statements and Notes thereto.

3.

Exhibits

Exhibit No.

 

Description

3

(i)

 

Certificate of Incorporation of the Company (incorporated by reference to Exhibit 3(i) to the Company's Form 10-K filed with the SEC on March 24, 2005).

3

(ii)

 

Bylaws of the Company (incorporated by reference to Exhibit 3(ii) to the Company's Form 10-QSB filed with the SEC on May 14, 2003)

4.1

 

 

Specimen Share of Common Stock (incorporated by reference to the Company's Form 10-KSB filed with the SEC on March 22, 2002)

4.2

 

 

Amended and Restated Declaration of Trust of 1st Constitution Capital Trust I dated as of April 10, 2002 among the Registrant, as sponsor, Wilmington Trust Company, as Delaware and institutional trustee, and the Administrators named therein (incorporated by reference to the Company's Form 10-QSB filed with the SEC on May 8, 2002)

4.3

 

 

Indenture dated as of April 10, 2002 between the Registrant, as issuer, and Wilmington Trust Company, as trustee, relating to the Floating Rate Junior Subordinated Debt Securities due 2032 (incorporated by reference to the Company's Form 10-QSB filed with the SEC on May 8, 2002)

 

 

36

 


 

Exhibit No.

 

Description

4.4

 

 

Guarantee Agreement dated as of April 10, 2002 between the Registrant and the Wilmington Trust Company, as guarantee trustee (incorporated by reference to the Company's Form 10-QSB filed with the SEC on May 8, 2002)

4.5

 

 

Rights Agreement, dated as of March 18, 2004, between 1st Constitution Bancorp and Registrar and Transfer Company, as Rights Agent, including the form of Certificate of Amendment to the Company's Certificate of Incorporation as Exhibit A thereto, the form of Rights Certificates as Exhibit B thereto, and the Summary of Rights as Exhibit C thereto. Pursuant to the Rights Agreement, printed Rights Certificates will not be mailed until after the Distribution Date (as such term is defined in the Rights Agreement) (incorporated by reference to the Company's Form 8-A12G filed with the SEC on March 18, 2004).

10.1

 

#

1st Constitution Bancorp Supplemental Executive Retirement Plan, dated as of October 1, 2002 (Incorporated by reference to the Company's Form 10-QSB filed with the SEC on November 13, 2002)

10.2

 

#

1st Constitution Bancorp Directors' Deferral Plan, dated as of October 1, 2002 (Incorporated by reference to the Company's Form 10-QSB filed with the SEC on November 13, 2002)

10.3

 

#

1st Constitution Bancorp Directors Insurance Plan, dated as of October 1, 2002 (Incorporated by reference to the Company's Form 10-QSB filed with the SEC on November 13, 2002)

10.4

 

#

1st Constitution Bancorp Form of Executive Life Insurance Agreement (Incorporated by reference to the Company's Form 10-QSB filed with the SEC on November 13, 2002)

10.5

 

#

Amended and Restated 1990 Stock Option Plan for Key Employees, as amended (incorporated by reference to Exhibit No. 10.1 to the Company's Form 10-QSB filed with the SEC on August 9, 2002)

10.6

 

#

1996 Employee Stock Option Plan, as amended (incorporated by reference to Exhibit No. 10.2 to the Company's Form 10-QSB filed with the SEC on August 9, 2002)

10.7

 

#

2000 Employee Stock Option and Restricted Stock Plan (incorporated by reference to Exhibit No. 6.3 to the Company's Form 10-SB filed with the SEC on June 15, 2001)

10.8

 

#

Directors Stock Option and Restricted Stock Plan (incorporated by reference to Exhibit No. 6.4 to the Company's Form 10-SB filed with the SEC on June 15, 2001)

10.9

 

#

Employment Agreement between the Company and Robert F. Mangano dated April 22, 1999 (incorporated by reference to Exhibit No. 6.5 to the Company's Form 10-SB filed with the SEC on June 15, 2001)

 

 

37

 

  

Exhibit No.

 

Description

10.10

 

#

Agreement for Consulting Services between the Company and Edward D. Knapp (incorporated by reference to Exhibit 10.10 to the Company's Form 10-KSB filed with the SEC on March 20, 2003)

10.11

 

#

Amendment to 1st Constitution Bancorp Directors Insurance Plan, dated as of February 19, 2004 (incorporated by reference to Exhibit 10.11 to the Company's Form 10-K filed with the SEC on March 25, 2004)

10.12

 

#

Amendment No. 1 to 1st Constitution Bancorp Supplemental Executive Retirement Plan, effective January 1, 2004 (incorporated by reference to Exhibit 10.12 to the Company's Form 10-Q filed with the SEC on August 11, 2004)

10.13

 

#

Change of Control Agreement, effective as of April 1, 2004, by and between the Company and Joseph M. Reardon (incorporated by reference to Exhibit 10.13 to the Company's Form 10-Q filed with the SEC on August 11, 2004)

10.14

 

#

Form of Stock Option Agreement under the 1st Constitution Bancorp Employee Stock Option and Restricted Stock Plan (incorporated by reference to Exhibit 10.14 to the Company's Form 8-K filed with the SEC on December 22, 2004)

10.15

 

#

Form of Restricted Stock Agreement under the 1st Constitution Bancorp Employee Stock Option and Restricted Stock Plan (incorporated by reference to Exhibit 10.15 to the Company's Form 8-K filed with the SEC on December 22, 2004)

10.16

 

#

Employment Agreement between the Company and Robert F. Mangano dated February 22, 2005 (incorporated by reference to Exhibit No. 10.16 to the Company's Form 8-K filed with the SEC on February 24, 2005)

10.17

 

#

The 1st Constitution Bancorp 2005 Equity Incentive Plan (incorporated by reference to Appendix A of the Company's proxy statement filed on April 15, 2005).

10.18

 

#

Form of Restricted Stock Agreement under the 1st Constitution Bancorp 2005 Equity Incentive Plan (incorporated by reference to Exhibit 10.18 to the Company's Form 10-Q filed with the SEC on August 8, 2005).

10.19

 

#

Form of Nonqualified Stock Option Agreement under the 1st Constitution Bancorp 2005 Equity Incentive Plan (incorporated by reference to Exhibit 10.19 to the Company's Form 10-Q filed with the SEC on August 8, 2005).

10.20

 

#

Form of Incentive Stock Option Agreement under the 1st Constitution Bancorp 2005 Equity Incentive Plan (incorporated by reference to Exhibit 10.20 to the Company's Form 10-Q filed with the SEC on August 8, 2005).

21

 

*

Subsidiaries of the Company

23.1

 

*

Consent of Independent Registered Public Accounting Firm - Grant Thornton LLP

 

 

38

 

  

Exhibit No.

 

Description

23.2

 

*

Consent of Independent Registered Public Accounting Firm - KPMG LLP

31.1

 

*

Certification of Robert F. Mangano, Chief Executive Officer of the Company, pursuant to Securities Exchange Act Rule 13a-14(a).

31.2

 

*

Certification of Joseph M. Reardon, Chief Financial Officer of the Company, pursuant to Securities Exchange Act Rule 13a-14(a).

32

 

*

Certifications pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of The Sarbanes-Oxley Act of 2002, signed by Robert F. Mangano, Chief Executive Officer of the Company, and Joseph M. Reardon, Chief Financial Officer of the Company.

 

 

*
#

Filed herewith.
A management contract or compensatory plan or arrangement required to be filed as an exhibit pursuant to Item 15(c) of Form 10-K.

 

(b)

Exhibits.

Exhibits required by Section 601 of Regulation S-K (see (a) above)

 

(c)

Financial Statement Schedules

See the notes to the Consolidated Financial Statements included in this report.

 

 

 

 

 

 

 

 

39

 


 

 

1ST CONSTITUTION BANCORP

INDEX TO CONSOLIDATED FINANCIAL STATEMENTS

   

Page 

Report of Independent Registered Public Accounting Firm – Grant Thornton LLP    F-2 
Report of Independent Registered Public Accounting Firm – KPMG LLP    F-3 
Consolidated Balance Sheet – December 31, 2005 and 2004    F-4 
Consolidated Statements of Income – Years Ended December 31, 2005, 2004 and 2003    F-5 
Consolidated Statements of Changes in Shareholders’ Equity for the Years Ended     
December 31, 2005, 2004 and 2003    F-6 
Consolidated Statements of Cash Flows for the Years Ended December 31, 2005, 2004 and 2003    F-7 
Notes to Consolidated Financial Statements    F-8 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

F-1

 


  

REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

 

Board of Directors and Shareholders
1st Constitution Bancorp:

 

We have audited the consolidated balance sheet of 1st Constitution Bancorp and subsidiaries as of December 31, 2005 and 2004 and the related consolidated statements of income, changes in shareholders' equity and cash flows for the year then ended. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audit.

We conducted our audit in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. The Company is not required to have, nor were we engaged to perform an audit of its internal control over financial reporting. Our audit included consideration of internal control over financial reporting as a basis for designing audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the Company's internal control over financial reporting. Accordingly, we express no such opinion. An audit also includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audit provides a reasonable basis for our opinion.

In our opinion, the financial statements referred to above present fairly, in all material respects, the consolidated financial position of 1st Constitution Bancorp and subsidiaries as of December 31, 2005 and 2004 and the consolidated results of their operations and their consolidated cash flows for the year then ended, in conformity with accounting principles generally accepted in the United States of America.

 

/s/ GRANT THORNTON LLP

Philadelphia, Pennsylvania
March 8, 2006

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

F-2

 


  

REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

 

The Board of Directors and Shareholders
1st Constitution Bancorp:

We have audited the accompanying consolidated statements of income, changes in shareholders' equity, and cash flows of 1st Constitution Bancorp and subsidiaries for the year ended December 31, 2003. These consolidated financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these consolidated financial statements based on our audit.

We conducted our audit in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audit provides a reasonable basis for our opinion.

In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the results of operations and cash flows of 1st Constitution Bancorp and subsidiaries for the year ended December 31, 2003, in conformity with U.S. generally accepted accounting principles.

 

/s/ KPMG LLP

Short Hills, New Jersey
February 6, 2004

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

F-3

 

  

1ST CONSTITUTION BANCORP
CONSOLIDATED BALANCE SHEETS
December 31, 2005 and 2004

 

ASSETS   
   2005 
 
2004 
CASH AND DUE FROM BANKS    $9,394,929    $7,898,395 
FEDERAL FUNDS SOLD / SHORT TERM INVESTMENTS   
2,742,821 
 
26,014 
         Total cash and cash equivalents   
12,137,750 
 
7,924,409 
SECURITIES         
        Available for sale, at fair value    69,236,658    85,588,649 

        Held to maturity (fair value of $21,521,026 and $12,292,250              in 2005 and 2004, respectively) 

  21,758,370    12,167,137 
                     Total securities    90,995,028    97,755,786 
LOANS HELD FOR SALE    16,757,734    9,927,881 
LOANS    240,014,349    210,653,051 
         Less- Allowance for loan losses   
(2,361,375) 
 
(2,005,169) 
                     Net loans    237,652,974    208,647,882 
PREMISES AND EQUIPMENT, net    2,596,852    2,324,219 
ACCRUED INTEREST RECEIVABLE    1,234,523    1,444,493 
BANK-OWNED LIFE INSURANCE    8,828,932    6,643,502 
OTHER ASSETS   
2,291,673 
 
1,162,268 
Total assets   
$372,495,466 
 
$335,830,440 
         
LIABILITIES AND SHAREHOLDERS’ EQUITY         
         
LIABILITIES:         
   Deposits         

         Non-interest bearing 

  $62,686,802    $50,794,581 

         Interest bearing 

 
243,122,665 
 
226,092,452 
                   Total deposits    305,809,467    276,887,033 
OTHER BORROWINGS    28,500,000    25,200,000 
REDEEMABLE SUBORDINATED DEBENTURES    5,155,000    5,155,000 
ACCRUED INTEREST PAYABLE    1,288,040    982,020 
ACCRUED EXPENSES AND OTHER LIABILITIES    1,946,092    816,003 
                     Total liabilities    342,698,599    309,040,056 
COMMITMENTS AND CONTINGENCIES         
SHAREHOLDERS’ EQUITY         
         Common stock, no par value; 30,000,000 
        shares authorized; 3,490,806 and 3,477,202 shares issued 
              and 3,437,266 and 3,471,743 shares outstanding 
              as of December 31, 2005 and 2004, respectively  		  25,589,320    22,255,402 
       Retained earnings    5,981,803    4,725,257 
       Treasury Stock, at cost, 53,540 shares and 5,458 shares 
               at December 31, 2005 and 2004, respectively  		  (1,008,998)    (86,896) 
       Accumulated other comprehensive income (loss)    (765,258)    (103,379) 
                     Total shareholders’ equity   
29,796,867 
 
26,790,384 
Total liabilities and shareholders’ equity   
$372,495,466 
 
$335,830,440 

 

F-4

 

 

 1ST CONSTITUTION BANCORP
CONSOLIDATED STATEMENTS OF INCOME

 

For the Years Ended December 31, 2005, 2004 and 2003

 

 
2005
  
   2004
  
2003
INTEREST INCOME:           
   Interest and fees on loans  $17,622,128    $13,422,067    $11,425,762 
   Interest on securities:           
         Taxable  3,017,885    3,196,936    2,619,813 
         Tax-exempt  660,878    386,088    311,764 
         Interest on Federal funds sold and 
              short-term investments  		27,181    10,977    29,458 
                     Total interest income  21,328,072     17,016,068    14,386,797 
 
INTEREST EXPENSE:           
   Interest on deposits  4,313,849    3,300,523    3,163,255 
   Interest on securities sold under 
       agreements to repurchase 
       and other borrowed funds		 1,363,507    981,689    952,910 
   Interest on redeemable subordinated debentures  350,823    263,083    257,852 
                     Total interest expense  6,028,179      4,545,295    4,374,017 
                     Net interest income  15,299,893    12,470,773    10,012,780 
PROVISION FOR LOAN LOSSES  405,000    240,000    240,000 
Net interest income after provision 
 for loan losses 		 14,894,893    12,230,773    9,772,780 
NON-INTEREST INCOME:           
   Service charges on deposit accounts  690,104    514,494    559,698 
   Gain on sale of loans held for sale  1,444,521    1,373,660    1,284,913 
   (Loss)/gain on sale of securities available for sale  (271,871)    27,545    - 
   Income on Bank-owned life insurance  235,430    312,496    261,301 
   Other income 
548,677 
 
329,047 
 
295,437 
                       Total other income 
2,646,861 
 
2,557,242 
 
2,401,349 
 
NON-INTEREST EXPENSES:           
   Salaries and employee benefits  5,894,200    4,955,587    3,979,655 
   Occupancy expense  1,365,930    1,071,463    818,545 
   Other operating expenses 
3,627,095 
 
2,962,911 
 
2,370,522 

Total other expenses    

10,887,225 
 
8,989,961 
 
7,168,722 
                       Income before income taxes  6,654,529    5,798,054    5,005,407 
INCOME TAXES 
2,094,402 
 
1,960,340 
 
1,776,907 
                       Net income 
$4,560,127 
 
$3,837,714 
 
$3,228,500 
NET INCOME PER SHARE           
         Basic  $1.32    $1.11    $0.94 
         Diluted 
$1.27 
 
$1.08 
 
$0.89 
WEIGHTED AVERAGE SHARES 
    OUTSTANDING  		         
         Basic  3,452,317    3,448,548    3,441,125 
         Diluted 
3,588,558 
 
3,584,217 
 
3,609,140 

  

F-5

 

 1ST CONSTITUTION BANCORP
 CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS’ EQUITY 

 

  For the Years Ended December 31, 2005, 2004 and 2003

 

 

Common
Stock

 

Retained 
Earnings

  

Treasury
Stock

  

Accumulated
Other
Comprehensive
(Loss) Income

  

Total 
Shareholders’
Equity
                   
BALANCE, December 31, 2002  $17,320,091    $2,978,873    ($119,844)    $815,722    $20,994,842 
Exercise of stock options, net  188,822    (275,674)    114,327        27,475 
 

5% stock dividend declared December 2003,
     including fractional share cash payments 
     (74,541 shares) 

2,185,915 

 

(2,185,915) 

 

 

 

 

 

 

Comprehensive Income:                   
 
 Net income – 2003      3,228,500            3,228,500 
   Unrealized gain on securities available 
        for sale, net of tax (benefit) of ($335,754) 		             (665,561)    (665,561) 
Comprehensive Income                  2,562,939 
                   
BALANCE, December 31, 2003  $19,694,828    $3,745,784    ($5,517)    $150,161    $23,585,256 
Exercise of stock options, net and issuance of vested 
    shares under employee benefit programs  		(290,277)        468,176        177,899 
 
Treasury Stock, 16,661 shares at cost          (549,555)        (549,555) 
 
5% stock dividend declared December 2004, 
   including fractional share cash payments  		2,850,851    (2,858,241)            (7,390) 
 
Comprehensive Income:                   
 Net income – 2004      3,837,714            3,837,714 
   Unrealized loss on securities available for sale 
     net of tax (benefit) of ($151,962)  		            (253,540)    (253,540) 
Comprehensive Income                  3,584,174 
 
BALANCE, December 31, 2004  $22,255,402    $4,725,257    ($86,896)    ($103,379)    $26,790,384 
 
Exercise of stock options, net and issuance of vested  30,336        338,837        369,173 
   shares under employee benefit programs                   
 
Treasury Stock, 66,699 shares at cost          (1,260,939)        (1,260,939) 
 
5% stock dividend declared December 2005, 
   including fractional share cash payments  		3,303,582    (3,303,582)            0 
 
Comprehensive Income:                   
 Net income – 2005      4,560,127            4,560,127 
   Unrealized loss on securities available for sale 
    net of tax benefit of $503,290  		            (662,631)    (662,631) 
Comprehensive Income                  3,897,496 
 
BALANCE, December 31, 2005  $25,589,320    $5,981,803    ($1,008,998)    ($765,258)    $29,796,867 

 

F-6

 

 1ST CONSTITUTION BANCORP
CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS' EQUITY
For the Years Ended December 31, 2005, 2004 and 2003

  

 
2005 
 
   2004 
  2003 
OPERATING ACTIVITIES:           
   Net income  $4,560,127    $3,837,714   
$3,228,500 
         Adjustments to reconcile net income
         to net cash provided by operating activities-    		         
         Provision for loan losses  405,000    240,000    240,000 
         Depreciation and amortization  523,441    385,106    327,446 
         Net amortization of premiums on securities  139,507    350,168    1,190,853 
         Gain on sale of loans held for sale  (1,444,521)    (1,373,660)    (1,284,913) 
         Loss (gain) on sale of securities available for sale  271,871    (27,545)    - 
         Originations of loans held for sale  (73,491,347)    (75,514,197)    (91,972,465) 
         Income on Bank-owned life insurance  (235,430)    (312,496)    (261,301) 
         Proceeds from sales of loans held for sale  68,106,015    82,365,958    94,150,868 
         Deferred tax benefit  (233,589)    (149,400)    (122,557) 
         Decrease (increase) in accrued interest receivable  209,970    (275,478)    93,988 
         (Increase) decrease in other assets  (113,591)    289,628    78,600 
         Increase (decrease) increase in accrued interest payable  306,020    75,444    (305,326) 
         Decrease (increase) increase in accrued expenses and other liabilities 
1,130,089 
 
(245,600) 
 
(734,717) 
 
               Net cash provided by operating activities 
133,562 
 
9,645,642 
 
4,628,976 
 
INVESTING ACTIVITIES:           
 
   Purchases of securities -           
         Available for sale  (15,511,405)    (34,116,716)    (62,222,441) 
         Held to maturity  (9,969,659)    (6,883,726)    (198,102) 
   Proceeds from maturities and prepaymentsof securities -            
         Available for sale  17,074,576    29,011,317    57,073,223 
         Held to maturity  360,173    894,985    1,164,762 
   Proceeds from sales of securities available for sale  13,292,413    3,801,399    - 
   Purchase of Bank owned life insurance  (1,950,000)    -    - 
   Net increase in loans  (29,410,092)    (46,724,208)    (13,023,820) 
   Capital expenditures  (796,074)    (1,347,808)   
(412,021) 
 
               Net cash used in investing activities 
(26,910,068) 
 
(55,364,757) 
 
(17,618,399) 
 
FINANCING ACTIVITIES:           
 
   Issuance of common stock, net  28,352    177,899    27,475 
   Purchase of Treasury Stock  (1,260,939)    (549,555)    - 
   Net increase in demand, savings and time deposits  28,922,434    31,533,309    21,204,260 
              
   Net decrease in securities sold under agreements to repurchase  -    (1,921,015)    (633,800) 
   Net advances (repayments) in other borrowings 
3,300,000 
 
9,700,000 
 
(2,500,000) 
 
               Net cash provided by financing activities 
30,989,847 
 
38,940,638 
 
18,097,935 
 
               Increase (decrease) in cash and cash equivalents 4,213,341    (6,778,477)    5,108,512 
           
   CASH AND CASH EQUIVALENTS 
         AT BEGINNING OF YEAR 
7,924,409 
 
14,702,886 
 
9,594,374 
 
   CASH AND CASH EQUIVALENTS 
    AT END OF YEAR 
$12,137,750 
 
$7,924,409 
 
$14,702,886 
SUPPLEMENTAL DISCLOSURES 
   OF CASH FLOW INFORMATION:  		         
         Cash paid during the year for -           
               Interest  $5,722,159    $4,469,851    $4,679,343 
               Income taxes 
2,040,016 
 
2,429,565 
 
1,909,578 

 

F-7

  

1ST CONSTITUTION BANCORP
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2005, 2004 AND 2003

1. Summary of Significant Accounting Policies

1ST Constitution Bancorp (the "Company") is a bank holding company registered under the Bank Holding Company Act of 1956, as amended, and was organized under the laws of the State of New Jersey. The Company is parent to 1st Constitution Bank (the "Bank"), a state chartered commercial bank. The Bank provides community banking services to a broad range of customers, including corporations, individuals, partnerships and other community organizations in the central New Jersey area. The Bank conducts its operations through its main office located in Cranbury, New Jersey, and operates eight additional branch offices in downtown Cranbury, Hamilton Square, Jamesburg, Montgomery, Perth Amboy, Plainsboro, West Windsor, and Princeton, New Jersey and a loan production office in Fort Lee, New Jersey.

Principles Of Consolidation

The accompanying consolidated financial statements include the accounts of the Company and its wholly-owned subsidiaries, 1ST Constitution Capital Trust I (the "Trust") (for periods prior to December 31, 2003) and the Bank and the Bank's wholly-owned subsidiaries, 1ST Constitution Investment Company of Delaware, Inc. and FCB Assets Holdings, Inc. All significant inter-company accounts and transactions have been eliminated. In accordance with the Company's adoption of Financial Accounting Interpretation No. 46, Consolidation of Variable Interest Entities, as revised December 2003, the Company de-consolidated the accounts and related activity of 1st Constitution Capital Trust I as of December 31, 2003.

Use of Estimates in the Preparation of Financial Statements

The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates.

Investment Securities

Investment Securities which the Bank has the intent and ability to hold until maturity are classified as held to maturity and are recorded at cost, adjusted for amortization of premiums and accretion of discounts using the interest method.

Investment Securities which are held for indefinite periods of time, which management intends to use as part of its asset/liability management strategy, or that may be sold in response to changes in interest rates, changes in prepayment risk, increased capital requirements or other similar factors, are classified as available for sale and are carried at estimated market value, except for Federal Home Loan Bank stock, which is carried at cost. Unrealized gains and losses on such securities are recorded as a separate component of shareholders' equity. Realized gains and losses, which are computed using the specific identification method, are recognized on a trade date basis.

In November 2005, the FASB issued FASB Staff Position (FSP) FAS 115-1 and FAS 124-1, "The Meaning of Other-Than-Temporary Impairment and Its Application to Certain Investments." This FSP provides guidance on determining if an investment is considered to be impaired, if the impairment is other-than-temporary and the measurement of an impairment loss. It also includes accounting considerations subsequent to the recognition of an other-than-temporary impairment and requires certain disclosures about unrealized losses that have not been recognized as other-than-temporary impairments. The guidance in this FSP amends Statement 115, Accounting for Certain Investments in Debt and Equity Securities, and is effective for reporting periods beginning after December 15, 2005. The Company is currently accounting for investments in accordance with this guidance, and therefore, the adoption of this FSP will not have a material impact on the Company's results of operations or financial position.

Bank-Owned Life Insurance

The Company invests in bank-owned life insurance (BOLI). BOLI involves the purchasing of life insurance by the Company on a chosen group of employees. The Company is the owner and beneficiary of the policies. This pool of insurance, due to the advantages of the Bank, is profitable to the Company. This profitability is used to offset a portion of future benefit cost increases. The Bank's deposits fund BOLI and the earnings from BOLI are recognized as noninterest income.

 

F-8

 

 

 Loans And Loans Held For Sale

Loans that management intended to hold to maturity are stated at the principal amount outstanding, net of unearned income. Unearned income is recognized over the lives of the respective loans, principally using the effective interest method. Income from direct financing leases is recorded over the life of the lease under the financing method of accounting. The investment includes the sum of aggregate rentals receivable and the estimated residual value of leased equipment, less deferred income. Interest income is generally not accrued on loans, including impaired loans, where interest or principal is 90 days or more past due, unless the loans are adequately secured and in the process of collection, or on loans where management has determined that the borrowers may be unable to meet contractual principal and/or interest obligations. When it is probable that, based upon current information, the Bank will not collect all amounts due under the contractual terms of the loan, the loan is reported as impaired. Smaller balance homogenous type loans, such as residential loans and loans to individuals, which are collectively evaluated, are excluded from consideration for impairment. Loan impairment is measured based upon the present value of the expected future cash flows discounted at the loan's effective interest rate or the underlying value of collateral for collateral dependent loans. When a loan, including an impaired loan, is placed on non-accrual, interest accruals cease and uncollected accrued interest is reversed and charged against current income. Non-accrual loans are generally not returned to accruing status until principal and interest payments have been brought current and full collectibility is reasonably assured. Cash receipts on non-accrual and impaired loans are applied to principal, unless the loan is deemed fully collectible. Loans held for sale are carried at the aggregate lower of cost or market value. Realized gains and losses on loans held for sale are recognized at settlement date and are determined based on the cost, including deferred net loan origination fees and the costs of the specific loans sold.

The Bank accounts for its transfers and servicing financial assets in accordance with SFAS No. 140, "Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities." The Bank originates mortgages under a definitive plan to sell or securitize those loans and service the loans owned by the investor. Upon the transfer of the mortgage loans in a sale or a securitization, the Bank records the servicing assets retained in accordance with SFAS No. 140. The Bank records mortgage servicing rights and the loans based on relative fair values at the date of origination.

Mortgage loans originated and intended for sale in the secondary market are carried at the lower aggregate cost or estimated fair value. Gains and losses on sales are also accounted for in accordance with SFAS No. 134, "Accounting for Mortgage Securities Retained after the Securitization of Mortgage Loans Held for Sale by a Mortgage Banking Enterprise". This statement requires that an entity engage in mortgage banking activities classify the retained mortgage-backed security or other interest, which resulted from the securitizations of a mortgage loan held for sale, based upon its ability and intent to sell or hold these investments.

The Bank adopted SFAS No. 149, "Amendment of Statement 133 on Derivative Instruments and Hedging Activities," on July 1, 2003. Implementation issue C13, "When a Loan Commitment Is Included in the Scope of Statement 133." is included in SFAS No. 149. SFAS No. 149 amends SFAS No. 133 to add a scope exception for borrowers (all commitments) and lenders (all commitments except those relating to mortgage loans that will be held for sale). Statement 149 also amends SFAS No. 133 to require a lender to account for loan commitments related to mortgage loans that will be held for sale as derivatives. The Bank periodically enters into commitments with the customers, which it intends to sell in the future.

The Bank adopted FASB Interpretation No. 45, "Guarantor's Accounting and Disclosure Requirements for Guarantees, including Indirect Guarantees of Indebtedness of Others" (FIN 45), on January 1, 2003. FIN 45 requires a guarantor entity, at the inception of a guarantee covered by the measurement provisions of the interpretation, to record a liability for the fair value of the obligation undertaken in issuing the guarantee.

Allowance for Loan Losses

The allowance for loan losses is a valuation reserve available for losses or expected on extensions of credit. Management maintains the allowance for loan losses at a level that is considered adequate to absorb losses on existing loans that may become uncollectible based upon an evaluation of known and inherent risks in the portfolio. Additions to the allowance are made by charges to the provision for loan losses. The evaluation considers a complete review of the following specific factors: historical losses by loan category, non-accrual loans, problem loans as identified through internal classifications, collateral values, and the growth and size of the portfolio. Additionally, current economic conditions and local real estate market conditions are considered.

The methodology includes the segregation of the loan portfolio into loan types with a further segregation into risk rating categories, such as special mention, substandard, doubtful, and loss. This allows for an allocation of the allowance for loan losses by loan type; however, the allowance is available to absorb any loan loss without restriction. Larger balance, non-homogeneous loans representing significant individual credit exposures are evaluated individually through the internal loan review process. It is this process that produces the watch list. The borrower's overall financial condition, repayment sources, guarantors and value of collateral, if appropriate, are evaluated. Based on these reviews, an estimate of probable losses for the individual larger-balance loans are determined, whenever possible, and used to establish loan loss reserves. In general, for non-homogeneous loans not individually assessed, and for homogeneous groups, such as residential mortgages and consumer credits, the loans are collectively evaluated based delinquency status, loan type, and industry historical losses. These loan groups are then internally risk rated.

 

F-9

 

 

The watch list includes loans that are assigned a rating of special mention, substandard, doubtful and loss. Loans criticized special mention have potential weaknesses that deserve management's close attention. If uncorrected, the potential weaknesses may result in deterioration of the repayment prospects. Loans classified substandard have a well-defined weakness or weaknesses that jeopardize the liquidation of the debt. They include loans that are inadequately protected by the current sound worth and paying capacity of the obligor or of the collateral pledged, if any. Loans classified doubtful have all the weaknesses inherent in loans classified substandard with the added characteristic that collection or liquidation in full, on the basis of current conditions and facts, is highly improbable. Loans rated as doubtful in whole, or in part, are placed in nonaccrual status. Loans classified as a loss are considered uncollectible and are charged to the allowance for loan losses.

The Company also maintains an unallocated allowance. The unallocated allowance is used to cover any factors or conditions which may cause a potential loan loss but are not specifically identifiable. It is prudent to maintain an unallocated portion of the allowance because no matter how detailed an analysis of potential loan losses is performed, these estimates by definition lack precision. Management must make estimates using assumptions and information that is often subjective and changing rapidly.

Loans are placed in a nonaccrual status when the ultimate collectibility of principal or interest in whole, or part, is in doubt. Past-due loans contractually past-due 90 days or more for either principal or interest are also placed in nonaccrual status unless they are both well secured and in the process of collection. Impaired loans, in accordance with SFAS 114, are evaluated individually.

All, or part, of the principal balance of commercial and commercial real estate loans, and construction loans are charged off to the allowance as soon as it is determined that the repayment of all, or part, of the principal balance is highly unlikely. Consumer loans are generally charged off no later than 120 days past due on a contractual basis, earlier in the event of bankruptcy, or if there is an amount deemed uncollectible.

Premises and Equipment

Premises and equipment are stated at cost less accumulated depreciation and amortization. Depreciation is computed primarily on the straight-line method over the estimated useful lives of the assets. Building, furniture and fixtures, equipment and leasehold improvements are depreciated or amortized over the estimated useful lives of the assets or lease terms, as applicable. Estimated useful lives of building is forty years, furniture and fixtures and equipment are three to fifteen years, and three to ten years for leasehold improvements. Maintenance and repairs are charged to expense as incurred.

Income Taxes

Income taxes are accounted for under the asset and liability method. Deferred tax assets and liabilities are recognized for the future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases and operating loss and tax credit carry forwards. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. The effect on deferred tax assets and liabilities of a change in tax rates is recognized in income in the period that includes the enactment date.

Other Real Estate

Other real estate is carried at the lower of fair value of the related property, as determined by current appraisals less estimated costs to sell, or the recorded investment in the property. Write-downs on these properties, which occur after the initial transfer from the loan portfolio, are recorded as operating expenses. Costs of holding such properties are charged to expense in the current period. Gains, to the extent allowable, and losses on the disposition of these properties are reflected in current operations.

Share-Based Compensation

Stock-based compensation is accounted for under the intrinsic value based method as prescribed by Accounting Principles Board (APB) Opinion No. 25, "Accounting for Stock Issued to Employees." Included below are the pro forma disclosures required by SFAS No. 123, "Accounting for Stock-Based Compensation," as amended by SFAS No. 148, "Accounting for Stock-Based Compensation-Transaction and Disclosure" which assumes the fair value based method of accounting had been adopted.

 

 F-10


 

 

2005

 

2004

 

2003

Net income -

 

 

 

 

 

 

As reported

 

$4,560,127

 

$3,837,714

 

$3,228,500

Deduct: Stock-based

employee compensation

determined under fair

value based method for

stock options, net

of related tax effects

 

 

 

 

40,277

 

 

 

 

25,538

 

 

 

 

17,548

Pro forma

 

$4,519,850

 

$3,812,175

 

$3,210,952

 

 

 

 

 

 

 

Net income per share -

 

 

 

 

 

 

As reported -

 

 

 

 

 

 

Basic

 

$1.32

 

$1.11

 

$0.94

Diluted

 

$1.27

 

$1.08

 

$0.89

Pro forma -

 

 

 

 

 

 

Basic

 

$1.31

 

$1.10

 

$0.93

Diluted

 

$1.26

 

$1.07

 

$0.89

 

The fair value of each option grant is estimated on the date of grant using the Black-Scholes option pricing model with the following weighted average assumptions used for grants in 2005, 2004 and 2003; dividend yield of 0%; expected volatility of 35% in 2005, 2004 and 2003; risk-free interest rates of 4.39%, 3.60% and 3.27%, respectively; and expected lives of 5 years.

FASB Statement No. 123 (revised 2004), Share-Based Payment. Statement 123(R) addresses the accounting for share-based payment transactions in which an enterprise receives employee services in exchange for (a) equity instruments of the enterprise or (b) liabilities that are based on the fair value of the enterprise's equity instruments or that may be settled by the issuance of such equity instruments. Statement 123(R) requires an entity to recognize the grant-date fair-value of stock options and other equity-based compensation issued to employees in the income statement. The revised Statement generally requires that an entity account for those transactions using the fair-value-based method; and eliminates an entity's ability to account for share-based compensation transactions using the intrinsic value method of accounting in APB Opinion No. 25, Accounting for Stock Issued to Employees, which was permitted under Statement 123, as originally issued. The revised Statement requires entities to disclose information about the nature of the share-based payment transactions and the effects of those transactions on the financial statements. Statement 123(R) is effective for the Company beginning January 1, 2006. The Company anticipates using the modified prospective transition method with the adoption of this standard. The Company is assessing the impact of adopting the new pronouncement and is currently unable to estimate its impact on its consolidated financial statements.

Benefit Plans

The Company provides certain retirement benefits to employees under a 401(k) plan. The Company's contributions to the 401(k) plan are expensed as incurred. The Company also provides retirement benefits to certain employees under a supplemental executive retirement plan. The plan is unfunded and the Company accrues actuarial determined benefit costs over the estimated service period of the employees in the plan.

Cash And Cash Equivalents

Cash and cash equivalents includes cash on hand, interest and non-interest bearing amounts due from banks, Federal funds sold and short-term investments. Generally, Federal funds are sold and short-term investments are made for a one or two-day period.

Reclassifications

Certain reclassifications have been made to the prior period amounts to conform with the current period presentation.

Net Income Per Share

Basic net income per share is calculated by dividing net income by the weighted-average number of common shares outstanding during the period. Diluted net income per share is calculated by dividing net income by the weighted-average number of common shares outstanding plus the weighted-average number of net shares that would be issued upon exercise of dilutive stock options and grants pursuant to the treasury stock method. Weighted average shares for the basic net income per share computation for the years ended December 31, 2005, 2004 and 2003 were 3,452,317 3,448,548 and 3,441,125, respectively. For the diluted net income per share computation, common stock equivalents of 136,241, 135,669 and 168,015 are included for the years

 

F-11

  

ended December 31, 2005, 2004 and 2003, respectively. All share information reported in the statements of income reflects a 5% stock dividend declared December 15, 2005 paid on January 31, 2006 to shareholders of record on January 17, 2006.

Comprehensive Income

The Company follows SFAS No. 130, "Reporting Comprehensive Income". SFAS No. 130 establishes standards to provide prominent disclosure of comprehensive income items . Comprehensive income is the charge in equity of a business enterprise during a period from transactions and other events and circumstances from non-owner sources .

The income tax effects allocated to comprehensive loss are as follows :

 

 

December 31, 2005

 

December 31, 2004

 

Before Tax

 

Tax Benefit

 

Net of Tax

 

Before Tax

 

Tax Benefit

 

Net of Tax

 

Amount

 

(Expense)

 

Amount

 

Amount

 

(Expense)

 

Amount

Unrealized losses during the period

($1,375,153)

 

$549,399

 

($825,754)

 

($377,957)

 

$141,696

 

($236,261)

 

 

 

 

 

 

 

 

 

 

 

 

Reclassification adjustment

(271,871)

 

108,748

 

(163,123)

 

27,545

 

(10,266)

 

17,279

 

 

 

 

 

 

 

 

 

 

 

 

Other comprehensive loss

($1,103,282)

 

$440,651

 

($662,631)

 

($405,502)

 

$152,962

 

($253,540)

 

 

 

 

 

 

 

 

 

 

 

 

 

Comprehensive income consists of net income and net unrealized gains (losses) on securities available for sale and is presented in the consolidated statements of changes in shareholders' equity.

Variable Interest Entities

Management has determined that the 1st Constitution Capital Trust I (the "Trust") qualifies as a variable interest entity under FASB Interpretation 46 ("FIN 46"). The Trust issued mandatorily redeemable preferred stock to investors and loaned the proceeds to the Company. The Trust holds, as its sole asset, subordinated debentures issued by the Company in 2002. Prior to December 31, 2003, the Trust was included in the Company's consolidated balance sheet and statements of income. Subsequent to the issuance of FIN 46, the FASB issued a revised interpretation, FIN 46(R), the provisions of which were required to be applied to certain variable interest entities, including the Trust, by March 31, 2004. The Company adopted the provisions under FIN 46 and accordingly deconsolidated the Trust as of December 31, 2003.

In March 2005, the Federal Reserve Board adopted a final rule that would continue to allow the inclusion of trust preferred securities in Tier 1 capital, but with stricter quantitative limits. Under the final rule, after a five-year transition period, the aggregate amount of trust preferred securities and certain other capital elements would be limited to 25% of Tier 1 capital elements, net of goodwill. The amount of trust preferred securities and certain other elements in excess of the limit could be included in Tier 2 capital, subject to restrictions. Based on the final rule, the Company expects to include all of its $5.2 million in trust preferred securities in Tier 1 capital.

Segment Information

SFAS No. 131, Segment Reporting, establishes standards for public business enterprises to report information about operating segments in their annual financial statements and requires that those enterprises report selected information about operating segments in subsequent interim financial reports issued to shareholders. It also established standards for related disclosure about products and services, geographic areas, and major customers. Operating segments are components of an enterprise, which are evaluated regularly by the chief operating decision-maker in deciding how to allocate and assess resources and performance. The Company's chief operating decision-maker is the President and Chief Executive Officer. The Company has applied the aggregation criteria set forth in SFAS No. 131 for its operating segments to create one reportable segment, "Community Banking."

The Company's community banking segment consists of construction, commercial, retail and mortgage banking. The community banking segment is managed as a single strategic unit, which generates revenue from a variety of products and services provided by the Company. For example, construction and commercial lending is dependent upon the ability of the Company to fund itself with retail deposits and other borrowings and to manage interest rate and credit risk. This situation is also similar for consumer and residential real estate lending.

 

F-12

 

 

2. Investment Securities

Amortized cost, gross unrealized gains and losses, and the estimated fair value by security type as of December 31, 2005 and December 31, 2004 are as follows:

        Gross    Gross     
    Amortized    Unrealized    Unrealized    Fair 

     2005    

 
Cost 
 
Gains 
 
Losses 
 
Value 
Available for sale-                 
   U. S. Treasury securities and                 
         obligations of U.S. Government                 
         sponsored corporations and agencies    $34,032,814    $7,198    $977,560    $33,062,452 
   Mortgage backed securities    29,250,341    90,286    302,193    29,038,434 
   Obligations of State and                 
         Political subdivisions    3,855,988    1,332    65,063    3,792,257 
   FHLB stock and other securities   
3,371,673 
 
0 
 
28,158 
 
3,343,515 
 
    $70,510,815    $98,817    $1,372,974    $69,236,658 
 
Held to maturity-                 
   Mortgage backed securities    $5,807,730    $7,233    $206,275    $5,608,688 
   Obligations of State and                 
         Political subdivisions   
15,950,641 
 
108,524 
  146,827   
15,912,337 
 
   
$21,758,370 
 
$115,757 
 
$353,102 
 
$21,521,026 
 
 
        Gross    Gross     
    Amortized    Unrealized    Unrealized    Fair 

     2004    

 
Cost 
 
Gains 
 
Losses 
 
Value 
Available for sale-                 
   U. S. Treasury securities and                 
         obligations of U.S. Government                 
         sponsored corporations and agencies    $57,848,615    $85,649    $538,057    $57,396,206 
   Mortgage backed securities    20,877,821    412,179    53,848    21,236,152 
   Obligations of State and                 
         Political subdivisions    3,883,354    3,070    47,662    3,838,762 
   FHLB stock and other securities   
3,149,734 
 
0 
  32,205   
3,117,529 
 
    $85,759,524    $500,897    $671,772    $85,588,649 
 
Held to maturity-                 
   Mortgage backed securities    $604,705    $24,174    $0    $628,879 
   Obligations of State and                 
         Political subdivisions   
11,562,432 
 
164,247 
  63,308   
11,553,371 
 
   
$12,167,137 
 
$188,421 
 
$63,308 
 
$12,292,250 


The amortized cost, estimated market value and weighted average yield of debt securities at December 31, 2005, by contractual maturity, are shown below. Expected maturities will differ from contractual maturities because borrowers may have the right to call or prepay obligations with or without call or prepayment penalties. Federal Home Loan Bank stock is included in "Held to maturity - Due in one year or less."

 

 

F-13

 


  

 

 

 

Amortized

Cost

 

Estimated

Market

Value

 

Weighted

Average

Yield*

Available for sale-

 

 

 

 

 

 

Due in one year or less

 

$4,620,617

 

$4,611,487

 

2.56%

Due after one year through five years

 

14,657,111

 

14,359,729

 

3.91%

Due after five years through ten years

 

15,131,245

 

14,905,727

 

4.73%

Due after ten years

 

36,101,843

 

35,359,715

 

4.95%

 

 

 

 

 

 

 

Total

 

$70,510,816

 

$69,236,658

 

4.53%

 

 

 

 

 

 

 

Held to maturity-

 

 

 

 

 

 

Due in one year or less

 

$4,180,681

 

$4,168,393

 

2.24%

Due after one year through five years

 

3,067,600

 

3,087,895

 

5.52%

Due after five years through ten years

 

3,248,929

 

3,215,590

 

5.38%

Due after ten years

 

11,261,161

 

11,049,148

 

5.62%

 

 

 

 

 

 

 

Total

 

$21,758,371

 

$21,521,026

 

4.92%

* computed on a tax equivalent basis.

Gross unrealized losses on securities and the estimated market value of the related securities aggregated by security category and length of time that individual securities have been in a continuous unrealized loss position at December 31, 2005 and December 31, 2004 are as follows:
 

2005

 

Less than 12 months

 

12 months or longer

 

Total

 

 

Fair

 

Unrealized

 

Fair

 

Unrealized

 

Fair

 

Unrealized

 

 

Value

 

Losses

 

Value

 

Losses

 

Value

 

Losses

U.S. Treasury securities and obligations
of U.S. Government sponsored
corporations and agencies

 

$16,355,981

 

($335,803)

 

$13,395,221

 

($641,757)

 

$29,751,202

 

($977,560)

 

 

 

 

 

 

 

 

 

 

 

 

 

Mortgage backed securities

 

25,099,031

 

(333,369)

 

3,905,417

 

(175,099)

 

29,004,448

 

(508,468)

 

 

 

 

 

 

 

 

 

 

 

 

 

Obligations of State and Political

 

 

 

 

 

 

 

 

 

 

 

 

Subdivisions

 

9,849,588

 

(88,838)

 

4,597,019

 

(123,052)

 

14,446,607

 

(211,890)

 

 

 

 

 

 

 

 

 

 

 

 

 

FHLB stock and other securities

 

0

 

0

 

1,435,715

 

(28,158)

 

1,435,715

 

(28,158)

 

 

 

 

 

 

 

 

 

 

 

 

 

Total temporarily impaired securities

 

$51,304,600

 

($758,010)

 

$23,333,372

 

($968,066)

 

$74,637,972

 

($1,726,076)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

2004

 

Less than 12 months

 

12 months or longer

 

Total

 

 

Fair

 

Unrealized

 

Fair

 

Unrealized

 

Fair

 

Unrealized

 

 

Value

 

Losses

 

Value

 

Losses

 

Value

 

Losses

U.S. Treasury securities and obligations
of U.S. Government sponsored
corporations and agencies

 

$22,717,689

 

($181,022)

 

$9,408,192

 

($357,035)

 

$32,125,881

 

($538,057)

 

 

 

 

 

 

 

 

 

 

 

 

 

Mortgage backed securities

 

3,992,374

 

(35,020)

 

1,480,487

 

(18,828)

 

5,472,861

 

(53,848)

 

 

 

 

 

 

 

 

 

 

 

 

 

Obligations of State and Political

 

 

 

 

 

 

 

 

 

 

 

 

subdivisions

 

8,988,653

 

(110,970)

 

0

 

0

 

8,988,653

 

(110,970)

 

 

 

 

 

 

 

 

 

 

 

 

 

FHLB stock and other securities

 

0

 

0

 

1,428,345

 

(32,205)

 

1,428,345

 

(32,205)

 

 

 

 

 

 

 

 

 

 

 

 

 

Total temporarily impaired securities

 

$35,698,716

 

($327,012)

 

$12,317,024

 

($408,068)

 

$48,015,740

 

($735,080)

 

U.S. Treasury obligations and direct obligations of U.S. Government agencies: The unrealized losses on investments in these securities were caused by interest rate increases. The contractual terms of these investments do not permit the issuer to settle the securities at a price less than the amortized cost of the investment. Because the Company has the ability and intent to hold these investments until a market price recovery or maturity, these investments are not considered other-than temporarily impaired.

 

F-14

 

  

Mortgage-backed securities: The unrealized losses on investments in mortgage-backed securities were caused by interest rate increases. The contractual cash flows of these securities are guaranteed by the issuer, primarily government or government sponsored agencies. It is expected that the securities would not be settled at a price less than the amortized cost of the investment. Because the decline in fair value is attributable to changes in interest rates and not credit quality, and because the Company has the ability and intent to hold these investments until a market price recovery or maturity, these investments are not considered other-than-temporarily impaired.

FHLB stock and other securities: The investments in these securities with unrealized losses are comprised of corporate trust preferred securities that mature in 2027. The unrealized losses on these securities were caused by interest rate increases. The contractual terms of the bonds do not allow the issuer to settle the securities at a price less than the face value of the bonds, which is greater than the amortized cost of the bonds. Because the decline in fair value is attributable to changes in interest rates and not credit quality, and because the Company has the intent and ability to hold these investments until a market price recovery or maturity, these investments are not considered other-than-temporarily impaired.

The Company recorded net losses on sales of securities available for sale of $271,871 in 2005 and net gains on sales of $27,545 in 2004. These portfolio transactions in 2005 and 2004 were primarily the result of modest portfolio restructurings. Their purpose was to improve the Company's longer-term interest rate risk position. There were no sales of securities in 2003.

As of December 31, 2005 and 2004, securities having a book value of $32,388,166 and $17,367,486, respectively, were pledged to secure public deposits, other borrowings and for other purposes required by law.

3. Loans and Loans Held for Sale

Loans are as follows:

 

 
2005 
 
2004 
 
         Construction loans  $109,862,614    $88,027,024   
         Residential real estate loans  8,602,975    9,815,366   
         Commercial and commercial real estate  104,448,196    96,021,077   
         Loans to individuals  16,441,994    16,002,619   
         Lease financing  21,073    74,543   
         All other 
637,497 
 
712,422 
 
 
$240,014,349 
 
$210,653,051 
 
 

The Bank's business is concentrated in New Jersey, particularly Middlesex, Mercer and Somerset counties. A significant portion of the total loan portfolio is secured by real estate or other collateral located in these areas.

The Bank had residential mortgage loans held for sale of $16,757,734 at December 31, 2005 and $9,927,769 at December 31, 2004. The Bank sells residential mortgage loans in the secondary market on a non-recourse basis. The related loan servicing rights are generally released to the purchaser. Loans held for sale at December 31, 2005 and 2004 are residential mortgage loans that the Bank intends to sell under forward contracts providing for delivery to purchasers generally within a two month period. Changes in fair value of the forward sales contracts, and the related loan origination commitments and closed loans, were not significant at December 31, 2005 and 2004.

4. Allowance for Loan Losses

A summary of the allowance for loan losses is as follows:

 

 
2005 
 
2004 
 
2003 
Balance, beginning of year  $2,005,169    $1,786,632    $1,669,882 
Provision charged to operations  405,000    240,000    240,000 
Loans charged off  (52,803)    (22,273)    (123,666) 
Recoveries of loans charged off  4,009   
810 
 
416 
Balance, end of year 
$2,361,375 
 
$2,005,169 
 
$1,786,632 

The amount of loans which were not accruing interest amounted to $833,150 and $1,049,411 at December 31, 2005 and 2004, respectively. Impaired loans totaled $833,150 and $1,049,411 at December 31, 2005 and 2004, respectively. There was no valuation allowance on impaired loans at December 31, 2005 and December 31, 2004. Loans 90 days or more past due and still accruing totaled $209 at December 31, 2005, $63,130 at December 31, 2004 and zero at December 31, 2003.

 

F-15

 

Additional income before taxes amounting to $111,340, $80,698 and $16,993 would have been recognized in 2005, 2004 and 2003, respectively, if interest on all loans had been recorded based upon original contract terms. No interest was recognized on non-accrual loans in 2005, 2004 or 2003. The average recorded investment in impaired loans for the years ended December 31, 2005, 2004 and 2003, was approximately $941,280, $690,097, and $240,949, respectively.

5. Loans to Related Parties

Activity related to loans to directors, executive officers and their affiliated interests during 2005 is as follows:

 

Balance, beginning of year    $4,491,192 
Loans granted    1,201,426 
Repayments of loans   
(3,060,456) 
Balance, end of year   
$2,632,162 


All such loans were made under customary terms and conditions and were current as to principal and interest payments as of December 31, 2005 and 2004.

6. Premises And Equipment

Premises and equipment consist of the following:

 

 

Estimated

Useful Lives

 

 

2005

 

 

2004

Land

 

 

$241,784

 

$ -

Building

40 Years

 

735,579

 

417,928

Leasehold improvements

10 Years

 

1,379,023

 

1,242,504

Furniture and equipment

3 - 15 Years

 

2,845,959

 

2,751,749

 

 

 

5,202,345

 

4,412,181

 

 

 

 

 

 

Less Accumulated depreciation

 

 

(2,605,493)

 

(2,087,962)

 

 

 

$2,596,852

 

$2,324,219

 

7. Deposits

Deposits consist of the following:

   
2005 
 
2004 
 
       Demand           
             Non-interest bearing    $62,686,802    $50,794,581   
             Interest bearing    102,479,894    110,082,085   
       Savings    49,547,438    27,310,910   
       Time   
91,095,333 
 
88,699,457 
 
   
$305,809,467 
 
$276,887,033 
 

Individual time deposits $100,000 or greater amounted to $3,385,000 and $13,178,791 at December 31, 2005 and 2004, respectively. As of December 31, 2005, time deposits mature as follows: $66,082,431 in 2006; $12,865,872 in 2007; $4,349,444 in 2008; $6,098,419 in 2009; and $1,699,167 in 2010.

8. Other Borrowings

The balance of other borrowings was $28,500,000 at December 31, 2005, consisting of long-term FHLB borrowings of $23,500,000 and overnight funds purchased of $5,000,000. The balance of other borrowings at December 31, 2004 consisted of FHLB borrowings of $15,500,000 and overnight funds purchased of $9,700,000.

 

F-16

 


  

During 2000, the Bank purchased three ten-year fixed rate convertible advances from the FHLB. These advances, in the amounts of $2,500,000, $5,000,000, and $5,000,000 bear interest at the rates of 5.50%, 5.34%, and 5.06%, respectively. These advances are convertible quarterly at the option of the FHLB.

These advances are fully secured by marketable securities and qualifying one-to-four family mortgage loans.

The FHLB advances as of December 31, 2005 mature as follows:

 

 

2005

Within one year

$ 8,000,000

Over two to three years

                 - -

Over three to four years

3,000,000

Over four to five years

12,500,000

Over five years

                - -

Total

$23,500,000

 

These callable advances have original maturity dates of five to ten years and call dates of one year to five years. After the original call period expires, the borrowings are callable quarterly. Due to the call provisions, expected maturities could differ from contractual maturities.

Securities sold under agreements to repurchase are summarized as follows:

 

 

2005

2004

2003

Balance outstanding at year end

- -

- -

$1,921,015

Weighted average interest rate at year end

- -

1.27%

1.15%

Average daily balance outstanding during year

- -

$1,674,172

$2,290,866

Weighted average interest rate during year

- -

1.28%

1.46%

Highest month-end outstanding balance

- -

$1,941,042

$2,562,549

 

9. Redeemable Subordinated Debentures

On April 10, 2002, 1ST Constitution Capital Trust I (the "Trust"), a statutory business trust and a wholly owned subsidiary of the Company, issued $5.0 million of variable rate Trust Preferred Securities in a pooled institutional placement transaction maturing April 22, 2032. The Trust utilized the $5.0 million proceeds along with $155,000 invested in the Trust by the Company to purchase $5,155,000 of subordinated debentures issued by the Company. The Subordinated Debentures have terms that mirror the Trust Preferred Securities. The Trust exists for the sole purpose of issuing Trust Preferred Securities. These Subordinated Debentures constitute the sole assets of the Trust. These Subordinated Debentures are redeemable in whole or part prior to maturity after April 22, 2007. The Trust is obligated to distribute all proceeds of a redemption of these Subordinated Debentures, whether voluntary or upon maturity, to holders of the Trust Preferred Securities. The Company's obligation with respect to the Trust Preferred Securities and the Subordinated Debentures, when taken together, provides a full and unconditional guarantee on a subordinated basis by the Company of the obligations of the Trust to pay amounts when due on the Trust Preferred Securities.

Management has determined that the 1st Constitution Capital Trust I (the "Trust") qualifies as a variable interest entity under FASB Interpretation 46 ("FIN 46"). The Trust issued mandatorily redeemable preferred stock to investors and loaned the proceeds to the Company. The Trust holds, as its sole asset, subordinated debentures issued by the Company in 2002. Prior to December 31, 2003, the Trust was included in the Company's consolidated balance sheet and statements of income. Subsequent to the issuance of FIN 46, the FASB issued a revised interpretation, FIN 46(R), the provisions of which were required to be applied to certain variable interest entities, including the Trust, by March 31, 2004. The Company adopted the provisions under FIN 46 and accordingly deconsolidated the Trust as of December 31, 2003.

 

F-17

 

  

10. Income Taxes

 

The components of income tax expense (benefit) are summarized as follows:

 

 

 

 

 

2005

 

2004

 

2003

 

Federal-

 

 

 

 

 

 

 

Current

 

$1,955,941

 

$1,836,439

 

$1,537,053

 

Deferred

 

(198,849)

 

(127,181)

 

(104,330)

 

 

 

1,757,887

 

1,709,258

 

1,432,723

 

State

 

 

 

 

 

 

 

Current

 

372,050

 

273,301

 

362,411

 

Deferred

 

(34,740)

 

(22,219)

 

(18,227)

 

 

 

337,310

 

251,082

 

344,184

 

 

 

 

 

 

 

 

 

 

 

$2,094,402

 

$1,960,340

 

$1,776,907

A comparison of income tax expense at the Federal statutory rate in 2005, 2004 and 2003 to the Company's provision for income taxes is as follows:
 

   
2005 
 
2004 
 
2003 
Federal income tax    $2,262,540    $1,971,338    $1,701,838 
Add (deduct) effect of:             
   State income taxes net of federal income tax effect    213,276    165,714    227,161 
   Tax-exempt interest income    (224,699)    (131,270)    (106,000) 
   Bank-owned life insurance    (80,046)    (106,249)    (88,842) 
   Other items, net   
(76,669) 
 
60,807 
 
42,750 
 
Provision for income taxes   
$2,094,402 
 
$1,960,340 
 
$1,776,907 

The tax effects of existing temporary differences that give rise to significant portions of the deferred tax assets and deferred tax liabilities are as follows:
 

   
2005 
 
     2004 
Deferred tax assets-         
       Allowance for loan losses    $943,133    $800,864 
       Employee Benefits    327,718    168,116 
       Unrealized loss on securities available for sale    508,899    95,106 
       Other   
8,221 
 
13,126 
 
Total deferred tax assets   
1,787,971 
 
1,077,212 
 
Deferred tax liabilities-         
       Unrealized gain on securities available for sale    -    26,858 
       Other    86,971    23,593 
Total deferred tax liabilities    86,971    50,451 
Net deferred tax asset   
$1,701,000 
 
$1,026,761 

Based upon the current facts, management has determined that it is more likely than not that there will be sufficient taxable income in future years to realize the deferred tax assets. However, there can be no assurances about the level of future earnings.

11. Benefit Plans

Retirement Savings Plan

The Bank has a 401(K) plan which covers substantially all employees with six months or more of service. The plan permits all eligible employees to make basic contributions to the plan up to 12% of base compensation. Under the plan, the Bank provided a matching contribution of 50% in 2005, 2004 and 2003 up to 6% of base compensation. Employer contributions to the plan amounted to $78,899 in 2005, $67,864 in 2004, and $57,830 in 2003.

 

F-18

 

 

Benefit Plans

The Bank maintains a salary continuation plan for key executives and a director deferred compensation plan for its board members. The plans provide for yearly retirement benefits to be paid over a specified period. In addition, there is an officer group term replacement plan for divisional officers. The present value of the benefits accrued under these plans as of December 31, 2005 and 2004 is approximately $820,527 and $420,921, respectively, and is included in other liabilities in the accompanying consolidated statements of condition. Compensation expense of approximately $399,606, $420,921 and $233,845 is included in the accompanying consolidated statement of income for the years ended December 31, 2005, 2004 and 2003, respectively.

In connection with the benefit plans, the Bank purchased $6.0 million in life insurance policies on the lives of its executives, directors and divisional officers. During 2005, the Bank purchased an additional $2.0 million. The Bank is the owner and beneficiary of the policies. The cash surrender values of the policies are approximately $8.8 million and $6.6 million as of December 31, 2005 and 2004, respectively.

12. Share Based Compensation

The Company's shareholders have approved stock option plans and stock grant plans for directors and key employees. The Company has also entered into an employment agreement pursuant to which additional options and stock grants were awarded to its President. The Bank accounts for the award of stock options in accordance with Accounting Principles Board Opinion No. 25, under which no compensation cost has been recognized.

A summary of the status of the Company's stock options at December 31, 2005, 2004 and 2003 and changes during the years then ended is presented below:

 

2005

 

2004

 

2003

 

Shares

 

Weighted Avg. Price

 

Shares

 

Weighted Avg. Price

 

Shares

 

Weighted Avg. Price

Outstanding, at beginning of year

198,833

 

$5.99

 

264,384

 

$5.07

 

299,066

 

$4.59

Granted

18,690

 

18.97

 

12,128

 

16.51

 

8,567

 

12.70

Exercised

(22,540)

 

8.08

 

(75,795)

 

4.62

 

(43,248)

 

3.16

Forfeited

- -

 

- -

 

(1,883)

 

10.25

 

- -

 

- -

 

 

 

 

 

 

 

 

 

 

 

 

Outstanding, at end of year

194,983

 

$5.50

 

198,833

 

$5.99

 

264,385

 

$5.07

Weighted average fair value of options granted during the year

 

 

$7.55

 

 

 

 

$12.76

 

 

 

 

$10.65

 

The following table summarizes information about options outstanding at December 31, 2005:

 

Options outstanding

 

Options exercisable

 

 

 

 

Weighted

 

 

 

 

 

 

 

 

Number

 

Average

 

Weighted

 

Number

 

Weighted

 

 

Outstanding at

 

Remaining

 

average

 

Outstanding at

 

Average

Range of

 

December 31,

 

Contractual

 

exercise

 

December 31,

 

Exercise

exercise prices

 

2005

 

life in years

 

price

 

2005

 

Price

$3.01 - $4.45

 

76,442

 

0.9

 

$3.07

 

76,442

 

$3.07

$5.02 - $5.46

 

49,793

 

3.5

 

5.45

 

49,793

 

5.45

$7.58 - $10.90

 

20,785

 

4.5

 

7.65

 

20,444

 

7.64

$11.42 - $16.51

 

29,273

 

8.1

 

13.90

 

16,860

 

13.27

$16.95 - $19.76

 

18,690

 

9.8

 

18.97

 

3,738

 

18.97

$3.01 - $19.76

 

194,983

 

3.9

 

$5.50

 

167,277

 

$5.30
                     

 

 

F-19

 


 

13. Commitments and Contingencies

As of December 31, 2005, future approximate minimum rental payments under non-cancelable operating leases are as follows:

 

2006  $676,981 
2007  656,332 
2008  614,526 
2009  610,819 
2010  618,811 
Thereafter 
3,052,827 
 
$6,230,296 

Rent expense aggregated $762,725, $694,997 and $557,592 for the years ended December 31, 2005, 2004 and 2003, respectively.

Commitments With Off-Balance Sheet Risk

The statement of condition does not reflect various commitments relating to financial instruments which are used in the normal course of business. Management does not anticipate that the settlement of those financial instruments will have a material adverse effect on the Company's financial position. These instruments include commitments to extend credit and letters of credit. These financial instruments carry various degrees of credit risk, which is defined as the possibility that a loss may occur from the failure of another party to perform according to the terms of the contract. As these off-balance sheet financial instruments have essentially the same credit risk involved in extending loans, the Bank generally uses the same credit and collateral policies in making these commitments and conditional obligations as it does for on-balance sheet investments. Additionally, as some commitments and conditional obligations are expected to expire without being drawn or returned, the contractual amounts do not necessarily represent future cash requirements.

Commitments to extend credit are legally binding loan commitments with set expiration dates. They are intended to be disbursed, subject to certain conditions, upon request of the borrower. The Bank receives a fee for providing a commitment. The Bank was committed to advance $124,136,000 to its borrowers as of December 31, 2005.

The Bank issues financial standby letters of credit that are within the scope of FASB Interpretation No. 45, Guarantor's Accounting and Disclosure Requirements for Guarantees, Including Indirect Guarantees of Indebtedness of Others. These are irrevocable undertakings by the Bank to guarantee payment of a specified financial obligation. Most of the Bank's financial standby letters of credit arise in connection with lending relationships and have terms of one year or less. The maximum potential future payments the Bank could be required to make equals the contract amount of the standby letters of credit and amounted to $3,848,473 at December 31, 2005. The Bank's recognized liability for financial standby letters of credit was $875,467 at December 31, 2004.

The Bank also enters into forward contracts to sell residential mortgage loans it has closed (loans held for sale) or that it expects to close (commitments to originate loans held for sale). These contracts are used to reduce the Bank's market price risk during the period from the commitment date to the sale date. The notional amount of the Bank's forward sales contracts was approximately $16.8 million at December 31, 2005 and $9.9 million at December 31, 2004. Changes in fair value of the forward sales contracts, and the related loan origination commitments and closed loans, were not significant at December 31, 2005 and 2004.

Litigation

The Company may, in the ordinary course of business, become a party to litigation involving collection matters, contract claims and other legal proceedings relating to the conduct of its business. The Company may also have various commitments and contingent liabilities which are not reflected in the accompanying consolidated statement of condition. Management is not aware of any present legal proceedings or contingent liabilities and commitments that would have a material impact on the Company's financial position or results of operations.

 

F-20

 


 14. Other Operating Expenses

The components of other operating expenses for the years ended December 31, 2005, 2004 and 2003 are as follows:

 

 
2005 
 
2004 
 
2003 
Equipment expense  $491,735    $464,928    $434,933 
Marketing  292,352    274,095    225,860 
Computer services  623,001    636,076    498,081 
Regulatory, professional and other fees  1,102,691    542,001    548,440 
Office expense  401,490    462,586    312,055 
All other expenses 
715,826 
 
583,225 
 
351,153 
 
$3,627,095 
 
$2,962,911 
 
$2,370,522 

15. Regulatory Requirements

The Bank is subject to various regulatory capital requirements administered by the Federal and state banking agencies. Failure to meet minimum capital requirements can initiate certain mandatory, and possibly additional discretionary, actions by regulators that, if undertaken, could have a direct material effect on the Bank's and the Company's financial statements. Under capital adequacy guidelines and the regulatory framework for prompt corrective action, the Bank must meet specific capital guidelines that involve quantitative measures of the Bank's assets, liabilities, and certain off-balance sheet items as calculated under regulatory accounting practices. The Bank's capital amounts and classifications are also subject to qualitative judgments by the regulators about components, risk weightings and other factors.

Quantitative measures established by regulation to ensure capital adequacy require the Bank to maintain minimum amounts and ratios of Total and Tier I capital (as defined in the regulations) to risk-weighted assets (as defined), and of Tier I capital to average assets (as defined). As of December 31, 2005, the Bank met all capital adequacy requirements to which it is subject.

To be categorized as adequately capitalized, the Bank must maintain minimum total risk-based, Tier I risk-based, and Tier I leverage ratios as set forth in the table. As of December 31, 2005, the most recent notification from the Bank's primary regulator categorized the Bank as well capitalized under the regulatory framework for prompt corrective action. There are no conditions or events since that notification that management believes have changed the Bank's category. Certain bank regulatory limitations exist on the availability of Bank assets available for the payment of dividends without prior approval of bank regulatory authorities.

Actual capital amounts and ratios for the Company and the Bank as of December 31, 2005 and 2004 are as follows:

 

 
Actual
    
For Capital 
Adequacy Purposes 
 
To Be Well Capitalized
Under Prompt  Corrective  Action Provisions 
 
Amount 
 
Ratio 
 
 Amount 
 
Ratio 
 
Amount 
 
Ratio 
 
As of December 31, 2005 -                       
Company                       
 Total capital (to Risk Weighted Assets)  $37,923,500    13.30%    $22,817,040    8%    $28,521,300    ≥10% 
 Tier I Capital (to Risk Weighted Assets)  35,562,125    12.47%    11,408,520    ≥4%    17,112,780    ≥6% 
 Tier I Capital (to Average Assets)  35,562,125    9.76%    14,580,112    ≥4%    18,225,140    ≥5% 
Bank                       
 Total capital (to Risk Weighted Assets)  $37,493,600    13.15%    $22,817,040    ≥8%    $28,521,300    ≥10% 
 Tier I Capital (to Risk Weighted Assets)  35,132,225    12.32%    11,408,520    ≥4%    17,112,780    ≥6% 
 Tier I Capital (to Average Assets)  35,132,225    9.64%    14,578,280    ≥4%    18,222,850    ≥5% 
 
As of December 31, 2004 -                       
Company                       
 Total capital (to Risk Weighted Assets)  $33,898,932    13.99%    $19,379,760    ≥8%    $24,224,700    ≥10% 
 Tier I Capital (to Risk Weighted Assets)  31,893,763    13.17%    9,689,880    ≥4%    14,534,820    ≥6% 
 Tier I Capital (to Average Assets)  31,893,763    10.16%    13,311,362    ≥4%    16,639,203    ≥5% 
Bank                       
 Total capital (to Risk Weighted Assets)  $33,566,803    13.86%    $19,374,000    ≥8%    $24,217,500    ≥10% 
 Tier I Capital (to Risk Weighted Assets)  31,561,634    13.03%    9,687,000    ≥4%    14,530,500    ≥6% 
 Tier I Capital (to Average Assets)  31,561,634    9.49%    13,308,440    ≥4%    16,635,550    ≥5% 

 

The primary source of dividends paid to the Company's shareholders is dividends paid to the Company by the Bank. Dividend payments by the Bank to the Company are subject to the New Jersey Banking Act of 1948 (the "Banking Act") and the Federal Deposit Insurance Act (the "FDIA"). Under the Banking Act and the FDIA, the Bank may not pay any dividends if after paying the dividend, it would be undercapitalized under applicable

 

F-21

capital requirements. In addition to these explicit limitations, the federal regulatory agencies are authorized to prohibit a banking subsidiary or bank holding company from engaging in an unsafe or unsound banking practice. Depending upon the circumstances, the agencies could take the position that paying a dividend would constitute an unsafe or unsound banking practice.

16. Estimated Fair Value Of Financial Instruments

The following is a summary of fair value versus the carrying value of the Bank's financial instruments. For the Bank, as for most financial institutions, the bulk of its assets and liabilities are considered financial instruments. Many of the Bank's financial instruments lack an available trading market as characterized by a willing buyer and willing seller engaging in an exchange transaction. Therefore, significant estimations and present value calculations were used by the Bank for the purpose of this note. Changes in assumptions could significantly affect these estimates.

Estimated fair values have been determined by the Bank using the best available data and an estimation methodology suitable for each category of financial instruments. Financial instruments, such as securities available for sale and securities held to maturity, actively traded in the secondary market have been valued using available market prices. Carrying values of cash and cash equivalents and securities sold under agreements to repurchase approximate fair value due to the short-term nature of these instruments. Other borrowings are valued on a discounted cash flow method utilizing current discount rates for instruments of similar remaining terms.

Financial instruments with stated maturities have been valued using a present value discounted cash flow with a discount rate approximating current market for similar assets and liabilities. For those loans and deposits with floating interest rates, it is assumed that estimated fair values generally approximate the recorded book balances.

The estimated fair values, and the recorded book balances, were as follows:

 

 
December 31, 2005 
 
December 31, 2004 
 
  Carrying        Carrying     
 
Value 
 
Fair Value 
 
 Value 
 
Fair Value 
 
Securities available for sale  $69,236,658    $69,236,658    85,588,649    85,588,649 
Securities held to maturity  21,758,370    21,521,026    12,167,137    12,292,250 
Loans held for sale  16,757,734    16,757,734    9,927,881    9,927,881 
Gross loans  240,014,349    241,109,000    210,653,051    211,588,000 
Deposits  305,809,467    304,865,000    276,887,033    276,586,000 
Other borrowings  28,500,000    28,584,000    25,200,000    25,968,000 

Loan commitments and standby letters of credit as of December 31, 2005 and 2004 are based on fees charged for similar agreements; accordingly, the estimated fair value of loan commitments and standby letters of credit is nominal.

17. Condensed Financial Statements of 1st Constitution Bancorp (Parent Company Only)

The following financial statements of the Company should be read in conjunction with the notes to the consolidated financial statements.

 

CONDENSED STATEMENTS OF CONDITION

 

 

December 31,

2005

December 31,

2004

Assets:

 

 

 

Cash

 

$31,328

$21,021

Investment securities available for sale

 

155,000

155,000

Investment in subsidiaries

 

34,361,360

31,458,256

Other assets

 

404,179

311,107

Total Assets

 

$34,951,867

$31,945,384

 

 

 

 

Liabilities And Shareholders' Equity

 

 

 

Subordinated debentures

 

$5,155,000

$5,155,000

Shareholders' equity

 

29,796,867

26,790,384

Total Liabilities and Shareholder's Equity

 

$34,951,867

$31,945,384

 

F-22

 


 

CONDENSED STATEMENTS OF INCOME

 

Year ended December 31,

 

2005

2004

2003

Operating Income:

 

 

 

Interest Income

$10,875

$8,156

$7,994

Total Operating Income

10,875

8,156

7,994

 

 

 

 

Operating Expense:

 

 

 

Interest Expense

361,699

271,239

265,845

Other Expense

32,004

32,004

32,004

Total Operating Expense

393,703

303,243

297,849

 

 

 

 

Loss before income taxes and equity in undistributed income of

Subsidiaries

 

(382,828)

 

(295,087)

 

(289,855)

Federal income tax benefit

(137,819)

(106,231)

(104,419)

 

 

 

 

Loss before equity in undistributed income of subsidiaries

(245,009)

(188,856)

(185,436)

Equity in undistributed income of subsidiaries

4,805,136

4,026,569

3,413,936

Net Income

$4,560,127

$3,837,714

$3,228,500

 

CONDENSED STATEMENTS OF CASH FLOWS

 

Year ended December 31,

 

2005

2004

2003

Cash Flows From Operating Activities:

 

 

 

Net Income

$4,560,127

$3,837,714

$3,228,500

Adjustments:

 

 

 

Increase in other assets

(87,465)

(65,057)

(75,837)

Equity in undistributed income of subsidiaries

(4,805,136)

(4,026,569)

(3,413,936)

Net cash used In Operating Activities

(332,474)

(253,912)

(261,273)

 

 

 

 

Cash Flows from Investing Activities:

 

 

 

Repayment of investments in subsidiaries

342,781

261,693

269,373

Net cash provided by Investing Activities

342,781

261,693

269,373

 

 

 

  

Net increase in cash

10,307

7,781

8,100

Cash as of beginning of year

21,021

13,150

5,050

Cash as of end of year

$31,328

$21,021

$13,150

 

18. Unaudited Quarterly Financial Data

 

 

 

 

 

2005

 

 

 

 

Dec. 31

 

Sept. 30

 

June 30

 

March 31

Summary of Operations

 

 

 

 

 

 

 

 

Interest income

 

 

$5,952,682

 

$5,518,301

 

$5,036,307

 

$4,820,782

Interest expense

 

 

1,750,817

 

1,591,652

 

1,405,594

 

1,280,116

Net interest income

 

 

4,201,865

 

3,926,649

 

3,630,713

 

3,540,666

Provision for loan losses

 

125,000

 

85,000

 

135,000

 

60,000

Net interest income after provision

 

 

 

 

 

 

 

for loan losses

 

 

4,076,865

 

3,841,649

 

3,495,713

 

3,480,666

Non-interest income

 

 

445,694

 

769,751

 

809,614

 

621,802

Non-interest expense

 

 

2,840,482

 

2,855,005

 

2,621,529

 

2,570,209

Income before income taxes

 

1,682,077

 

1,756,395

 

1,683,798

 

1,532,259

Income taxes

 

 

487,721

 

567,529

 

552,424

 

486,728

Net income

 

 

$1,194,356

 

$1,188,866

 

$1,131,374

 

$1,045,531

 

 

 

 

 

 

 

 

 

 

 

Net income per share :

 

 

 

 

 

 

 

 

Basic

 

 

 

$0.36

 

$0.34

 

$0.32

 

$0.30

Diluted

 

 

 

$0.34

 

$0.33

 

$0.31

 

$0.29

 

 

F-23

 


 

 

 

 

 

 

2004

 

 

 

 

Dec. 31

 

Sept. 30

 

June 30

 

March 31

Summary of Operations

 

 

 

 

 

 

 

 

Interest income

 

 

$4,580,274

 

$4,403,646

 

$4,043,826

 

$3,988,322

Interest expense

 

 

1,230,950

 

1,211,334

 

1,069,777

 

1,033,234

Net interest income

 

 

3,349,324

 

3,192,312

 

2,974,049

 

2,955,088

Provision for loan losses

 

60,000

 

60,000

 

60,000

 

60,000

Net interest income after provision

 

 

 

 

 

 

 

for loan losses

 

 

3,289,324

 

3,132,312

 

2,914,049

 

2,895,088

Non-interest income

 

 

703,031

 

647,897

 

694,355

 

511,959

Non-interest expense

 

 

2,278,380

 

2,355,577

 

2,236,092

 

2,119,912

Income before income taxes

 

1,713,975

 

1,424,632

 

1,372,312

 

1,287,135

Income taxes

 

 

638,864

 

468,537

 

441,611

 

411,328

Net income

 

 

$1,075,111

 

$956,095

 

$930,701

 

$875,807

 

 

 

 

 

 

 

 

 

 

 

Net income per share :

 

 

 

 

 

 

 

 

Basic

 

 

 

$0.29

 

$0.28

 

$0.28

 

$0.26

Diluted

 

 

 

$0.28

 

$0.28

 

$0.27

 

$0.25

 

 

 

 

 

 

 

 

 

 

 

F-24

 


  

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.

 

 

1ST CONSTITUTION BANCORP

 

Date: March 10, 2006

 By:

/s/ ROBERT F. MANGANO      
    Robert F. Mangano
   

President and Chief Executive Officer

(Principal Executive Officer)

 

Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the dates indicated.

 

Signature

Capacity

Date
     

/s/ ROBERT F. MANGANO            

President, Chief Executive Officer and Director

 March 10, 2006
Robert F. Mangano (Principal Executive Officer)  
     

/s/ CHARLES S. CROW, III            

Chairman of the Board

 March 10, 2006
Charles S. Crow, III    

 

  

 
/s/ DAVID C. REED          

Director

 March 10, 2006
David C. Reed    
     
   
 Director

 March 10, 2006
William M. Rue    
     
/s/ FRANK E. WALSH, III        
 Director

 March 10, 2006
Frank E. Walsh, III    
     

/s/ JOSEPH M. REARDON 

Senior Vice President and Treasurer (Principal

March 10, 2006

Joseph M. Reardon

Accounting Officer)

 

 

 

40

 


  

1ST CONSTITUTION BANCORP
INDEX TO EXHIBITS

 

Exhibit No.

 

Description

3

(i)

 

Certificate of Incorporation of the Company (incorporated by reference to Exhibit 3(i) to the Company's Form 10-K filed with the SEC on March 24, 2005).

3

(ii)

 

Bylaws of the Company (incorporated by reference to Exhibit 3(ii) to the Company's Form 10-QSB filed with the SEC on May 14, 2003)

4.1

 

 

Specimen Share of Common Stock (incorporated by reference to the Company's Form 10-KSB filed with the SEC on March 22, 2002)

4.2

 

 

Amended and Restated Declaration of Trust of 1st Constitution Capital Trust I dated as of April 10, 2002 among the Registrant, as sponsor, Wilmington Trust Company, as Delaware and institutional trustee, and the Administrators named therein (incorporated by reference to the Company's Form 10-QSB filed with the SEC on May 8, 2002)

4.3

 

 

Indenture dated as of April 10, 2002 between the Registrant, as issuer, and Wilmington Trust Company, as trustee, relating to the Floating Rate Junior Subordinated Debt Securities due 2032 (incorporated by reference to the Company's Form 10-QSB filed with the SEC on May 8, 2002)

4.4

 

 

Guarantee Agreement dated as of April 10, 2002 between the Registrant and the Wilmington Trust Company, as guarantee trustee (incorporated by reference to the Company's Form 10-QSB filed with the SEC on May 8, 2002)

4.5

 

 

Rights Agreement, dated as of March 18, 2004, between 1st Constitution Bancorp and Registrar and Transfer Company, as Rights Agent, including the form of Certificate of Amendment to the Company's Certificate of Incorporation as Exhibit A thereto, the form of Rights Certificates as Exhibit B thereto, and the Summary of Rights as Exhibit C thereto. Pursuant to the Rights Agreement, printed Rights Certificates will not be mailed until after the Distribution Date (as such term is defined in the Rights Agreement) (incorporated by reference to the Company's Form 8-A12G filed with the SEC on March 18, 2004).

10.1

 

#

1st Constitution Bancorp Supplemental Executive Retirement Plan, dated as of October 1, 2002 (Incorporated by reference to the Company's Form 10-QSB filed with the SEC on November 13, 2002)

10.2

 

#

1st Constitution Bancorp Directors' Deferral Plan, dated as of October 1, 2002 (Incorporated by reference to the Company's Form 10-QSB filed with the SEC on November 13, 2002)

10.3

 

#

1st Constitution Bancorp Directors Insurance Plan, dated as of October 1, 2002 (Incorporated by reference to the Company's Form 10-QSB filed with the SEC on November 13, 2002)

10.4

 

#

1st Constitution Bancorp Form of Executive Life Insurance Agreement (Incorporated by reference to the Company's Form 10-QSB filed with the SEC on November 13, 2002)

 

 

 


  

Exhibit No.

 

Description

10.5

 

#

Amended and Restated 1990 Stock Option Plan for Key Employees, as amended (incorporated by reference to Exhibit No. 10.1 to the Company's Form 10-QSB filed with the SEC on August 9, 2002)

10.6

 

#

1996 Employee Stock Option Plan, as amended (incorporated by reference to Exhibit No. 10.2 to the Company's Form 10-QSB filed with the SEC on August 9, 2002)

10.7

 

#

2000 Employee Stock Option and Restricted Stock Plan (incorporated by reference to Exhibit No. 6.3 to the Company's Form 10-SB filed with the SEC on June 15, 2001)

10.8

 

#

Directors Stock Option and Restricted Stock Plan (incorporated by reference to Exhibit No. 6.4 to the Company's Form 10-SB filed with the SEC on June 15, 2001)

10.9

 

#

Employment Agreement between the Company and Robert F. Mangano dated April 22, 1999 (incorporated by reference to Exhibit No. 6.5 to the Company's Form 10-SB filed with the SEC on June 15, 2001)

10.10

 

#

Agreement for Consulting Services between the Company and Edward D. Knapp (incorporated by reference to Exhibit 10.10 to the Company's Form 10-KSB filed with the SEC on March 20, 2003)

10.11

 

#

Amendment to 1st Constitution Bancorp Directors Insurance Plan, dated as of February 19, 2004 (incorporated by reference to Exhibit 10.11 to the Company's Form 10-K filed with the SEC on March 25, 2004)

10.12

 

#

Amendment No. 1 to 1st Constitution Bancorp Supplemental Executive Retirement Plan, effective January 1, 2004 (incorporated by reference to Exhibit 10.12 to the Company's Form 10-Q filed with the SEC on August 11, 2004)

10.13

 

#

Change of Control Agreement, effective as of April 1, 2004, by and between the Company and Joseph M. Reardon (incorporated by reference to Exhibit 10.13 to the Company's Form 10-Q filed with the SEC on August 11, 2004)

10.14

 

#

Form of Stock Option Agreement under the 1st Constitution Bancorp Employee Stock Option and Restricted Stock Plan (incorporated by reference to Exhibit 10.14 to the Company's Form 8-K filed with the SEC on December 22, 2004)

10.15

 

#

Form of Restricted Stock Agreement under the 1st Constitution Bancorp Employee Stock Option and Restricted Stock Plan (incorporated by reference to Exhibit 10.15 to the Company's Form 8-K filed with the SEC on December 22, 2004)

10.16

 

#

Employment Agreement between the Company and Robert F. Mangano dated February 22, 2005 (incorporated by reference to Exhibit No. 10.16 to the Company's Form 8-K filed with the SEC on February 24, 2005)

10.17

 

#

The 1st Constitution Bancorp 2005 Equity Incentive Plan (incorporated by reference to Appendix A of the Company's proxy statement filed on April 15, 2005).

 

 

 


 

Exhibit No.

 

Description

10.18

 

#

Form of Restricted Stock Agreement under the 1st Constitution Bancorp 2005 Equity Incentive Plan (incorporated by reference to Exhibit 10.18 to the Company's Form 10-Q filed with the SEC on August 8, 2005).

10.19

 

#

Form of Nonqualified Stock Option Agreement under the 1st Constitution Bancorp 2005 Equity Incentive Plan (incorporated by reference to Exhibit 10.19 to the Company's Form 10-Q filed with the SEC on August 8, 2005).

10.20

 

#

Form of Incentive Stock Option Agreement under the 1st Constitution Bancorp 2005 Equity Incentive Plan (incorporated by reference to Exhibit 10.20 to the Company's Form 10-Q filed with the SEC on August 8, 2005).

21

 

*

Subsidiaries of the Company

23.1

 

*

Consent of Independent Registered Public Accounting Firm - Grant Thornton LLP

23.2

 

*

Consent of Independent Registered Public Accounting Firm - KPMG LLP

31.1

 

*

Certification of Robert F. Mangano, Chief Executive Officer of the Company, pursuant to Securities Exchange Act Rule 13a-14(a).

31.2

 

*

Certification of Joseph M. Reardon, Chief Financial Officer of the Company, pursuant to Securities Exchange Act Rule 13a-14(a).

32

 

*

Certifications pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of The Sarbanes-Oxley Act of 2002, signed by Robert F. Mangano, Chief Executive Officer of the Company, and Joseph M. Reardon, Chief Financial Officer of the Company.

 

 

*
#

Filed herewith.
A management contract or compensatory plan or arrangement required to be filed as an exhibit pursuant to Item 15(c) of Form 10-K.

 

 

 

 

 

 

 

 

 

 

 

 


 

EX-21 2 ex21.htm

Exhibit 21- Subsidiaries of the Registrant

 

 

 

Name of Subsidiary

 

Other Names Under Which Subsidiary Conducts Business

 

State or Other Jurisdiction of Incorporation or Organization

 

 

 

 

 

1st Constitution Bank

 

N/A

 

New Jersey

 

 

 

 

 

1st Constitution Capital Trust I

 

N/A

 

Delaware

 

 

 

 

 

1st Constitution Investment Company

 

N/A

 

Delaware

 

 

 

 

 

FCB Assets Holdings, Inc.

 

N/A

 

New Jersey

 

 

 

 

 

1st Constitution Title Agency, LLC*

 

N/A

 

New Jersey

 

 

 

 

 

 

* Inactive

 

 

 

 

 


 EX-23.1 3 ex231.htm CONSENT OF GRANT THORNTON LLP

Exhibit 23.1 – Grant Thornton LLP

CONSENT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

We have issued our report dated March 8, 2006, accompanying the consolidated financial statements in the Annual Report of 1st Constitution Bancorp on Form 10-K for the year ended December 31, 2005. We hereby consent to the incorporation by reference of said report in the Registration Statement of 1st Constitution Bancorp on Form S-8 (file No. 333-98177, effective August 15, 2002).
 

/s/ GRANT THORNTON LLP

Philadelphia, Pennsylvania
March 8, 2006

 

 


 EX-23.2 4 ex232.htm CONSENT OF KPMG LLP

Exhibit 23.2 – KPMG LLP

Consent of Independent Registered Public Accounting Firm

 

The Board of Directors
1st Constitution Bancorp:



We consent to incorporation by reference in registration statement (No. 333-98177) filed on Form S-8, of our report dated February 6, 2004, relating to the consolidated statements of income, changes in shareholders’ equity, and cash flows of 1st Constitution Bancorp and subsidiaries for the year ended December 31, 2003, which report appears in the December 31, 2005 Annual Report on Form 10-K of 1st Constitution Bancorp.

 

KPMG LLP



Short Hills, New Jersey
March 10, 2006

 

 


 EX-31.1 5 ex311.htm

Exhibit 31.1

CERTIFICATIONS

I, Robert F. Mangano, certify that:

 

 1.

I have reviewed this annual report on Form 10-K of 1st Constitution Bancorp;
  2. Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report;
  3.  Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report;
  4. The registrant's other certifying officer(s) and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) for the registrant and have:
      (a)           Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared;
      (b)           Evaluated the effectiveness of the registrant’s disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and
      (c)           Disclosed in this report any change in the registrant’s internal control over financial reporting that occurred during the registrant’s most recent fiscal quarter (the registrant’s fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonably likely to materially affect, the registrant’s internal control over financial reporting; and
  5. The registrant’s other certifying officer(s) and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant’s auditors and the audit committee of the registrant’s board of directors (or persons performing the equivalent functions):
      (a)           All significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant’s ability to record, process, summarize and report financial information; and
      (b)           Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant’s internal control over financial reporting.


Date: March 10, 2006
 

/s/ ROBERT F. MANGANO

Name:

Robert F. Mangano

Title:

President and Chief Executive Officer

 

 

 


 EX-31.2 6 ex312.htm

Exhibit 31.2

CERTIFICATIONS

I, Joseph M. Reardon, certify that:

 

 1.

I have reviewed this annual report on Form 10-K of 1st Constitution Bancorp;
  2. Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report;
  3.  Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report;
  4. The registrant’s other certifying officer(s) and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) for the registrant and have:
      (a)           Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared;
      (b)           Evaluated the effectiveness of the registrant’s disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and
      (c)           Disclosed in this report any change in the registrant’s internal control over financial reporting that occurred during the registrant’s most recent fiscal quarter (the registrant’s fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonably likely to materially affect, the registrant’s internal control over financial reporting; and
  5. The registrant’s other certifying officer(s) and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant’s auditors and the audit committee of the registrant’s board of directors (or persons performing the equivalent functions):
      (a)           All significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant’s ability to record, process, summarize and report financial information; and
      (b)           Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant’s internal control over financial reporting.


Date: March 10, 2006
 

/s/ JOSEPH M. REARDON

Name:

Joseph M. Reardon

Title:

Senior Vice President and
Treasurer

 

 

 

 


 EX-32 7 ex32.htm

Exhibit 32

CERTIFICATIONS PURSUANT TO
18 U.S.C. SECTION 1350,
AS ADOPTED PURSUANT TO
SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002

In connection with this Annual Report on Form 10-K of 1st Constitution Bancorp (the “Company”) for the fiscal year ended December 31, 2005 as filed with the Securities and Exchange Commission on the date hereof, (the “Report”), each of the undersigned officers of the Company hereby certifies, pursuant to 18 U.S.C. (section) 1350, as adopted pursuant to (section) 906 of the Sarbanes-Oxley Act of 2002, that to the best of his knowledge:

(1)           The Report fully complies with the requirements of Section 13(a) or 15(d) of the Securities Exchange Act of 1934; and

(2)           The information contained in the Report fairly presents, in all material respects, the financial condition and results of operations of the Company.

 

/s/ ROBERT F. MANGANO

Name:

Robert F. Mangano

Title:

President and Chief Executive Officer
Date: March 10, 2006


 
/s/ JOSEPH M. REARDON

Name:

Joseph M. Reardon

Title:

Senior Vice President and
Treasurer
Date: March 10, 2006

 

 

 

 


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