UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF
THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended September 30, 2011
Commission file number 000-13580
SUFFOLK BANCORP
(Exact Name of Registrant as Specified in Its Charter)
New York State | 11-2708279 | |
(State or Other Jurisdiction of Incorporation or Organization) |
(I.R.S. Employer Identification No.) | |
4 West Second Street, Riverhead, New York | 11901 | |
(Address of Principal Executive Offices) | (Zip Code) |
(631) 208-2400
(Registrants Telephone Number, Including Area Code)
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes x No ¨
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes x No ¨
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of large accelerated filer, accelerated filer and smaller reporting company in Rule 12b-2 of the Exchange Act.
Large accelerated filer | ¨ | Accelerated filer | x | |||
Non-accelerated filer | ¨ (Do not check if a smaller reporting company) | Smaller reporting company | ¨ |
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes ¨ No x
Indicate the number of shares outstanding of each of the issuers classes of common stock, as of the latest practicable date.
9,726,814 SHARES OF COMMON STOCK OUTSTANDING AS OF November 1, 2011
This page left blank intentionally.
SUFFOLK BANCORP AND SUBSIDIARIES
TABLE OF CONTENTS
2 | ||||
2 | ||||
CONSOLIDATED STATEMENTS OF OPERATIONS FOR THE THREE MONTHS ENDED |
3 | |||
CONSOLIDATED STATEMENTS OF OPERATIONS FOR THE NINE MONTHS ENDED |
4 | |||
CONSOLIDATED STATEMENTS OF CASH FLOWS FOR THE NINE MONTHS ENDED |
5 | |||
6 | ||||
6 | ||||
6 | ||||
7 | ||||
7 | ||||
11 | ||||
12 | ||||
24 | ||||
24 | ||||
25 | ||||
26 | ||||
27 | ||||
Item 2 - MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION |
28 | |||
28 | ||||
28 | ||||
29 | ||||
29 | ||||
29 | ||||
29 | ||||
32 | ||||
33 | ||||
33 | ||||
33 | ||||
34 | ||||
34 | ||||
37 | ||||
40 | ||||
40 | ||||
Item 3 - Quantitative and Qualitative Disclosures about Market Risk |
41 | |||
41 | ||||
41 | ||||
41 | ||||
42 | ||||
44 | ||||
44 | ||||
44 | ||||
Item 2 - Unregistered Sales of Equity Securities and Use of Proceeds |
46 | |||
46 | ||||
46 |
SUFFOLK BANCORP AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CONDITION AS OF
(in thousands of dollars except for share data)
September 30, 2011 | December 31, 2010 | |||||||
unaudited | restated | |||||||
ASSETS | ||||||||
Cash & Due from Banks |
$ | 166,966 | $ | 41,149 | ||||
Federal Reserve Bank Stock |
712 | 652 | ||||||
Federal Home Loan Bank Stock |
1,744 | 3,531 | ||||||
Investment Securities: |
||||||||
Available for Sale, at Fair Value |
307,362 | 396,670 | ||||||
Held to Maturity (Fair Value of $10,390 and $10,703, respectively) |
||||||||
Obligations of States & Political Subdivisions |
9,422 | 9,936 | ||||||
Other Securities |
80 | 80 | ||||||
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|
|
|
|||||
Total Investment Securities |
316,864 | 406,686 | ||||||
|
|
|
|
|||||
Total Loans |
1,012,888 | 1,112,279 | ||||||
Less: Allowance for Loan Losses |
43,693 | 28,419 | ||||||
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|
|
|
|||||
Net Loans |
969,195 | 1,083,860 | ||||||
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|
|
|||||
Premises & Equipment, Net |
26,904 | 25,548 | ||||||
Other Real Estate Owned, Net |
1,800 | 5,719 | ||||||
Accrued Interest and Loan Fees Receivable |
7,318 | 7,025 | ||||||
Goodwill |
814 | 814 | ||||||
Other Assets |
30,502 | 31,883 | ||||||
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|
|||||
TOTAL ASSETS |
$ | 1,522,819 | $ | 1,606,867 | ||||
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|
|||||
LIABILITIES & STOCKHOLDERS EQUITY |
||||||||
Demand Deposits |
$ | 519,604 | $ | 493,630 | ||||
Saving, N.O.W. & Money Market Deposits |
562,203 | 601,828 | ||||||
Time Certificates of $100,000 or more |
181,415 | 210,096 | ||||||
Other Time Deposits |
89,957 | 97,199 | ||||||
|
|
|
|
|||||
Total Deposits |
1,353,179 | 1,402,753 | ||||||
Federal Home Loan Bank Borrowings |
| 40,000 | ||||||
Dividend Payable on Common Stock |
| 1,454 | ||||||
Accrued Interest Payable |
419 | 591 | ||||||
Other Liabilities |
29,017 | 25,249 | ||||||
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|
|
|
|||||
TOTAL LIABILITIES |
1,382,615 | 1,470,047 | ||||||
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|
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STOCKHOLDERS EQUITY |
||||||||
Common Stock (par value $2.50; 15,000,000 shares authorized; 9,726,814 and 9,692,312 shares outstanding at September 30, 2011 and December 31, 2010, respectively) |
34,330 | 34,236 | ||||||
Surplus |
24,010 | 23,368 | ||||||
Retained Earnings |
90,148 | 91,450 | ||||||
Treasury Stock at Par (4,005,270 and 4,002,158 shares, respectively) |
(10,013 | ) | (10,005 | ) | ||||
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|
|||||
138,475 | 139,049 | |||||||
Accumulated Other Comprehensive Gain (Loss), Net of Tax |
1,729 | (2,229 | ) | |||||
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|
|||||
TOTAL STOCKHOLDERS EQUITY |
140,204 | 136,820 | ||||||
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|
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|
|||||
TOTAL LIABILITIES & STOCKHOLDERS EQUITY |
$ | 1,522,819 | $ | 1,606,867 | ||||
|
|
|
|
See accompanying notes to consolidated financial statements.
Page 2
SUFFOLK BANCORP AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS FOR THE THREE MONTHS ENDED
(in thousands of dollars except for share and per share data)
September 30, 2011 | September 30, 2010 | |||||||||
unaudited | unaudited restated |
|||||||||
INTEREST INCOME |
||||||||||
Federal Funds Sold & Interest Due from Banks |
$ | 79 | $ | 3 | ||||||
United States Treasury Securities |
1 | 71 | ||||||||
Obligations of States & Political Subdivisions |
1,544 | 1,979 | ||||||||
Mortgage-Backed Securities |
1,412 | 1,888 | ||||||||
U.S. Government Agency Obligations |
44 | 202 | ||||||||
Other Securities |
59 | 95 | ||||||||
Loans and Loan Fees |
15,100 | 17,464 | ||||||||
|
|
|
|
|||||||
Total Interest Income |
18,239 | 21,702 | ||||||||
|
|
|
|
|||||||
INTEREST EXPENSE |
||||||||||
Saving, N.O.W. & Money Market Deposits |
435 | 827 | ||||||||
Time Certificates of $100,000 or more |
471 | 709 | ||||||||
Other Time Deposits |
307 | 436 | ||||||||
Federal Funds Purchased and Repurchase Agreements |
1 | | ||||||||
Borrowings |
| 363 | ||||||||
|
|
|
|
|||||||
Total Interest Expense |
1,214 | 2,335 | ||||||||
|
|
|
|
|||||||
Net Interest Income |
17,025 | 19,367 | ||||||||
Provision for Loan Losses |
900 | 14,729 | ||||||||
|
|
|
|
|||||||
Net Interest Income After Provision for Loan Losses |
16,125 | 4,638 | ||||||||
|
|
|
|
|||||||
OTHER INCOME |
||||||||||
Service Charges on Deposit Accounts |
953 | 1,215 | ||||||||
Other Service Charges, Commissions & Fees |
988 | 1,007 | ||||||||
Fiduciary Fees |
213 | 243 | ||||||||
Other Operating Income |
236 | 202 | ||||||||
|
|
|
|
|||||||
Total Other Income |
2,390 | 2,667 | ||||||||
|
|
|
|
|||||||
OTHER EXPENSE |
||||||||||
Salaries & Employee Benefits |
8,141 | 7,457 | ||||||||
Net Occupancy Expense |
1,435 | 1,336 | ||||||||
Equipment Expense |
506 | 511 | ||||||||
Outside Services |
1,425 | 727 | ||||||||
FDIC Assessments |
555 | 862 | ||||||||
OREO Expense |
182 | | ||||||||
Other Operating Expense |
2,683 | 2,128 | ||||||||
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|
|
|
|||||||
Total Other Expense |
14,927 | 13,021 | ||||||||
|
|
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|
|||||||
Income (Loss) Before Income Taxes |
3,588 | (5,716 | ) | |||||||
Provision (Benefit) for Income Taxes |
516 | (2,579 | ) | |||||||
|
|
|
|
|||||||
NET (LOSS) INCOME |
$ | 3,072 | $ | (3,137 | ) | |||||
|
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|
|||||||
Weighted Average: Common Shares Outstanding |
9,726,948 | 9,662,328 | ||||||||
Dilutive Stock Options |
| | ||||||||
|
|
|
|
|||||||
Weighted Average Total Common Shares and Dilutive Options |
9,726,948 | 9,662,328 | ||||||||
EARNINGS (LOSS) PER COMMON SHARE |
Basic |
$ | 0.32 | $ | (0.32 | ) | ||||
Diluted |
$ | 0.32 | $ | (0.32 | ) | |||||
DIVIDENDS PER COMMON SHARE |
| $ | 0.22 |
See accompanying notes to consolidated financial statements.
Page 3
SUFFOLK BANCORP AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS FOR THE NINE MONTHS ENDED
(in thousands of dollars except for share and per share data)
September 30, 2011 | September 30, 2010 | |||||||||||
unaudited | unaudited restated |
|||||||||||
INTEREST INCOME |
||||||||||||
Federal Funds Sold & Interest Due from Banks |
$ | 140 | $ | 8 | ||||||||
United States Treasury Securities |
96 | 213 | ||||||||||
Obligations of States & Political Subdivisions |
5,332 | 5,818 | ||||||||||
Mortgage-Backed Securities |
4,558 | 5,957 | ||||||||||
U.S. Government Agency Obligations |
337 | 607 | ||||||||||
Other Securities |
203 | 320 | ||||||||||
Loans and Loan Fees |
47,488 | 52,545 | ||||||||||
|
|
|
|
|||||||||
Total Interest Income |
58,154 | 65,468 | ||||||||||
|
|
|
|
|||||||||
INTEREST EXPENSE |
||||||||||||
Saving, N.O.W. & Money Market Deposits |
1,618 | 2,551 | ||||||||||
Time Certificates of $100,000 or more |
1,576 | 2,271 | ||||||||||
Other Time Deposits |
985 | 1,365 | ||||||||||
Federal Funds Purchased and Repurchase Agreements |
1 | 2 | ||||||||||
Borrowings |
654 | 1,322 | ||||||||||
|
|
|
|
|||||||||
Total Interest Expense |
4,834 | 7,511 | ||||||||||
|
|
|
|
|||||||||
Net Interest Income |
53,320 | 57,957 | ||||||||||
Provision for Loan Losses |
24,088 | 26,549 | ||||||||||
|
|
|
|
|||||||||
Net Interest Income After Provision for Loan Losses |
29,232 | 31,408 | ||||||||||
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|
|
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OTHER INCOME |
||||||||||||
Service Charges on Deposit Accounts |
2,964 | 3,745 | ||||||||||
Other Service Charges, Commissions & Fees |
2,631 | 2,591 | ||||||||||
Fiduciary Fees |
644 | 760 | ||||||||||
Net Gain on Sale of Securities Available for Sale |
1,645 | 12 | ||||||||||
Other Operating Income |
830 | 689 | ||||||||||
|
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|
|
|||||||||
Total Other Income |
8,714 | 7,797 | ||||||||||
|
|
|
|
|||||||||
OTHER EXPENSE |
||||||||||||
Salaries & Employee Benefits |
23,458 | 21,682 | ||||||||||
Net Occupancy Expense |
4,391 | 4,030 | ||||||||||
Equipment Expense |
1,451 | 1,576 | ||||||||||
Outside Services |
3,423 | 1,646 | ||||||||||
FDIC Assessments |
2,541 | 2,089 | ||||||||||
OREO Expense |
293 | | ||||||||||
Prepayment Fee on Borrowing |
1,028 | | ||||||||||
Other Operating Expense |
7,145 | 6,280 | ||||||||||
|
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|
|||||||||
Total Other Expense |
43,730 | 37,303 | ||||||||||
|
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|
|||||||||
(Loss) Income Before Income Taxes |
(5,784 | ) | 1,902 | |||||||||
(Benefit) Provision for Income Taxes |
(4,552 | ) | (1,285 | ) | ||||||||
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|
|||||||||
NET INCOME (LOSS) |
$ | (1,232 | ) | $ | 3,187 | |||||||
|
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|
|||||||||
Weighted Average: Common Shares Outstanding |
|
9,718,809 | 9,649,550 | |||||||||
Dilutive Stock Options |
|
| 6,408 | |||||||||
|
|
|
|
|||||||||
Weighted Average Total Common Shares and Dilutive Options |
|
9,718,809 | 9,655,958 | |||||||||
EARNINGS (LOSS) PER COMMON SHARE |
Basic | $ | (0.13 | ) | $ | 0.33 | ||||||
Diluted | $ | (0.13 | ) | $ | 0.33 | |||||||
DIVIDENDS PER COMMON SHARE |
| $ | 0.66 |
See accompanying notes to consolidated financial statements.
Page 4
SUFFOLK BANCORP AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS FOR THE NINE MONTHS ENDED
(in thousands of dollars)
September 30, 2011 | September 30, 2010 | |||||||
unaudited | unaudited | |||||||
NET INCOME (LOSS) |
$ | (1,232 | ) | $ | 3,187 | |||
ADJUSTMENTS TO RECONCILE NET INCOME (LOSS) TO NET CASH |
||||||||
CASH FLOWS FROM OPERATING ACTIVITIES |
||||||||
Provision for Loan Losses |
24,088 | 26,549 | ||||||
Depreciation & Amortization |
2,019 | 1,881 | ||||||
Stock Based Compensation |
| 8 | ||||||
Accretion of Discounts |
(89 | ) | (118 | ) | ||||
Amortization of Premiums |
1,890 | 2,122 | ||||||
Increase in Accrued Interest and Loan Fees Receivable |
(293 | ) | (672 | ) | ||||
Increase in Other Assets |
(3,732 | ) | (5,463 | ) | ||||
Decrease in Accrued Interest Payable |
(172 | ) | (179 | ) | ||||
Increase (Decrease) in Income Taxes Payable |
2,345 | (2,131 | ) | |||||
Increase in Other Liabilities |
1,572 | 2,075 | ||||||
Net Gain on Sale of Securities Available for Sale |
(1,645 | ) | (12 | ) | ||||
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|
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Net Cash Provided by Operating Activities |
24,751 | 27,247 | ||||||
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CASH FLOWS FROM INVESTING ACTIVITIES |
||||||||
Principal Payments on Investment Securities |
25,479 | 22,689 | ||||||
Proceeds from Sale of Investment Securities Available for Sale |
44,174 | 1,232 | ||||||
Maturities of Investment Securities Available for Sale |
29,605 | 2,000 | ||||||
Purchases of Investment Securities Available for Sale |
(3,287 | ) | (22,904 | ) | ||||
Maturities of Investment Securities Held to Maturity |
3,951 | 6,836 | ||||||
Purchases of Investment Securities Held to Maturity |
(1,715 | ) | (2,833 | ) | ||||
Loan (Disbursements) & Repayments, Net |
90,708 | 13,740 | ||||||
Purchases of Premises & Equipment, Net |
(1,398 | ) | (904 | ) | ||||
Disposition of Other Real Estate Owned |
3,919 | | ||||||
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|
|
|
|||||
Net Cash Provided by Investing Activities |
191,436 | 19,856 | ||||||
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|
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CASH FLOWS FROM FINANCING ACTIVITIES |
||||||||
Net (Decrease) Increase in Deposit Accounts |
(49,574 | ) | 90,000 | |||||
Short-term Borrowings and (Repayments), Net |
(40,000 | ) | (110,800 | ) | ||||
Dividends Paid to Shareholders |
(1,454 | ) | (6,361 | ) | ||||
Stock Dividend Reinvestment, Net |
658 | 870 | ||||||
Stock Options and Stock Appreciation Rights Exercised |
| 209 | ||||||
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|
|||||
Net Cash Used in Financing Activities |
(90,370 | ) | (26,082 | ) | ||||
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|
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Net Increase in Cash & Cash Equivalents |
125,817 | 21,021 | ||||||
Cash & Cash Equivalents Beginning of Period |
41,149 | 37,007 | ||||||
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Cash & Cash Equivalents End of Period |
$ | 166,966 | $ | 58,028 | ||||
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Supplemental Disclosure of Cash Flow Information |
||||||||
Cash Received During the Nine Month Period for Interest |
$ | 57,861 | $ | 64,797 | ||||
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Cash Paid During the Nine Month Period for: |
||||||||
Interest |
$ | 5,006 | $ | 7,689 | ||||
Income Taxes |
197 | 8,020 | ||||||
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Total Cash Paid for Interest & Income Taxes |
$ | 5,203 | $ | 15,709 | ||||
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|
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|
See accompanying notes to consolidated financial statements.
Page 5
SUFFOLK BANCORP AND SUBSIDIARIES
NOTES TO THE UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
In the opinion of management, the accompanying unaudited consolidated financial statements of Suffolk Bancorp (Suffolk) and its consolidated subsidiaries, primarily Suffolk County National Bank (the Bank), have been prepared to reflect all adjustments (consisting solely of normally recurring accruals) necessary for a fair presentation of the financial condition and results of operations for the periods presented. Certain information and footnotes normally included in consolidated financial statements prepared in accordance with generally accepted accounting principles in the United States of America (U.S. GAAP) have been condensed or omitted. Notwithstanding, management believes that the disclosures are adequate to prevent the information from misleading the reader, particularly when the accompanying consolidated financial statements are read in conjunction with the audited consolidated financial statements and notes thereto included in the Registrants restated Annual Report on Form 10-K/A for the year ended December 31, 2010,
The results of operations for the nine months ended September 30, 2011 are not necessarily indicative of the results of operations to be expected for the remainder of the year.
Certain prior period amounts have been reclassified to conform to the current periods presentation.
At September 30, 2011, Suffolk had one stock-based employee compensation plan, the Suffolk Bancorp 2009 Stock Incentive Plan (the Plan), under which 500,000 shares of Suffolks common stock were originally reserved for issuance to key employees and directors, and of which none had yet been issued at September 30, 2011. Options are awarded by a committee appointed by the Board of Directors. The Plan provides that the option price shall not be less than the fair value of the common stock on the date the option is granted. All options are exercisable for a period of ten years or less. The Plan provides for but does not require the grant of stock appreciation rights that the holder may exercise instead of the underlying option. When the stock appreciation right is exercised, the underlying option is canceled. The optionee receives shares of common stock or cash with a fair market value equal to the excess of the fair value of the shares subject to the option at the time of exercise (or the portion thereof so exercised) over the aggregate option price of the shares set forth in the option agreement. The exercise of stock appreciation rights is treated as the exercise of the underlying option. Options vest after one year and expire after ten years except as otherwise specified in the option agreement.
Stock-based compensation for all share-based payments to employees, including grants of employee stock options, is recorded in the financial statements based on their fair values. During the nine months ended September 30, 2011, no compensation expense was recorded for stock-based compensation. As of September 30, 2011, there was no unrecognized compensation cost related to non-vested options under the Plan.
The following table presents the options granted, exercised, or expired under the 1999 Plan during the nine months ended September 30, 2011:
Shares | Wtd. Avg. Exercise | |||||||
Balance at December 31, 2010 |
89,500 | $ | 30.32 | |||||
Options granted |
| | ||||||
Options exercised |
(5,000 | ) | 15.50 | |||||
Options expired or terminated |
(23,000 | ) | 28.67 | |||||
|
|
|
|
|||||
Balance at September 30, 2011 |
61,500 | $ | 32.15 | |||||
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Page 6
The following table presents certain information about the valuation of vested options outstanding on September 30, 2011 and December 31, 2010:
At, or during, |
Nine Months Ended September 30, 2011 |
Year Ended December 31, 2010 |
||||||
Exercisable options (vested) |
61,500 | 89,500 | ||||||
Weighted average fair value of options (Black-Scholes model) at date of grant: |
| | ||||||
Black-Scholes Assumptions: |
||||||||
Risk-free interest rate |
| | ||||||
Expected dividend yield |
| | ||||||
Expected life in years |
| | ||||||
Expected volatility |
| |
The following table details contractual weighted-average lives of outstanding options at various prices:
By range of exercise prices | ||||||||||||
from |
$ | 28.30 | $ | 34.39 | ||||||||
to |
32.90 | 34.95 | ||||||||||
|
|
|
|
|||||||||
Outstanding stock options |
44,500 | 17,000 | ||||||||||
Weighted-average remaining life |
5.08 | 3.73 | ||||||||||
Weighted-average exercise price |
$ | 31.14 | $ | 34.79 | ||||||||
Exercisable stock options |
44,500 | 17,000 | ||||||||||
Weighted-average remaining life |
5.08 | 3.73 | ||||||||||
Weighted-average exercise price |
$ | 31.14 | $ | 34.79 | ||||||||
Weighted-average | ||||||||||||
At all prices |
Options | price | life (yrs) | |||||||||
Total outstanding(1) |
61,500 | $ | 32.15 | 4.71 | ||||||||
Total exercisable |
61,500 | $ | 32.15 | 4.71 | ||||||||
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|
(1) | During the nine months ended September 30, 2011 and the three months ended September 30, 2011 options to purchase 61,500 shares of common stock at a price of $28.30-$34.95 per share were outstanding. Options to purchase 93,500 shares of common stock at a price of $13.13-$34.95 per share were outstanding during the nine months ended September 30, 2010 and options to purchase 87,333 shares of common stock at a price $28.30-$34.95 per share were outstanding during the three months ended September 30, 2010. None of these options was included in the computation of the diluted earnings per share (EPS) on the Consolidated Statements of Operation because the exercise price was greater than the average market price of the common shares and the net loss recognized in the nine-month period ended September 30, 2011, and the quarter ended September 30, 2010. These options expire beginning in 2013. |
Suffolk uses an asset and liability approach to accounting for income taxes. The asset and liability approach requires the recognition of deferred tax assets and liabilities for the expected future tax consequences of temporary differences between the carrying amounts and the tax bases of assets and liabilities. Deferred tax assets are recognized if it is more likely than not that a future benefit will be realized. It is managements position that no valuation allowance is necessary against any of Suffolks deferred tax assets. Suffolk accounts for income taxes in accordance with Financial Accounting Standards Board (FASB) Accounting Standards Codification (ASC) 740, Income Taxes, which prescribes the recognition and measurement criteria related to tax positions taken or expected to be taken in a tax return. Suffolk had unrecognized tax benefits including interest of approximately $34,000 as of September 30, 2011. Suffolk recognizes interest and penalties accrued relating to unrecognized tax benefits in income tax expense.
Suffolk records investments available for sale and impaired loans at fair value. Fair value measurement is determined based on the assumptions that market participants would use in pricing the asset or liability in an exchange. The definition of fair value includes the exchange price which is the price in an orderly transaction between market participants to sell an asset or transfer a liability in the principal market for the asset or liability. Market participant assumptions include assumptions about risk, the risk inherent in a particular valuation technique used to measure fair value and/or the risk inherent in the inputs to the valuation technique, as well as the effect of credit risk on the fair value of liabilities. Suffolk uses three levels of the fair value inputs to measure assets, as described below.
Page 7
Basis of Fair Value Measurement:
Level 1 Unadjusted, quoted prices in active markets that are accessible at the measurement date for identical, unrestricted assets or liabilities;
Level 2 - Quoted prices in markets that are not active, or inputs that use pricing models or matrix pricing;
Level 3 - Prices or valuation techniques that require inputs that are both significant to the fair value measurement and unobservable (i.e., supported by little or no market activity).
The following table presents the carrying amounts and fair values of Suffolks financial instruments. FASB ASC 825, Financial Instruments, defines the fair value of a financial instrument as the amount at which the instrument could be exchanged in a current transaction between willing parties, other than in a forced sale or liquidation: (in thousands)
September 30, 2011 | December 31,
2010 Restated |
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Carrying Amount |
Fair Value |
Carrying Amount |
Fair Value |
|||||||||||||
Cash & cash equivalents |
$ | 166,966 | $ | 166,966 | $ | 41,149 | $ | 41,149 | ||||||||
Investment securities available for sale |
307,362 | 307,362 | 396,670 | 396,670 | ||||||||||||
Investment securities held to maturity |
9,502 | 10,390 | 10,016 | 10,703 | ||||||||||||
Total Loans |
1,012,888 | 1,045,321 | 1,112,279 | 1,144,678 | ||||||||||||
Accrued interest and loan fees receivable |
7,318 | 7,318 | 7,025 | 7,025 | ||||||||||||
Deposits |
1,353,179 | 1,355,586 | 1,402,753 | 1,404,514 | ||||||||||||
Borrowings |
| | 40,000 | 41,387 | ||||||||||||
Accrued interest payable |
419 | 419 | 591 | 591 |
Fair value estimates are made at a specific point in time and may be based on judgments regarding losses expected in the future, risk, and other factors that are subjective in nature. The methods and assumptions used to produce the fair value estimates follow.
Short-term financial instruments are valued at the carrying amounts included in the consolidated statements of condition, which are reasonable estimates of fair value due to the relatively short term of the instruments. This approach applies to cash and cash equivalents; accrued interest and loan fees receivable; non-interest-bearing demand deposits; N.O.W., money market, and saving accounts; and accrued interest payable. Federal Home Loan Bank advances/borrowings are measured using a discounted replacement cost of funds approach.
Fair values are estimated for portfolios of loans with similar characteristics. Loans are segregated by type. The fair value of performing loans was calculated by discounting scheduled cash flows through the estimated maturity using estimated market discount rates that reflect the credit and interest rate risk of the loan. Estimated maturity is based on the Banks history of repayments for each type of loan and an estimate of the effect of the current economy. Fair value for significant non-performing loans is based on recent external appraisals of collateral, if any. If appraisals are not available, estimated cash flows are discounted using a rate commensurate with the associated risk. Assumptions regarding credit risk, cash flows, and discount rates are made using available market information and specific borrower information.
Page 8
The carrying amount and fair value of loans were as follows: (in thousands)
September 30, 2011 | December 31,
2010 Restated |
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Carrying Amount |
Fair Value |
Carrying Amount |
Fair Value |
|||||||||||||
Commercial, financial & agricultural |
$ | 213,569 | $ | 217,456 | $ | 248,750 | $ | 253,153 | ||||||||
Commercial real estate |
433,057 | 452,995 | 431,179 | 449,418 | ||||||||||||
Real estate construction loans |
62,023 | 62,263 | 82,720 | 83,389 | ||||||||||||
Residential mortgages (1st & 2nd liens) |
171,515 | 178,784 | 195,993 | 203,909 | ||||||||||||
Home equity loans |
80,704 | 80,725 | 84,696 | 84,719 | ||||||||||||
Consumer loans, net of unearned discounts |
51,516 | 52,594 | 67,814 | 68,963 | ||||||||||||
Other loans |
504 | 504 | 1,127 | 1,127 | ||||||||||||
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Totals |
$ | 1,012,888 | $ | 1,045,321 | $ | 1,112,279 | $ | 1,144,678 | ||||||||
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Other assets measured at fair value were as follows: (in thousands)
Fair Value Measurements Using | ||||||||||||||||
Description |
September 30, 2011 | Active Markets
for Identical Assets Quoted Prices (Level 1) |
Significant Other Observable Inputs (Level 2) |
Significant Unobservable Inputs (Level 3) |
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Impaired loans |
$ | 120,743 | $ | | $ | | $ | 120,743 | ||||||||
Other real estate owned |
1,800 | | | 1,800 | ||||||||||||
Mortgage servicing rights (1) |
1,630 | | | 1,630 | ||||||||||||
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Total |
$ | 124,173 | $ | | $ | | $ | 124,173 | ||||||||
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(1) | Mortgage servicing rights are measured at fair value on a recurring basis. |
Fair Value Measurements Using | ||||||||||||||||
Description |
December 31,
2010 Restated |
Active Markets
for Identical Assets Quoted Prices (Level 1) |
Significant Other Observable Inputs (Level 2) |
Significant Unobservable Inputs (Level 3) |
||||||||||||
Impaired loans |
$ | 90,825 | $ | | $ | | $ | 90,825 | ||||||||
Other real estate owned |
5,719 | | | 5,719 | ||||||||||||
Mortgage servicing rights (1) |
1,596 | | | 1,596 | ||||||||||||
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Total |
$ | 98,140 | $ | | $ | | $ | 98,140 | ||||||||
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(1) | Mortgage servicing rights are measured at fair value on a recurring basis. |
Impaired loans are evaluated and valued at the time the loan is identified as impaired. The loans are measured based on the value of the collateral securing these loans, or techniques that are not based on market activity for loans that are not collateral dependent and require managements judgment. Collateral may be real estate and/or business assets including equipment, inventory and/or accounts receivable. The value of real estate collateral is determined based on appraisals by qualified licensed appraisers hired by Suffolk. The value of business equipment may be based on an appraisal by qualified licensed appraisers hired by Suffolk if significant, or may be valued based on the equipments net book value on the business financial statements. Inventory and accounts receivable collateral may be valued based on independent field examiner review or aging reports, if significant. Reviews by field examiners may be conducted based on the loan exposure and reliance on this type of collateral. Appraised and reported values may be discounted based on managements historical knowledge, changes in market conditions from the time of valuation, and/or managements expertise and knowledge of the client and clients business. Impaired loans are reviewed and evaluated on at least a quarterly basis for additional impairment and adjusted accordingly, based on the same factors identified above.
The fair value of the investment portfolio, including mortgage-backed securities, was based on quoted market prices or market prices of similar instruments.
Page 9
The following tables summarize the valuation of financial instruments measured at fair value on a recurring basis in the consolidated statements of condition at September 30, 2011 and December 31, 2010, including the additional requirement to segregate classifications to correspond to the major security type classifications utilized for disclosure purposes: (in thousands)
Fair Value Measurements Using | ||||||||||||||||
Description |
September 30, 2011 | Active Markets for Identical Assets Quoted Prices (Level 1) |
Significant Other Observable Inputs (Level 2) |
Significant Unobservable Inputs (Level 3) |
||||||||||||
U.S. Treasury securities |
$ | | $ | | $ | | $ | | ||||||||
U.S. government agency debt |
| | | | ||||||||||||
Collateralized mortgage obligations |
136,016 | | 136,016 | | ||||||||||||
Mortgage-backed securities |
462 | | 462 | | ||||||||||||
Obligations of states and political subdivisions |
170,884 | | 170,884 | | ||||||||||||
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Total |
$ | 307,362 | $ | | $ | 307,362 | $ | | ||||||||
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Fair Value Measurements Using | ||||||||||||||||
Description |
December 31, 2010 | Active Markets for Identical Assets Quoted Prices (Level 1) |
Significant Other Observable Inputs (Level 2) |
Significant Unobservable Inputs (Level 3) |
||||||||||||
U.S. Treasury securities |
$ | 8,102 | $ | 8,102 | $ | | $ | | ||||||||
U.S. government agency debt |
22,495 | 22,495 | | | ||||||||||||
Collateralized mortgage obligations |
162,323 | | 162,323 | | ||||||||||||
Mortgage-backed securities |
510 | | 510 | | ||||||||||||
Obligations of states and political subdivisions |
203,240 | | 203,240 | | ||||||||||||
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Total |
$ | 396,670 | $ | 30,597 | $ | 366,073 | $ | | ||||||||
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The types of instruments valued based on quoted market prices in active markets include most U.S. government debt and agency debt securities. Such instruments are generally classified within level 1 and level 2 of the fair value hierarchy. Suffolk does not adjust the quoted price for such instruments.
The types of instruments valued based on quoted prices in markets that are not active, broker or dealer quotations, or alternative pricing sources with reasonable levels of price transparency include state and municipal obligations, mortgage-backed securities and collateralized mortgage obligations. Such instruments are generally classified within level 2 of the fair value hierarchy.
FASB ASC 820, Fair Value Measurements and Disclosures, provides additional guidance in determining fair values when the volume and level of activity for the asset or liability have significantly decreased, particularly when there is no active market or where the price inputs being used represent distressed sales. It also provides guidelines for making fair value measurements more consistent with principles, reaffirming the need to use judgment to ascertain if a formerly active market has become inactive and in determining fair values when markets become inactive.
The fair value of certificates of deposit is calculated by discounting cash flows with applicable origination rates. At September 30, 2011, the fair value of certificates of deposit totaling $273,775,000 had a carrying value of $271,372,000.
The fair value of commitments to extend credit was estimated by either discounting cash flows or using the fees currently charged to enter into similar agreements, taking into account the remaining terms of the agreements and the current creditworthiness of the counterparties.
Page 10
Credit in the form of revolving open-end lines secured by one-to-four-family residential properties, commercial real estate, construction and land development loans, and lease financing arrangements was $85,311,000 and $123,672,000 as of September 30, 2011 and December 31, 2010, respectively.
The estimated fair value of written financial guarantees and letters of credit is based on fees currently charged for similar agreements. The contractual amounts of these commitments were $48,238,000 and $58,319,000 at September 30, 2011 and December 31, 2010, respectively. The fees charged for the commitments were not material in amount.
The amortized cost, estimated fair values, and gross unrealized gains and losses of Suffolks investment securities available for sale and held to maturity at September 30, 2011 and December 31, 2010, respectively, were: (in thousands)
September 30, 2011 | December 31, 2010 | |||||||||||||||||||||||||||||||
Amortized Cost |
Estimated Fair Value |
Gross Unrealized Gains |
Gross Unrealized Losses |
Amortized Cost |
Estimated Fair Value |
Gross Unrealized Gains |
Gross Unrealized Losses |
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Available for sale: |
||||||||||||||||||||||||||||||||
U.S. Treasury securities |
$ | | $ | | $ | | $ | | $ | 8,014 | $ | 8,102 | $ | 88 | $ | | ||||||||||||||||
U.S. government agency debt |
| | | 22,196 | 22,495 | 299 | | |||||||||||||||||||||||||
Collateralized mortgage obligations |
130,703 | 136,016 | 6,947 | (1,634 | ) | 157,179 | 162,323 | 6,627 | (1,483 | ) | ||||||||||||||||||||||
Mortgage-backed securities |
404 | 462 | 58 | | 452 | 510 | 58 | | ||||||||||||||||||||||||
Obligations of states and political subdivisions |
157,190 | 170,884 | 13,694 | | 196,578 | 203,240 | 7,511 | (849 | ) | |||||||||||||||||||||||
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Balance |
288,297 | 307,362 | 20,699 | (1,634 | ) | 384,419 | 396,670 | 14,583 | (2,332 | ) | ||||||||||||||||||||||
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Held to maturity: |
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Obligations of states and political subdivisions |
9,422 | 10,310 | 888 | | 9,936 | 10,623 | 695 | (8 | ) | |||||||||||||||||||||||
Other securities |
80 | 80 | | | 80 | 80 | | | ||||||||||||||||||||||||
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Balance |
9,502 | 10,390 | 888 | | 10,016 | 10,703 | 695 | (8 | ) | |||||||||||||||||||||||
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Total investment securities |
$ | 297,799 | $ | 317,752 | $ | 21,587 | $ | (1,634 | ) | $ | 394,435 | $ | 407,373 | $ | 15,278 | $ | (2,340 | ) | ||||||||||||||
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The amortized cost, maturities, and approximate fair value of Suffolks investment securities at September 30, 2011 were as follows: (in thousands)
Available for Sale | Held to Maturity | |||||||||||||||||||||||||||||||||||||||||||||||
U.S. Treasury Securities |
U.S. Govt. Agency Debt |
Obligations of States & Political Subdivisions |
Obligations of States & Political Subdivisions |
Other Securities |
Total Amortized Cost |
Total Fair Value |
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Amortized | Fair | Amortized | Fair | Amortized | Fair | Amortized | Fair | Amortized | Fair | |||||||||||||||||||||||||||||||||||||||
(1) Maturity (in years) |
Cost | Value | Cost | Value | Cost | Value | Cost | Value | Cost | Value | ||||||||||||||||||||||||||||||||||||||
Within 1 |
$ | | $ | | $ | | $ | | $ | 581 | $ | 588 | $ | 2,241 | $ | 2,261 | $ | | $ | | $ | 2,822 | $ | 2,849 | ||||||||||||||||||||||||
After 1 but within 5 |
| | | | 46,266 | 50,313 | 4,108 | 4,429 | | | 50,374 | 54,742 | ||||||||||||||||||||||||||||||||||||
After 5 but within 10 |
| | | | 108,814 | 118,330 | 3,073 | 3,620 | | | 111,887 | 121,950 | ||||||||||||||||||||||||||||||||||||
After 10 |
| | | | 1,529 | 1,653 | | | | | 1,529 | 1,653 | ||||||||||||||||||||||||||||||||||||
Other Securities |
| | | | | | | | 80 | 80 | 80 | 80 | ||||||||||||||||||||||||||||||||||||
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Subtotal |
| | | | 157,190 | 170,884 | 9,422 | 10,310 | 80 | 80 | 166,692 | 181,274 | ||||||||||||||||||||||||||||||||||||
Collateralized mortgage obligations |
| | | | | | | | | | 130,703 | 136,016 | ||||||||||||||||||||||||||||||||||||
Mortgage-backed securities |
| | | | | | | | | | 404 | 462 | ||||||||||||||||||||||||||||||||||||
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Total |
$ | | $ | | $ | | $ | | $ | 157,190 | $ | 170,884 | $ | 9,422 | $ | 10,310 | $ | 80 | $ | 80 | $ | 297,799 | $ | 317,752 | ||||||||||||||||||||||||
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(1) | Maturities shown are stated maturities. Securities backed by mortgages are expected to have substantial periodic prepayments resulting in weighted average lives considerably less than what would be surmised from the table above. |
Page 11
As a member of the Federal Reserve System, the Bank owns Federal Reserve Bank stock with a book value of $712,000. The stock has no maturity and there is no public market for the investment.
As a member of the Federal Home Loan Bank of New York (FHLB), the Bank owns FHLB stock with a book value of $1,744,000. As of September 30, 2011, the Bank owns 17,442 shares valued at approximately $1,744,000 as its membership portion. The stock has no maturity and there is no public market for the investment. Assets pledged as collateral to FHLB as of September 30, 2011 and December 31, 2010 totaled $271,307,000 and $356,349,000, respectively, consisting of eligible loans and investment securities as determined under FHLB guidelines. The Bank evaluates the FHLB stock for impairment, concluding that there was no impairment as of September 30, 2011.
At September 30, 2011 investment securities carried at $201,481,000 were pledged to secure trust deposits and public funds on deposit.
The table below indicates the length of time individual securities, both held-to-maturity and available-for-sale, have been held in a continuous unrealized loss position at the date indicated: (in thousands)
As of September 30, 2011 | Less than 12 months | 12 months or longer | Total | |||||||||||||||||||||||||
Type of securities |
Number of Securities |
Fair Value |
Unrealized losses |
Fair value |
Unrealized losses |
Fair value |
Unrealized losses |
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Collateralized mortgage obligations |
2 | $ | | $ | | $ | 9,010 | $ | 1,634 | $ | 9,010 | $ | 1,634 | |||||||||||||||
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Total |
2 | $ | | $ | | $ | 9,010 | $ | 1,634 | $ | 9,010 | $ | 1,634 | |||||||||||||||
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As of December 31, 2010 | Less than 12 months | 12 months or longer | Total | |||||||||||||||||||||||||
Type of securities |
Number of Securities |
Fair Value |
Unrealized losses |
Fair value |
Unrealized losses |
Fair value |
Unrealized losses |
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Municipal Securities |
89 | $ | 39,836 | $ | 857 | $ | | $ | | $ | 39,836 | $ | 857 | |||||||||||||||
Collateralized mortgage obligations |
2 | | | 10,981 | 1,483 | 10,981 | 1,483 | |||||||||||||||||||||
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Total |
91 | $ | 39,836 | $ | 857 | $ | 10,981 | $ | 1,483 | $ | 50,817 | $ | 2,340 | |||||||||||||||
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Management has considered factors such as market value, cash flows, and analysis of underlying collateral regarding other-than-temporarily impaired securities and determined that there are no other-than-temporarily impaired securities as of September 30, 2011.
The unrealized losses in collateralized mortgage obligations at September 30, 2011 were caused by changes in interest rates, a significant widening of credit spreads across markets for these securities, and illiquidity in the financial markets for these instruments. These securities include two private issues held at a continuous, unrealized loss for more than twelve months. Each of these securities has some level of credit enhancement, and none are collateralized by sub-prime loans. With the assistance of a third party, management reviews the characteristics of these securities periodically, including levels of delinquency and foreclosure, projected losses at various degrees of severity, and credit enhancement and coverage. These securities are performing according to their terms, and, in the opinion of management, will continue to do so.
Suffolk does not have the intent to sell these securities and does not anticipate that it will be necessary to sell these securities before the full recovery of principal and interest due, which may be at maturity. Therefore, Suffolk did not consider these investments to be other-than-temporarily impaired at September 30, 2011.
In August 2011, in consultation with the Audit Committee, Suffolks management determined it was not properly identifying loan losses in the period incurred. This was the result of deficiencies in Suffolks internal controls with respect to credit administration and credit risk management, primarily with regard to risk-rating as well as with respect to the timing and recognition of charge-offs, impaired loans, and classified loans. As a result, certain loans should have been considered impaired, charged-off, or classified. The effect of these errors was recorded in the consolidated financial statements as of and for the year ended December 31, 2010 and the quarter ended September 30, 2010.
Suffolk takes into account applicable guidance under U.S. GAAP, including particularly ASC 855 Subsequent Events. Under this statement, subsequent events are defined as events or transactions that occur after the balance sheet date but before financial statements are issued or are available to be issued. This statement requires that entities recognize in the financial statements the effects of all subsequent events that provide additional evidence about conditions that existed as of the balance
Page 12
sheet date, including any estimates underlying the financial statements. The entity should not recognize subsequent events that provide evidence about conditions that arose after the balance sheet date, but should disclose those events which are so important that nondisclosure would make the financial statements misleading.
The allowance for loan losses is a valuation allowance for probable incurred credit losses. Loan losses are charged against the allowance when management believes the un-collectibility of a loan balance is confirmed. Subsequent recoveries, if any, are credited to the allowance. Management estimates the allowance balance required using past loan loss experience, the nature and volume of the portfolio, information about specific borrower situations and estimated collateral values, economic conditions, and other factors. Allocations of the allowance may be made for specific loans, but the entire allowance is available for any loan that, in managements judgment, should be charged off.
The allowance consists of specific and general components. The specific component relates to loans that are individually classified as impaired.
A loan is impaired when, based on current information and events, it is probable that Suffolk will be unable to collect all amounts due according to the contractual terms of the loan agreement. Loans for which the terms have been modified resulting in a concession, and for which the borrower is experiencing financial difficulties, are considered troubled debt restructurings and classified as impaired. Generally, troubled debt restructurings are initially classified as non-accrual until sufficient time has passed to assess whether the restructured loan will continue to perform. Generally, Suffolk returns a troubled-debt restructuring to accrual status upon six months of performance under the new terms.
Factors considered by management in determining impairment include payment status, collateral value, and the probability of collecting scheduled principal and interest payments when due. Loans that experience insignificant payment delays and payment shortfalls generally are not classified as impaired. Management determines the significance of payment delays and payment shortfalls on case-by-case basis, taking into consideration all of the circumstances surrounding the loan and the borrower, including the length of the delay, the reasons for the delay, the borrowers prior payment record, and the amount of the shortfall in relation to the principal and interest owed.
Commercial and commercial real estate loans over $250,000 are individually evaluated for impairment. However, the independent review of the loan portfolio included selected loans with balances less than $250,000. If a loan is impaired, a portion of the allowance is allocated so that the loan is reported, net, at the present value of estimated future cash flows using the loans existing rate or at the fair value of collateral if repayment is expected solely from the collateral. Large groups of homogeneous loans with smaller individual balances, such as consumer and residential real estate loans, are evaluated collectively for impairment, and accordingly, are not separately identified for impairment disclosures. Troubled debt restructurings are separately identified for impairment disclosures and are measured at the present value of estimated future cash flows using the loans effective rate at inception. If a troubled debt restructuring is considered to be collateral-dependent, the loan is reported, net, at the fair value of the collateral. For troubled debt restructurings that subsequently default, Suffolk determines the amount of reserve in accordance with the accounting policy for the allowance for loan losses.
The general component covers non impaired loans and is based on historical loss experience, adjusted for qualitative factors. The historical loss experience is determined by portfolio segment, and is based on the actual loss history experienced by Suffolk over the historical loan loss period which is a rolling twelve month period. This actual loss experience is supplemented with other qualitative factors based on the risks present for each portfolio segment. These qualitative factors include consideration of the following: levels of and trends in delinquencies and impaired loans; levels of and trends in charge-offs and recoveries; trends in volume and terms of loans; effects of any changes in risk selection and underwriting standards; other changes in lending policies, procedures, and practices; experience, ability, and depth of lending management and other relevant staff; national and local economic trends and conditions; industry conditions; and effects of changes in credit concentrations. The following portfolio segments have been identified:
| Commercial, financial & agricultural loans |
| Commercial real estate mortgages |
| Real estate construction loans |
| Residential mortgages (1st and 2nd liens) |
| Home equity loans |
| Consumer loans |
This amount is determined by applying historical loss factors to pools of loans within the portfolio having similar risk characteristics.
Page 13
In addition, the qualitative factors are considered for areas of concern that cannot be fully quantified in the allocation based on historical net charge-off ratios. Qualitative factors include:
| Economic outlook |
| Trends in delinquency and problem loans |
| Changes in loan volume and nature of terms of loans |
| Effects of changes in lending policy |
| Experience, ability, and depth of lending management and staff |
| Concentrations of credit |
| Effectiveness of loan review processes |
| Changes in value of underlying collateral |
| Competition, regulation, and other external factors |
For performing loans, an estimate of adequacy is made by applying qualitative factors specific to the portfolio to the period-end balances. Consideration is also given to the type and collateral of the loans with particular attention paid to commercial real estate construction loans, due to the inherent risk of this type of loan. Allocated and general reserves are available for any identified loss.
Delinquent, non-performing, and classified loans have trended upward. These are primary factors in the determination of the allowance.
At September 30, 2011, non-performing loans, including restructured and non-accrual loans, totaled $92,070,000 as compared to $28,911,000 at December 31, 2010. When compared to total loans, non-performing loans rose to 9.09 percent at September 30, 2011, up from 2.61 percent at December 31, 2010. Commercial loans, commercial mortgages and commercial real estate construction loans were primarily responsible for the increase. Non-performing loans include all non-accrual loans.
Page 14
The following table presents information about the allowance for loan losses: (in thousands of dollars except for ratios)
Period Ended: |
Nine Months Ended September 30, 2011 |
Year Ended December 31, 2010 Restated |
||||||
Allowance for loan losses, January 1, |
$ | 28,419 | $ | 12,333 | ||||
Loans charged-off: |
||||||||
Commercial, financial & agricultural loans |
6,537 | 8,501 | ||||||
Commercial real estate mortgages |
1,832 | 2,788 | ||||||
Real estate construction loans |
232 | 3,548 | ||||||
Residential mortgages (1st and 2nd liens) |
411 | 769 | ||||||
Home equity loans |
191 | 315 | ||||||
Consumer loans |
178 | 317 | ||||||
Other loans |
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|
|
|||||
Total Charge-offs |
$ | 9,381 | $ | 16,238 | ||||
|
|
|
|
|||||
Loans recovered after being charged-off |
Nine Months Ended September 30, 2011 |
Year Ended December 31, 2010 Restated |
||||||
Commercial, financial & agricultural loans |
551 | 69 | ||||||
Commercial real estate mortgages |
| | ||||||
Real estate construction loans |
| | ||||||
Residential mortgages (1st and 2nd liens) |
1 | | ||||||
Home equity loans |
| | ||||||
Consumer loans |
65 | 118 | ||||||
Other loans |
| | ||||||
|
|
|
|
|||||
Total recoveries |
$ | 617 | $ | 187 | ||||
|
|
|
|
|||||
Net loans charged-off |
8,764 | 16,051 | ||||||
Reclass (to) from allowance for contingent liabilities |
(50 | ) | 51 | |||||
Provision for loan losses |
24,088 | 32,086 | ||||||
|
|
|
|
|||||
Allowance for loan losses, Ending Balance |
$ | 43,693 | $ | 28,419 | ||||
|
|
|
|
Further information pertaining to the allowance for loan losses at September 30, 2011 is as follows: (in thousands)
Commercial, financial, and agricultural |
Commercial real estate |
Real estate construction loans |
Residential mortgages (1st and 2nd liens) |
Home equity loans |
Consumer loans |
Total | ||||||||||||||||||||||
Allowance for loan losses: |
||||||||||||||||||||||||||||
Ending balance (total allowance) |
$ | 23,746 | $ | 13,710 | $ | 2,020 | $ | 2,097 | $ | 1,718 | $ | 402 | $ | 43,693 | ||||||||||||||
Ending balance: individually evaluated for impairment |
6,249 | 4,654 | 1,695 | | | | 12,598 | |||||||||||||||||||||
Ending balance: collectively evaluated for impairment |
17,497 | 9,056 | 325 | 2,097 | 1,718 | 402 | 31,095 | |||||||||||||||||||||
Loan balances: |
||||||||||||||||||||||||||||
Ending balance (loan portfolio) (1) |
$ | 213,569 | $ | 433,057 | $ | 62,023 | $ | 171,515 | $ | 80,704 | $ | 51,516 | $ | 1,012,384 | ||||||||||||||
Ending balance: individually evaluated for impairment |
31,009 | 64,663 | 25,135 | 7,902 | 3,912 | 720 | 133,341 | |||||||||||||||||||||
Ending balance: collectively evaluated for impairment |
182,560 | 368,394 | 36,888 | 163,613 | 76,792 | 50,796 | 879,043 |
(1) | Other loans of $504, not included here, consist of overdraft advances, nearly all of which have been repaid subsequent to September 30, 2011. |
Page 15
Further information pertaining to the allowance for loan losses at December 31, 2010 (restated) is as follows: (in thousands)
Commercial, financial, and agricultural |
Commercial real estate |
Real estate construction loans |
Residential mortgages (1st and 2nd liens) |
Home equity loans |
Consumer loans (2) |
Total | ||||||||||||||||||||||
Allowance for loan losses: |
||||||||||||||||||||||||||||
Ending balance (total allowance) |
$ | 13,826 | $ | 9,226 | $ | 3,177 | $ | 519 | $ | 1,392 | $ | 279 | $ | 28,419 | ||||||||||||||
Ending balance: individually evaluated for impairment |
2,845 | 5,636 | 935 | | | | 9,416 | |||||||||||||||||||||
Ending balance: collectively evaluated for impairment |
10,981 | 3,590 | 2,242 | 519 | 1,392 | 279 | 19,003 | |||||||||||||||||||||
Loan balances: |
||||||||||||||||||||||||||||
Ending balance (loan portfolio) (1) |
$ | 248,750 | $ | 431,179 | $ | 82,720 | $ | 195,993 | $ | 84,696 | $ | 67,814 | $ | 1,111,152 | ||||||||||||||
Ending balance: individually evaluated for impairment |
17,277 | 51,540 | 26,897 | 3,466 | 986 | 75 | 100,241 | |||||||||||||||||||||
Ending balance: collectively evaluated for impairment |
231,473 | 379,639 | 55,823 | 192,527 | 83,710 | 67,739 | 1,010,911 |
(1) | Other loans of $1,127, not included here, consist of overdraft advances, nearly all of which have been repaid subsequent to year-end. |
(2) | Net of unearned discounts totalling $28 at December 31, 2010. |
The following is a summary of current and past due loans at September 30, 2011: (in thousands)
30-59 days past due |
60-89 days past due |
90 days and over past due |
Total past due | Current | Total loans | |||||||||||||||||||
Commercial: |
||||||||||||||||||||||||
Commercial, financial, and agricultural |
$ | 3,951 | $ | 7,685 | $ | 17,197 | $ | 28,833 | $ | 184,736 | $ | 213,569 | ||||||||||||
Commercial real estate |
3,034 | 898 | 45,687 | 49,619 | 383,438 | 433,057 | ||||||||||||||||||
Real estate construction loans |
| 4,250 | 17,976 | 22,226 | 39,797 | 62,023 | ||||||||||||||||||
Consumer: |
||||||||||||||||||||||||
Residential mortgages (1st and 2nd liens) |
3,141 | 510 | 6,578 | 10,229 | 161,286 | 171,515 | ||||||||||||||||||
Home equity loans |
123 | | 3,912 | 4,035 | 76,669 | 80,704 | ||||||||||||||||||
Consumer loans |
350 | 2 | 720 | 1,072 | 50,444 | 51,516 | ||||||||||||||||||
|
|
|
|
|
|
|
|
|
|
|
|
|||||||||||||
Total (1) |
$ | 10,599 | $ | 13,345 | $ | 92,070 | $ | 116,014 | $ | 896,370 | $ | 1,012,384 | ||||||||||||
|
|
|
|
|
|
|
|
|
|
|
|
(1) | Other loans of $504, not included here, consist of overdraft advances, nearly all of which have been repaid subsequent to September 30, 2011. |
Page 16
The following is a summary of current and past due loans at December 31, 2010 (restated): (in thousands)
30-59 days past due |
60-89 days past due |
90 days and over past due |
Total past due | Current | Total loans | |||||||||||||||||||
Commercial: |
||||||||||||||||||||||||
Commercial, financial, and agricultural |
$ | 212 | $ | 81 | $ | 2,382 | $ | 2,675 | $ | 246,075 | $ | 248,750 | ||||||||||||
Commercial real estate |
4,375 | 243 | 11,601 | 16,219 | 414,960 | 431,179 | ||||||||||||||||||
Real estate construction loans |
| | 10,481 | 10,481 | 72,239 | 82,720 | ||||||||||||||||||
Consumer: |
||||||||||||||||||||||||
Residential mortgages (1st and 2nd liens) |
2,162 | 1,934 | 3,466 | 7,562 | 188,431 | 195,993 | ||||||||||||||||||
Home equity loans |
637 | 1,140 | 986 | 2,763 | 81,933 | 84,696 | ||||||||||||||||||
Consumer loans (2) |
408 | 108 | 75 | 591 | 67,223 | 67,814 | ||||||||||||||||||
|
|
|
|
|
|
|
|
|
|
|
|
|||||||||||||
Total (1) |
$ | 7,794 | $ | 3,506 | $ | 28,991 | $ | 40,291 | $ | 1,070,861 | $ | 1,111,152 | ||||||||||||
|
|
|
|
|
|
|
|
|
|
|
|
(1) | Other loans of $1,127, not included here, consist of overdraft advances, nearly all of which have been repaid subsequent to year-end. |
(2) | Net of unearned discounts totalling $28 at December 31, 2010. |
Page 17
The following is a summary of impaired loans: (in thousands)
September 30, 2011 | December 31, 2010 | |||||||||||||||||||||||||||||||
Restated | ||||||||||||||||||||||||||||||||
Impaired Loans with Valuation Reserves |
Impaired Loans without Valuation Reserves |
Total Impaired Loans |
Total Valuation Reserves |
Impaired Loans with Valuation Reserves |
Impaired Loans without Valuation Reserves |
Total Impaired Loans |
Total Valuation Reserves |
|||||||||||||||||||||||||
Commercial, financial & agricultural loans |
$ | 15,726 | $ | 15,283 | $ | 31,009 | $ | 6,249 | $ | 8,227 | $ | 9,050 | $ | 17,277 | $ | 2,845 | ||||||||||||||||
Commercial real estate mortgages |
21,255 | 43,408 | $ | 64,663 | 4,654 | 34,301 | 17,239 | 51,540 | 5,636 | |||||||||||||||||||||||
Real estate construction loans |
8,717 | 16,418 | 25,135 | 1,695 | 6,569 | 20,328 | 26,897 | 935 | ||||||||||||||||||||||||
Residential mortgages (1st and 2nd liens) |
| 7,902 | 7,902 | | | 3,466 | 3,466 | | ||||||||||||||||||||||||
Home equity loans |
| 3,912 | 3,912 | | | 986 | 986 | | ||||||||||||||||||||||||
Consumer loans |
| 720 | 720 | | | 75 | 75 | | ||||||||||||||||||||||||
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|||||||||||||||||
Total |
$ | 45,698 | $ | 87,643 | $ | 133,341 | $ | 12,598 | $ | 49,097 | $ | 51,144 | $ | 100,241 | $ | 9,416 | ||||||||||||||||
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Year ended | ||||||||
Nine months
ended September 30, 2011 |
December 31,
2010 Restated |
|||||||
Average investment in impaired loans |
$ | 120,823 | $ | 63,101 | ||||
Three months | Three months | Nine months | Nine months | |||||||||||||
ended | ended | ended | ended | |||||||||||||
9/30/11 | 9/30/10 | 9/30/11 | 9/30/10 | |||||||||||||
Interest income recognized on impaired loans |
$ | 1,403 | $ | 1,462 | $ | 3,681 | $ | 2,556 | ||||||||
Interest income recognized on a cash basis on impaired loans |
$ | | $ | | $ | | $ | |
The following is a summary of information pertaining to impaired and non-accrual loans: (in thousands)
September 30, 2011 | December 31,
2010 Restated |
|||||||
Impaired loans without a valuation allowance |
$ | 87,643 | $ | 51,144 | ||||
Impaired loans with a valuation allowance |
45,698 | 49,097 | ||||||
|
|
|
|
|||||
Total impaired loans |
133,341 | 100,241 | ||||||
|
|
|
|
|||||
Valuation allowance related to impaired loans |
$ | 12,598 | $ | 9,416 | ||||
Total non-accrual loans (1) |
92,070 | 28,991 | ||||||
Total loans past due 90 days or more and still accruing |
| | ||||||
Troubled debt restructurings accruing interest |
1,505 | 11,904 | ||||||
Troubled debt restructurings - nonaccruing |
27,855 | 12,140 |
(1) | Includes troubled debt restructurings of $12,140 on December 31, 2010 and $27,855 on September 30, 2011 |
Additional interest income of approximately $1,571,000 and $3,335,000 would have been recorded during the three and nine month periods ended September 30, 2011, respectively, if the loans had performed in accordance with their original terms.
A total of $5,195,000 is committed to be advanced in connection with impaired loans as of September 30, 2011.
Page 18
The following table summarizes loan balances and allocates the allowance for loan losses by risk rating as of September 30, 2011: (in thousands)
Commercial, financial, and agricultural |
Commercial real estate |
Real estate construction loans |
Residential mortgages (1st and 2nd liens) |
Home equity loans |
Consumer loans |
Total | ||||||||||||||||||||||
Unimpaired loans: |
||||||||||||||||||||||||||||
Total pass loans (1) |
$ | 131,862 | $ | 278,132 | $ | 14,354 | $ | 163,613 | $ | 76,792 | $ | 50,796 | $ | 715,549 | ||||||||||||||
Loss factor (2) |
10.51 | % | 2.49 | % | 1.05 | % | 1.28 | % | 2.24 | % | 0.79 | % | 3.51 | % | ||||||||||||||
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|||||||||||||||
Reserve |
13,863 | 6,919 | 151 | 2,097 | 1,718 | 402 | 25,150 | |||||||||||||||||||||
Total special mention loans |
21,996 | 48,228 | 7,180 | | | | 77,404 | |||||||||||||||||||||
Loss factor |
6.97 | % | 2.37 | % | 0.78 | % | 3.53 | % | ||||||||||||||||||||
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|||||||||||||||
Reserve |
1,533 | 1,142 | 56 | | | | 2,731 | |||||||||||||||||||||
Total substandard loans |
28,702 | 42,034 | 15,354 | | | | 86,090 | |||||||||||||||||||||
Loss factor |
7.32 | % | 2.37 | % | 0.78 | % | 3.73 | % | ||||||||||||||||||||
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|||||||||||||||
Reserve |
2,101 | 995 | 119 | | | | 3,215 | |||||||||||||||||||||
Impaired loans: |
||||||||||||||||||||||||||||
Total substandard loans |
29,950 | 64,130 | 23,628 | 7,902 | 3,912 | 720 | 130,242 | |||||||||||||||||||||
Loss factor |
18.93 | % | 7.26 | % | 1.79 | % (3) | 8.25 | % | ||||||||||||||||||||
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|||||||||||||||
Reserve |
5,669 | 4,654 | 423 | | | | 10,746 | |||||||||||||||||||||
Total doubtful loans |
1,059 | 533 | 1,507 | | | | 3,099 | |||||||||||||||||||||
Loss factor |
54.77 | % | 0.00 | % | 84.41 | % | 59.76 | % | ||||||||||||||||||||
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|||||||||||||||
Reserve |
580 | | 1,272 | | | | 1,852 | |||||||||||||||||||||
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|||||||||||||||
Total unimpaired loans |
$ | 182,560 | $ | 368,394 | $ | 36,888 | $ | 163,613 | $ | 76,792 | $ | 50,796 | $ | 879,043 | ||||||||||||||
Total reserve on unimpaired loans |
$ | 17,497 | $ | 9,056 | $ | 326 | $ | 2,097 | $ | 1,718 | $ | 402 | $ | 31,096 | ||||||||||||||
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(1) | Loans risk-graded 1-4. Other loans of $504, not included here, consist of overdraft advances, nearly all of which have been repaid subsequent to September 30, 2011 |
(2) | Loss factor calculation is specific reserves as a percentage of balance for a portfolio segment. |
(3) | Loss factor is driven by higher collateral positions and charge offs taken within this portfolio segment. |
Page 19
The following table summarizes loan balances and allocates the allowance for loan losses by risk rating as of December 31, 2010: (restated) (in thousands)
Commercial, financial, and agricultural |
Commercial real estate |
Real estate construction loans |
Residential mortgages (1st and 2nd liens) |
Home equity loans |
Consumer loans (4) |
Total | ||||||||||||||||||||||
Unimpaired loans: |
||||||||||||||||||||||||||||
Total pass loans (1) |
$ | 202,926 | $ | 314,447 | $ | 39,530 | $ | 192,527 | $ | 83,710 | $ | 67,739 | $ | 900,879 | ||||||||||||||
Loss factor (2) |
4.80 | % | 0.95 | % | 3.96 | % | 0.27 | % | 1.66 | % | 0.41 | % | 1.83 | % | ||||||||||||||
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|||||||||||||||
Reserve |
9,731 | 2,996 | 1,567 | 519 | 1,392 | 279 | 16,484 | |||||||||||||||||||||
Total special mention loans |
6,291 | 28,823 | 1,773 | | | | 36,887 | |||||||||||||||||||||
Loss factor |
4.43 | % | 0.91 | % | 4.12 | % | 1.67 | % | ||||||||||||||||||||
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|||||||||||||||
Reserve |
279 | 263 | 73 | | | | 615 | |||||||||||||||||||||
Total substandard loans |
22,256 | 36,369 | 14,520 | | | | 73,145 | |||||||||||||||||||||
Loss factor |
4.36 | % | 0.91 | % | 4.15 | % | 2.60 | % | ||||||||||||||||||||
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|||||||||||||||
Reserve |
971 | 331 | 602 | | | | 1,904 | |||||||||||||||||||||
Impaired loans: |
||||||||||||||||||||||||||||
Total substandard loans |
16,792 | 51,540 | 26,226 | 3,466 | 986 | 75 | 99,085 | |||||||||||||||||||||
Loss factor |
14.37 | % | 10.94 | % | 1.01 | % (3) | 8.39 | % | ||||||||||||||||||||
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|||||||||||||||
Reserve |
2,413 | 5,636 | 264 | | | | 8,313 | |||||||||||||||||||||
Total doubtful loans |
485 | | 671 | | | | 1,156 | |||||||||||||||||||||
Loss factor |
89.07 | % | 100.00 | % | 95.42 | % | ||||||||||||||||||||||
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|||||||||||||||
Reserve |
432 | | 671 | | | | 1,103 | |||||||||||||||||||||
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|||||||||||||||
Total unimpaired loans |
$ | 231,473 | $ | 379,639 | $ | 55,823 | $ | 192,527 | $ | 83,710 | $ | 67,739 | $ | 1,010,911 | ||||||||||||||
Total reserve on unimpaired loans |
$ | 10,981 | $ | 3,590 | $ | 2,242 | $ | 519 | $ | 1,392 | $ | 279 | $ | 19,003 | ||||||||||||||
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(1) | Loans risk-graded 1-4. Other loans of $1,127, not included here, consist of overdraft advances, nearly all of which have been repaid subsequent to year-end. |
(2) | Loss factor calculation is specific reserves as a percentage of balance for a portfolio segment. |
(3) | Loss factor is driven by higher collateral positions and charge offs taken within this portfolio segment. |
(4) | Net of unearned discount totalling $28 at December 31, 2010 |
The following table summarizes the allowance for loan losses by loan type for the three months ended September 30, 2011: (in thousands)
Allowance for loan losses |
Commercial, financial & agricultural loans |
Commercial real estate mortgages |
Real estate construction loans |
Residential mortgages (1st and 2nd liens) |
Home equity loans |
Consumer loans |
Total | |||||||||||||||||||||
Beginning balance |
$ | 30,486 | $ | 11,210 | $ | 4,163 | $ | 1,691 | $ | 1,908 | $ | 453 | $ | 49,911 | ||||||||||||||
Total charge-offs |
(5,248 | ) | (1,832 | ) | (232 | ) | (121 | ) | (34 | ) | (7,467 | ) | ||||||||||||||||
Total recoveries |
373 | | | | | 26 | 399 | |||||||||||||||||||||
Reclass to allowance for contingent liabilities |
| (50 | ) | | | | | (50 | ) | |||||||||||||||||||
Provision for loan losses |
(1,865 | ) | 4,382 | (1,911 | ) | 406 | (69 | ) | (43 | ) | 900 | |||||||||||||||||
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|||||||||||||||
Ending balance |
$ | 23,746 | $ | 13,710 | $ | 2,020 | $ | 2,097 | $ | 1,718 | $ | 402 | $ | 43,693 | ||||||||||||||
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Page 20
Credit Quality Information
The Bank utilizes an eight-grade risk-rating system for commercial loans, commercial real estate and construction loans as follows:
Risk Grade 1 Excellent:
Loans secured by liquid collateral, such as certificates of deposit, reputable bank letters of credit, or other cash equivalents; loans that are guaranteed or otherwise backed by the full faith and credit of the United States government or an agency thereof, such as the Small Business Administration; or loans to any publicly held company with a current long-term debt rating of A or better.
Risk Grade 2 Good:
Loans to businesses that have strong financial statements containing an unqualified opinion from a CPA firm and at least three consecutive years of profits; loans supported by un-audited financial statements containing strong balance sheets, five consecutive years of profits, a five-year satisfactory relationship with the Bank, and key balance sheet and income statement trends that are either stable or positive; loans secured by publicly traded marketable securities where there is no impediment to liquidation; loans to individuals backed by liquid personal assets, established credit history, and unquestionable character; or loans to publicly held companies with current long-term debt ratings of Baa or better.
Risk Grade 3 Satisfactory:
Loans supported by financial statements (audited or un-audited) that indicate average or slightly below average risk and having some deficiency or vulnerability to changing economic conditions; loans with some weakness but offsetting features of other support are readily available; loans that are meeting the terms of repayment, but which may be susceptible to deterioration if adverse factors are encountered.
Loans may be graded Satisfactory when there is no recent information on which to base a current risk evaluation and the following conditions apply:
| At inception, the loan was properly underwritten, did not possess an unwarranted level of credit risk, and the loan met the above criteria for a risk grade of Excellent, Good, or Satisfactory; |
| At inception, the loan was secured with collateral possessing a loan value adequate to protect the Bank from loss. |
| The loan has exhibited two or more years of satisfactory repayment with a reasonable reduction of the principal balance. |
| During the period that the loan has been outstanding, there has been no evidence of any credit weakness. Some examples of weakness include slow payment, lack of cooperation by the borrower, breach of loan covenants, or |
| The borrower is in an industry known to be experiencing problems. If any of these credit weaknesses is observed, a lower risk grade may be warranted. |
Risk Grade 4 Satisfactory/Monitored:
Loans in this category are considered to be of acceptable credit quality, but contain greater credit risk than satisfactory loans due to weak balance sheets, marginal earnings or cash flow, or other uncertainties. These loans warrant a higher than average level of monitoring to ensure that weaknesses do not advance. The level of risk in a Satisfactory/Monitored loan is within acceptable underwriting guidelines so long as the loan is given the proper level of management supervision.
Risk Grade 5 Special Mention:
Loans which possess some credit deficiency or potential weakness which deserves close attention. Such loans pose an unwarranted financial risk that, if not corrected, could weaken the loan by adversely impacting the future repayment ability of the borrower. The key distinctions of a Special Mention classification are that (1) it is indicative of an unwarranted level of risk and (2) weaknesses are considered potential, not defined, impairments to the primary source of repayment.
Page 21
Risk Grade 6 Substandard:
One or more of the following characteristics may be exhibited in loans classified Substandard:
| Loans which possess a defined credit weakness. The likelihood that a loan will be paid from the primary source of repayment is uncertain. Financial deterioration is under way and very close attention is warranted to ensure that the loan is collected without loss. |
| Loans are inadequately protected by the current net worth and paying capacity of the obligor. |
| The primary source of repayment is gone, and the Bank is forced to rely on a secondary source of repayment, such as collateral liquidation or guarantees. |
| Loans have a distinct possibility that the Bank will sustain some loss if deficiencies are not corrected. |
| Unusual courses of action are needed to maintain a high probability of repayment. |
| The borrower is not generating enough cash flow to repay loan principal; however, it continues to make interest payments. |
| The lender is forced into a subordinated or unsecured position due to flaws in documentation. |
| Loans have been restructured so that payment schedules, terms, and collateral represent concessions to the borrower when compared to the normal loan terms. |
| The lender is seriously contemplating foreclosure or legal action due to the apparent deterioration in the loan. |
| There is a significant deterioration in market conditions to which the borrower is highly vulnerable. |
Risk Grade 7 Doubtful:
One or more of the following characteristics may be present in loans classified Doubtful:
| Loans have all of the weaknesses of those classified as Substandard. However, based on existing conditions, these weaknesses make full collection of principal highly improbable. |
| The primary source of repayment is gone, and there is considerable doubt as to the quality of the secondary source of repayment. |
| The possibility of loss is high but because of certain important pending factors which may strengthen the loan, loss classification is deferred until the exact status of repayment is known. |
Risk Grade 8 Loss:
Loans are considered uncollectible and of such little value that continuing to carry them as assets is not feasible. Loans will be classified Loss when it is neither practical nor desirable to defer writing off or reserving all or a portion of a basically worthless asset, even though partial recovery may be possible at some time in the future.
The Bank considers real estate, home equity and consumer loans secured by real estate (such as mobile homes) that are contractually past due 90 days or more or where legal action has commenced against the borrower to be substandard. The Bank follows the Federal Financial Institutions Examination Council (FFIEC) Uniform Retail Credit Classification guidelines.
The Bank reviews formally, annually, the ratings on all commercial and industrial, commercial real estate and construction loans greater than $1 million. Quarterly, the Bank engages an independent third-party to review a significant portion of loans within these segments. Management uses the results of these reviews as part of its annual review process.
Page 22
The following table identifies credit risk by the internally assigned grade at September 30, 2011: (in thousands)
Credit Risk Profile By Internally Assigned Grade | ||||||||||||||||||||||||||||
Commercial Credit Exposure | Consumer Credit Exposure | |||||||||||||||||||||||||||
Commercial, financial, and agricultural |
Commercial real estate |
Real estate construction loans |
Residential mortgages (1st and 2nd liens) |
Home equity loans |
Consumer loans | Total | ||||||||||||||||||||||
Grade: |
||||||||||||||||||||||||||||
Pass (1) |
$ | 131,862 | $ | 278,132 | $ | 14,354 | $ | 163,613 | $ | 76,792 | $ | 50,796 | $ | 715,549 | ||||||||||||||
Special mention |
21,996 | 48,228 | 7,180 | | | | 77,404 | |||||||||||||||||||||
Substandard |
58,652 | 106,164 | 38,982 | 7,902 | 3,912 | 720 | 216,332 | |||||||||||||||||||||
Doubtful |
1,059 | 533 | 1,507 | | | | 3,099 | |||||||||||||||||||||
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|||||||||||||||
Total |
$ | 213,569 | $ | 433,057 | $ | 62,023 | $ | 171,515 | $ | 80,704 | $ | 51,516 | $ | 1,012,384 | ||||||||||||||
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|
|
|
|
|
|
|
|
|
|
|
|
|
(1) | Other loans of $504, not included here, consist of overdraft advances, nearly all of which have been repaid subsequent to September 30, 2011 |
The following table identifies credit risk by the internally assigned grade at December 31, 2010 (restated): (in thousands)
Credit Risk Profile By Internally Assigned Grade | ||||||||||||||||||||||||||||
Restated | ||||||||||||||||||||||||||||
Commercial Credit Exposure | Consumer Credit Exposure | |||||||||||||||||||||||||||
Commercial, financial, and agricultural |
Commercial real estate |
Real estate construction loans |
Residential mortgages (1st and 2nd liens) |
Home equity loans |
Consumer loans (2) |
Total | ||||||||||||||||||||||
Grade: |
||||||||||||||||||||||||||||
Pass (1) |
$ | 202,926 | $ | 314,447 | $ | 39,530 | $ | 192,527 | $ | 83,710 | $ | 67,739 | $ | 900,879 | ||||||||||||||
Special mention |
6,291 | 28,823 | 1,773 | | | | 36,887 | |||||||||||||||||||||
Substandard |
39,048 | 87,909 | 40,746 | 3,466 | 986 | 75 | 172,230 | |||||||||||||||||||||
Doubtful |
485 | | 671 | | | | 1,156 | |||||||||||||||||||||
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|||||||||||||||
Total |
$ | 248,750 | $ | 431,179 | $ | 82,720 | $ | 195,993 | $ | 84,696 | $ | 67,814 | $ | 1,111,152 | ||||||||||||||
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|
|
|
|
|
|
|
|
|
|
|
|
|
(1) | Other loans of $1,127, not included here, consist of overdraft advances, nearly all of which have been repaid subsequent to December 31, 2010. |
(2) | Net of unearned discount totalling $28 at December 31, 2010 |
The following table summarizes as of September 30, 2011 loans that have been restructured during the periods presented (dollars in thousands):
For the three months ended September 30, 2011 |
For the nine months ended September 30, 2011 |
|||||||||||||||||||||||
Troubled Debt Restructurings |
# of Loans |
Pre- Modification Outstanding Recorded Investment |
Post- Modification Outstanding Recorded Investment |
# of Loans |
Pre- Modification Outstanding Recorded Investment |
Post- Modification Outstanding Recorded Investment |
||||||||||||||||||
Commercial, financial, and agricultural |
4 | $ | 578 | $ | 579 | 28 | $ | 3,714 | $ | 3,738 | ||||||||||||||
Commercial, secured by real estate |
1 | 1,210 | 1,210 | 7 | 8,071 | 8,071 | ||||||||||||||||||
Real estate construction loans |
0 | | | 0 | | | ||||||||||||||||||
Residential mortgages |
1 | 100 | 100 | 5 | 1,437 | 1,622 | ||||||||||||||||||
Home Equity |
0 | | | 1 | 291 | 291 | ||||||||||||||||||
Consumer |
0 | | | 2 | 34 | 34 | ||||||||||||||||||
|
|
|
|
|
|
|
|
|
|
|
|
|||||||||||||
6 | $ | 1,888 | $ | 1,889 | 43 | $ | 13,547 | $ | 13,756 | |||||||||||||||
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|
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|
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Page 23
The following table summarizes as of September 30, 2011, loans that were restructured that have subsequently defaulted within the last twelve months: (dollars in thousands)
Defaulted Troubled Debt Restructurings |
Number of Loans |
Recorded Investment |
||||||
Commercial, financial, and agricultural |
37 | $ | 440 | |||||
Commercial, secured by real estate |
4 | 9,677 | ||||||
Real estate construction loans |
1 | 4,598 | ||||||
Residential mortgages |
2 | 671 | ||||||
Home Equity |
1 | | ||||||
Consumer |
0 | | ||||||
|
|
|
|
|||||
45 | $ | 15,386 | ||||||
|
|
|
|
Defaulted restructured loans include 30 contracts with zero balances: 28 commercial, financial, and agricultural loans , one commercial loan secured by real estate and one home equity loan. The home equity loan and one commercial, financial, and agricultural loan were paid off, the remaining 28 were charged off.
Comprehensive income includes net income and all other changes in equity during a period except those resulting from investments by owners and distributions to owners. Other comprehensive income includes revenues, expenses, gains, and losses that under generally accepted accounting principles are included in comprehensive income but excluded from net income. Comprehensive income and accumulated other comprehensive income are reported net of related income taxes. Accumulated other comprehensive income for the Bank consists of unrealized holding gains or losses on securities available for sale, and gains or losses on the unfunded projected benefit obligation of the pension plan.
The following table summarizes the changes in accumulated other comprehensive income (loss): (in thousands)
For the period ended, |
September 30, 2011 | December 31,
2010 Restated |
||||||
Balance January 1, |
$ | (2,229 | ) | $ | (1,707 | ) | ||
Net change in unrealized net gain on investment securities, net of tax |
5,025 | 2,122 | ||||||
Reclassification of gains on sales of securities recognized, net of tax |
(978 | ) | (223 | ) | ||||
Postretirement plan projected benefit obligation |
(89 | ) | (2,421 | ) | ||||
|
|
|
|
|||||
Total accumulated other comprehensive income (loss) |
$ | 1,729 | $ | (2,229 | ) | |||
|
|
|
|
The unrealized gain on investment securities at September 30, 2011 is mainly attributable to an increase of $4,177,000 in the market value of obligations of state and political subdivisions, and in collateralized mortgage obligations of $100,000, offset by decreases of $177,000 in the market value of U.S. government agency debt, and $52,000 in the market value of U.S. treasury securities.
Suffolk accounts for its retirement plan in accordance with FASB ASC 715, Compensation Retirement Benefits and FASB ASC 960, Plan Accounting Defined Benefit Pension Plans, which require an employer that is a business entity and sponsors one or more single-employer defined benefit plans to recognize the funded status of a benefit plan in its statement of financial position; recognize as a component of other comprehensive income, net of tax, the gains or losses and prior service costs or credits that arise during the period but are not recognized as components of net periodic benefit cost; measure defined benefit plan assets and obligations as of the date of fiscal year-end statements of financial position (with limited exceptions); and disclose in the notes to financial statements additional information about certain effects of net periodic benefit cost for the next fiscal year that arise from delayed recognition of the gains or losses, prior service costs or credits, and transition asset and obligation. Plan assets and benefit obligations shall be measured as of the date of its statement of financial position and in determining the amount of net periodic benefit cost. Suffolk has adopted the provisions of the codification, which have been recorded in the accompanying consolidated statement of condition and disclosures.
Page 24
Suffolk presents information concerning net periodic defined benefit pension expense for the three and nine months ended September 30, 2011 and 2010, including the following components: (in thousands)
3 months | 3 months | 9 months | 9 months | |||||||||||||
9/30/2011 | 9/30/2010 | 9/30/2011 | 9/30/2010 | |||||||||||||
Service cost |
$ | 545 | $ | 451 | $ | 1,635 | $ | 1,353 | ||||||||
Interest cost |
563 | 510 | 1,688 | 1,529 | ||||||||||||
Expected return on plan assets |
(560 | ) | (538 | ) | (1,680 | ) | (1,613 | ) | ||||||||
Amortization of prior service cost |
244 | 181 | 732 | 543 | ||||||||||||
|
|
|
|
|
|
|
|
|||||||||
Net periodic benefit expense |
$ | 792 | $ | 604 | $ | 2,375 | $ | 1,812 | ||||||||
|
|
|
|
|
|
|
|
There is no minimum required contribution for the pension plan year ending September 30, 2011. There were no additional contributions required to be made to the plan in the nine months ended September 30, 2011.
(9) Recent Accounting Pronouncements
In January 2011, the Financial Accounting Standards Board (FASB) issued Accounting Standards Update (ASU) No. 2011-01, which temporarily delays the effective date of the required disclosures about troubled debt restructurings contained in ASU No. 2010-20. The delay is intended to allow the FASB additional time to deliberate what constitutes a troubled debt restructuring. All other amendments contained in ASU No. 2010-20 are effective as issued. Adoption of this update did not have a material effect on Suffolks results of operations or financial condition.
In April 2011, the FASB issued ASU No. 2011-02, which amends the authoritative accounting guidance under ASC Topic 310 Receivables. The update provides clarifying guidance as to what constitutes a troubled debt restructuring. The update provides clarifying guidance on a creditors evaluation of the following: (1) how a restructuring constitutes a concession; and (2) if the debtor is experiencing financial difficulties. The amendments in this update are effective for the first interim or annual period beginning on or after June 15, 2011, and should be applied retrospectively to the beginning of the annual period of adoption. In addition, disclosures about troubled debt restructurings which were delayed by the issuance of ASU No. 2011-01, are effective for interim and annual periods beginning on or after June 15, 2011. Adoption of this update did not have a material effect on Suffolks results of operations or financial condition.
In April 2011, the FASB issued ASU No. 2011-03, which amends the authoritative accounting guidance under ASC Topic 860 Transfers and Servicing. The amendments in this update remove from the assessment of effective control (1) the criterion requiring the transferor to have the ability to repurchase or redeem the financial assets on substantially the agreed terms, even in the event of default by the transferee, and (2) the collateral maintenance implementation guidance related to that criterion. The amendments in this update are effective for the first interim or annual period beginning on or after December 15, 2011, and should be applied prospectively to transactions or modifications of existing transactions that occur on or after the effective date. Early adoption is not permitted. Adoption of this update did not have a material effect on Suffolks results of operations or financial condition.
In May 2011, the FASB issued ASU No. 2011-04, which amends the authoritative accounting guidance under ASC Topic 820 Fair Value Measurement to more closely align US GAAP with International Financial Reporting Standards (IFRS). This standard requires the disclosure of: (1) the reason for the measurement for both recurring and nonrecurring fair value measurements;(2) all transfers between levels of the fair value hierarchy must be separately reported and described; (3) for all Level 2 and Level 3 fair value measurements, a description of the valuation technique(s) and the inputs used in those measurements; (4) For Level 3 measurements, the quantitative information about the significant unobservable inputs used in those measurements; and (5) A description of the valuation processes used in Level 3 fair value measurements, as well as narrative descriptions about those measurements sensitivity to changes in unobservable inputs if such changes would significantly alter the fair value measurement. The amendment is effective for interim and annual periods beginning after December 15, 2011 and early application is not permitted. Adoption of this update is not expected to have a material effect on Suffolks results of operations or financial condition.
In June 2011, the FASB issued ASU No. 2011-05 in order to improve the comparability, consistency and transparency of financial reporting and to increase the prominence of items reported in other comprehensive income. This standard eliminates the option to present components of other comprehensive income as part of the statement of changes in stockholders equity. This update requires all non-owner changes in stockholders equity be presented either in a single continuous statement of comprehensive income or in two separate but consecutive statements. In the two-statement approach, the first statement should present total net income and its components followed consecutively by a second
Page 25
statement that should present total other comprehensive income, the components of other comprehensive income, and the total of comprehensive income. This update is effective for public companies for fiscal years ending after December 31, 2011. Early adoption is permitted because compliance with the amendments is already permitted. The amendments in this update should be applied retrospectively. For public entities, the amendments are effective for fiscal years, and interim periods within those years, beginning after December 15, 2011. The amendments do not require any transition disclosures. Adoption of this update is not expected to have a material effect on the Suffolks results of operations or financial condition.
In September 2011 the FASB issued ASU 2011-08, Testing Goodwill for Impairment, to give both public and nonpublic entities the option to qualitatively determine whether they can bypass the two-step goodwill impairment test under FASB ASC 350-20, Intangibles Goodwill and Other. Under the new guidance, if an entity chooses to perform a qualitative assessment and determines that it is more likely than not (a more than 50 percent likelihood) that the fair value of a reporting unit is less than its carrying amount, it would then perform Step 1 of the annual goodwill impairment test in ASC 350-20 and, if necessary, proceed to Step 2. Otherwise, no further evaluation would be necessary. The amended guidance is effective for interim and annual goodwill impairment tests performed for fiscal years beginning after December 15, 2011, although early adoption is permitted, including for annual and interim goodwill impairment tests performed as of a date before September 15, 2011, if an entitys financial statements for the most recent annual or interim period have not yet been issued. Suffolk has decided to adopt ASU 2011-08 effective in the third quarter of 2011. Adoption of this update did not have a material effect on Suffolks results of operations or financial condition.
On October 25, 2010, the Bank, following discussion with the Office of the Comptroller of the Currency (the OCC) entered into an agreement with the OCC (the Agreement). The Agreement requires the Bank to take certain actions, including a review of management, the establishment of a three-year strategic plan and capital program, and the establishment of programs related to internal audit, maintaining an adequate allowance for loan losses, real property appraisal, credit risk management, credit concentrations, Bank Secrecy Act compliance and information technology.
Management and the board of directors are committed to taking all necessary actions to promptly address the requirements of the Agreement, and believe that the Bank has already made measurable progress in addressing these requirements. In connection with the foregoing, the Bank has retained legal and other resources including the services of a qualified compliance consultant to assist and advise in meeting the requirements of the Agreement.
The Bank is subject to individual minimum capital ratios (IMCRs) established by the OCC requiring Tier 1 Leverage Capital equal to at least 8.00 percent of adjusted total assets; Tier 1 Risk-based Capital equal to at least 10.50 percent of risk-weighted assets; and Total Risk Based Capital equal to at least 12.00 percent of risk-weighted assets. Management believes the Bank met all three IMCRs at September 30, 2011: Tier 1 Capital was 8.50 percent of adjusted total assets; Tier 1 Capital was 12.53 percent of risk-weighted assets; Total Risk Based Capital was 13.82 percent of risk-weighted assets. Failure to meet minimum capital requirements can initiate certain mandatory and possibly additional discretionary actions by regulators that, if undertaken, could have a direct material effect on the Banks financial statements.
At September 30, 2011, Suffolks Tier 1 capital ratio was 8.57 percent of adjusted total assets, Tier 1 capital ratio was 12.60 percent of risk-weighted assets, and Total Risk Based capital ratio was 13.88 percent of risk-weighted assets.
The ability of the Bank to pay dividends to Suffolk is subject to certain regulatory restrictions. Generally, dividends declared in a given year by a national bank are limited to its net profit, as defined by regulatory agencies, for that year, combined with its retained net income for the preceding two years, less any required transfer to surplus or to fund for the retirement of any preferred stock of which the Bank has none as of September 30, 2011. In addition, a national bank may not pay any dividends in an amount greater than its undivided profits and a national bank may not declare any dividends if such declaration would leave the Bank inadequately capitalized. Therefore, the ability of the Bank to declare dividends will depend on its future net income and capital requirements. In addition, under the Agreement the Bank is required to establish a dividend policy that will permit the declaration of a dividend only when the Bank is in compliance with its capital program and with the prior written determination of no supervisory objection by the OCC.
While subject to the Agreement, Suffolk expects that its and the Banks management and board of directors will be required to focus a substantial amount of time on complying with its terms. There also is no guarantee that the Bank will be able to fully comply with the Agreement. If the Bank fails to comply with the terms of the Agreement, it could be subject to further regulatory enforcement actions.
Page 26
On July 11, 2011 a shareholder derivative action, Robert J. Levy v. J. Gordon Huszagh, et al., No. 11 Civ. 3321 (JS), was filed in the U.S. District Court for the Eastern District of New York against the directors of Suffolk and a former officer of Suffolk. Suffolk was named as a nominal defendant. The complaint seeks damages against the individual defendants in an unspecified amount, and alleges that the individual defendants breached their fiduciary duties by making improper statements regarding the sufficiency of Suffolks allowance for loan losses and loan portfolio credit quality, and by failing to establish sufficient allowances for loan losses and to establish effective credit risk management policies. On September 30, 2011, Suffolk and the directors filed a motion to dismiss the complaint.
On October 28, 2011, a separate shareholder derivative action, Susan Forbush v. Edgar F. Goodale, et al., No. 33538/11, was filed in the Supreme Court of the State of New York for the County of Suffolk, against the directors of Suffolk and a former officer of Suffolk. Suffolk was named as a nominal defendant. The complaint asserts claims that are substantially similar to those asserted in the Levy action.
On October 20, 2011, a putative shareholder class action, James E. Fisher v. Suffolk Bancorp, et al., No. 11 Civ. 5114 (SJ), was filed in the U.S. District Court for the Eastern District of New York against Suffolk, its chief executive officer, and a former chief financial officer of Suffolk. The complaint alleges that the defendants violated Sections 10(b) and 20(a) of the Securities Exchange Act of 1934 by knowingly or recklessly making false statements about, or failing to disclose accurate information about, Suffolks financial results and condition, loan loss reserves, impaired assets, internal and disclosure controls, and banking practices. The complaint seeks damages in an unspecified amount on behalf of purchasers of Suffolks common stock between March 12, 2010 and August 10, 2011.
The foregoing matters are in their preliminary phases and it is not possible to ascertain whether there is a reasonable possibility of a loss from these matters. Therefore we have concluded that an amount for a loss contingency is not to be accrued or disclosed at this time. Suffolk believes that it has substantial defenses to the claims filed against it in these lawsuits and, to the extent that these actions proceed, Suffolk intends to defend itself vigorously.
Suffolk has been informed that the SECs New York regional office is conducting an informal inquiry to determine whether there have been violations of the federal securities laws in connection with Suffolks financial reporting. The SEC has not asserted that any federal securities law violation has occurred. Suffolk believes it is in compliance with all federal securities laws and believes it has cooperated fully with the SECs informal inquiry. Although the ultimate outcome of the informal inquiry cannot be ascertained at this time, based upon information that presently is available to it, Suffolk does not believe that the informal inquiry, when resolved, will have a material adverse effect on Suffolks results of operations or financial condition.
Page 27
Item 2 - MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
For the Three and Nine Month Periods ended September 30, 2011 and 2010
At Suffolk, net interest income decreased $2,342,000, or 12.1 percent compared to the third quarter of 2010. The decline in net interest income was driven by declines in both yields and balances of earning assets, and also by the temporary reinvestment of liquidity in low-yielding bank deposits, offset by an improvement in the Banks cost of deposits. See table on page 30. Interest income decreased $3,463,000, or 16.0 percent, and interest expense decreased $1,121,000, or 48.0 percent. The net interest margin decreased to 4.72 percent in the third quarter of 2011, down from 5.13 percent during the third quarter of 2010. The provision for loan losses decreased by 93.9 percent over the third quarter of 2010, from $14,729,000 to $900,000.
In August 2011, in consultation with the Audit Committee, Suffolks management determined it was not properly identifying loan losses in the period incurred. This was the result of deficiencies in Suffolks internal controls with respect to credit administration and credit risk management, primarily with regard to risk-rating as well as with respect to the timing and recognition of charge-offs, impaired loans, and classified loans. As a result, certain loans should have been considered impaired, charged-off, or classified. The effects of these errors were recorded in the consolidated financial statements as of and for the year ended December 31, 2010 and the quarter ended September 30, 2010. At September 30, 2011, of the $92,070,000 of non-performing loans, $74,153,000 was secured by collateral valued at approximately $122,516,000, having an average loan-to-value ratio of approximately 61 percent. The unsecured portion of $17,917,000 amounted to 177 basis points of net loans at quarter end. To determine the adequacy of the allowance for loan losses Suffolk considered the status of non-performing loans on its books. Although Suffolk continues to work with borrowers to ensure the collection of nonperforming credits, some of these loans were being paid more slowly than originally anticipated. Non-performing loans secured by commercial real estate totaled $45,687,000, or 49.6 percent of total non-performing loans. The allowance is established through a provision for loan losses based on managements evaluation of the risk inherent in the various components of the loan portfolio and other factors, including Suffolks own historical loan loss experience as well as Suffolks peer bank loss experiences.
Non-performing assets as a percent of total assets were 191 basis points at September 30, 2010; 216 basis points at December 31, 2010; 320 basis points at March 31, 2011; 383 basis points at June 30, 2011; and 616 basis points at September 30, 2011. Non-performing loans to total loans amounted to 283 basis points at September 30, 2010; 261 basis points at December 31, 2010; 440 basis points at March 31, 2011; 553 basis points at June 30, 2011; and 909 basis points at September 30, 2011. As non-performing loans, primarily non-accrual loans, remain non-accruing over a period of time, on the basis of objective and selective criteria, Suffolk may or may not elect to charge these and other loans off prudentially, even when they remain in collection and there is the reasonable remaining expectation of the recovery of amounts owed and expenses incurred in collection. These charge-offs may or may not mirror trends, on a trailing basis, in ratios of non-performing assets to total assets and non-performing loans to total loans. The amounts charged off may be substantial in comparison with Suffolks past loss history, although they may result in net recoveries at some point in the future if the economy improves and borrowers financial conditions strengthen, although there can be no assurance that this will happen. Further discussion concerning the determination of the provision for loan losses is found in the following under the caption, Allowance for Loan Losses.
Basic Performance and Current Activities
Return on average equity totalled 9.03 percent for the third quarter of 2011, on an annualized basis, and basic earnings-per-share increased from ($0.32) in the third quarter of 2010 to $0.32 in the third quarter of 2011.
Continuing managerial emphasis included:
| Maintaining emphasis on both commercial and personal demand deposits, and non-maturity time deposits as a key part of relationships with customers while responding as necessary to demand in Suffolks market for certificates of deposit of all sizes. Suffolk continues its emphasis on the profitability of the whole relationship of its customers with the Bank, seeking when possible to both make loans to and obtain funding from the best qualified customers. |
| Managing net loan charge-offs and non-performing loans. During the third quarter of 2011, net charge-offs amounted to 2.87 percent of average net loans, on an annualized basis. Non-performing loans, those more than 90 days past due, increased. Lending staffs first efforts continue to be directed to the management of such credits, and then to developing new business with an emphasis on the most profitable customer relationships. |
Page 28
| Managing the investment portfolio in a difficult rate environment, reducing balances of municipal securities to moderate concentration risk, and paying down advances from the Federal Home Loan Bank to reduce liabilities, and increase leverage capital ratios, which was accomplished during the third quarter of 2011. |
Net income was $3,072,000 for the third quarter of 2011, up 197.9 percent from ($3,137,000) posted during the same period last year. Basic earnings-per-share for the quarter was $0.32 versus earnings-per-share of ($0.32), an increase of 200.0 percent. The key reason for the increase was a decline in the provision for loan losses for the third quarter from $14,729,000 to $900,000 which drove a rise in net interest income after provision for loan losses from $4,638,000 to $16,125,000, an increase of 247.7 percent. Net loss for the nine months ended September 30, 2011 was ($1,232,000), primarily attributable to a decline of net interest income of $4,637,000, or 8.0 percent year over year. In addition, other expense increased $6,427,000, or 17.2 percent, due in large part to outside services, including consulting services, which more than doubled year over year, from $1,646,000 to $3,423,000. FDIC assessments increased $452,000, or 21.6 percent. In addition, a prepayment fee of $1,028,000 was charged by the Federal Home Loan Bank of NY for the early payoff of a term borrowing. Earnings (loss) per share went from $0.33 to ($0.13) for the nine months ended September 30, 2010 and September 30, 2011, respectively
Interest income was $18,239,000 for the third quarter of 2011, down 16.0 percent from $21,702,000 posted for the same quarter in 2010. Average net loans during the third quarter of 2011 totaled $1,035,628,000 compared to $1,123,851,000 for the same period of 2010. During the third quarter of 2011, the yield on a fully taxable-equivalent basis was 5.04 percent on average earning assets of $1,511,595,000, down from 5.72 percent on average earning assets of $1,590,211,000 during the third quarter of 2010. Interest income was $58,154,000 for the nine months ended September 30, 2011 compared to $65,468,000 for the nine months ended September 30, 2010. Average interest earning assets decreased $65,195,000, coupled with a drop in the average rate earned of 41 basis points, from 5.68 percent to 5.27 percent. Year over year, the average balance of interest bearing deposits with banks increased from $5,883,000 to $86,723,000, with an average rate for the nine months ended September 30, 2011 of 0.22 percent.
Interest expense for the third quarter of 2011 was $1,214,000, down 48.0 percent from $2,335,000 for the same period of 2010. During the third quarter of 2011, the cost of funds was 0.56 percent on average interest-bearing liabilities of $872,426,000, down from 0.94 percent on average interest-bearing liabilities of $991,869,000 during the third quarter of 2010. Interest-bearing deposit rates decreased quarter over quarter. Interest expense decreased $2,677,000 for the nine months ended September 30, 2011, due primarily to a lower cost of interest bearing deposits of 0.69 percent compared to 0.96 percent for the nine months ended September 30, 2010. Interest expense decreased from $6,187,000 to $4,179,000 for interest bearing deposits for the nine months ended September 30, 2011 as compared to the same period in 2010.
A portion of the Banks demand deposits are reclassified as savings accounts on a daily basis. The purpose of the reclassification is to reduce the non-interest-bearing reserve balances that the Bank is required to maintain with the Federal Reserve Bank, and thereby increase funds available for investment. Although these balances are classified as saving accounts for regulatory purposes, they are included in demand deposits in the accompanying consolidated statements of condition.
Net interest income, before the provision for loan losses, is the largest component of Suffolks earnings. It was $17,025,000 for the third quarter of 2011, down 12.1 percent from $19,367,000 during the same period of 2010. The net interest margin for the quarter, on a fully taxable-equivalent basis, was 4.72 percent compared to 5.13 percent for the same period of 2010. Net interest income decreased 8.0 percent, from $57,957,000 to $53,320,000 for the nine months ended September 30, 2011 as compared to the same period in 2010. The net interest margin on a fully taxable-equivalent basis decreased 21 basis points, from 5.06 percent for the nine months ended September 30, 2010 to 4.85 percent for the nine months ended September 30, 2011. The cost of interest-bearing funds decreased from 0.96 percent to 0.69 percent; however the average yield on interest-earning assets decreased from 5.68 percent to 5.27 percent, or 41 basis points.
Page 29
In June 2011, Suffolk sold approximately $40,000,000 of municipal investment securities resulting in a net gain of approximately $1,645,000. Suffolk prepaid a Federal Home Loan Bank fixed rate borrowing in the amount of $40,000,000. There was a prepayment fee of $1,028,000 charged to pay off this advance. These actions are part of the Banks strategy to increase the Banks capital ratios and to reduce risk in the municipal portfolio by selling lower-rated securities, as well as to eliminate a higher-cost source of funds.
The following table details the components of Suffolks net interest income for the quarter on a taxable-equivalent basis: (in thousands)
Quarters ended September 30, |
2011 | 2010 (restated) | ||||||||||||||||||||||
Average Balance |
Interest | Average Rate |
Average Balance |
Interest | Average Rate |
|||||||||||||||||||
INTEREST-EARNING ASSETS |
||||||||||||||||||||||||
U.S. Treasury securities |
$ | 1,313 | $ | 1 | 0.30 | % | $ | 8,231 | $ | 71 | 3.45 | % | ||||||||||||
Collateralized mortgage obligations |
141,585 | 1,404 | 3.97 | 179,152 | 1,879 | 4.20 | ||||||||||||||||||
Mortgage backed securities |
464 | 7 | 6.44 | 534 | 9 | 6.77 | ||||||||||||||||||
Obligations of states and political subdivisions |
178,497 | 2,347 | 5.26 | 226,280 | 3,007 | 5.32 | ||||||||||||||||||
U.S. government agency obligations |
5,316 | 44 | 3.30 | 42,670 | 202 | 1.90 | ||||||||||||||||||
Other securities |
2,538 | 59 | 9.30 | 4,966 | 95 | 7.65 | ||||||||||||||||||
Federal funds sold and interest bearing bank deposits |
146,254 | 79 | 0.21 | 4,527 | 3 | 0.27 | ||||||||||||||||||
Loans, net of allowance for loan losses |
||||||||||||||||||||||||
Commercial, financial & agricultural loans |
226,617 | 3,077 | 5.43 | 248,111 | 3,772 | 6.08 | ||||||||||||||||||
Commercial real estate mortgages |
435,533 | 6,727 | 6.18 | 406,115 | 6,716 | 6.61 | ||||||||||||||||||
Real estate construction loans |
65,722 | 994 | 6.05 | 112,634 | 1,706 | 6.06 | ||||||||||||||||||
Residential mortgages (1st and 2nd liens) |
170,346 | 2,548 | 5.98 | 198,383 | 3,037 | 6.12 | ||||||||||||||||||
Home equity loans |
81,283 | 777 | 3.82 | 85,446 | 923 | 4.32 | ||||||||||||||||||
Consumer loans |
55,553 | 977 | 7.03 | 72,244 | 1,310 | 7.25 | ||||||||||||||||||
Other loans (overdrafts) |
574 | | | 918 | | | ||||||||||||||||||
|
|
|
|
|
|
|
|
|
|
|
|
|||||||||||||
Total interest-earning assets |
$ | 1,511,595 | $ | 19,041 | 5.04 | % | $ | 1,590,211 | $ | 22,730 | 5.72 | % | ||||||||||||
|
|
|
|
|
|
|
|
|
|
|
|
|||||||||||||
Cash and due from banks |
$ | 36,533 | $ | 43,922 | ||||||||||||||||||||
Other non-interest-earning assets |
24,630 | 58,366 | ||||||||||||||||||||||
|
|
|
|
|||||||||||||||||||||
Total assets |
$ | 1,572,758 | $ | 1,692,499 | ||||||||||||||||||||
INTEREST-BEARING LIABILITIES |
||||||||||||||||||||||||
Saving, N.O.W. and money market deposits |
$ | 587,759 | $ | 435 | 0.30 | % | $ | 607,447 | $ | 827 | 0.54 | % | ||||||||||||
Time deposits |
284,378 | 778 | 1.09 | 328,868 | 1,145 | 1.39 | ||||||||||||||||||
|
|
|
|
|
|
|
|
|
|
|
|
|||||||||||||
Total saving and time deposits |
872,137 | 1,213 | 0.56 | 936,315 | 1,972 | 0.84 | ||||||||||||||||||
Federal funds purchased and securities sold under agreement to repurchase |
233 | | | 344 | | | ||||||||||||||||||
Other borrowings |
56 | 1 | 0.35 | 55,210 | 363 | 2.63 | ||||||||||||||||||
|
|
|
|
|
|
|
|
|
|
|
|
|||||||||||||
Total interest-bearing liabilities |
$ | 872,426 | $ | 1,214 | 0.56 | % | $ | 991,869 | $ | 2,335 | 0.94 | % | ||||||||||||
|
|
|
|
|
|
|
|
|
|
|
|
|||||||||||||
Rate spread |
4.48 | % | 4.78 | % | ||||||||||||||||||||
Non-interest-bearing deposits |
$ | 530,217 | $ | 523,685 | ||||||||||||||||||||
Other non-interest-bearing liabilities |
34,091 | 31,029 | ||||||||||||||||||||||
|
|
|
|
|||||||||||||||||||||
Total liabilities |
$ | 1,436,734 | $ | 1,546,583 | ||||||||||||||||||||
Stockholders equity |
136,024 | 145,916 | ||||||||||||||||||||||
|
|
|
|
|||||||||||||||||||||
Total liabilities and stockholders equity |
$ | 1,572,758 | $ | 1,692,499 | ||||||||||||||||||||
Net-interest income (taxable-equivalent basis) and effective interest rate differential |
$ | 17,827 | 4.72 | % | $ | 20,395 | 5.13 | % | ||||||||||||||||
Less: taxable-equivalent basis adjustment |
(802 | ) | (1,028 | ) | ||||||||||||||||||||
|
|
|
|
|||||||||||||||||||||
Net-interest income |
$ | 17,025 | $ | 19,367 | ||||||||||||||||||||
|
|
|
|
Page 30
The following table details the components of Suffolks net interest income for the year to date on a taxable-equivalent basis: (in thousands)
Year to date ended September 30, |
2011 | 2010 (restated) | ||||||||||||||||||||||
Average Balance |
Interest | Average Rate |
Average Balance |
Interest | Average Rate |
|||||||||||||||||||
INTEREST-EARNING ASSETS |
||||||||||||||||||||||||
U.S. Treasury securities |
$ | 7,398 | $ | 98 | 1.76 | % | $ | 8,271 | $ | 213 | 3.43 | % | ||||||||||||
Collateralized mortgage obligations |
149,898 | 4,535 | 4.03 | 185,323 | 5,929 | 4.27 | ||||||||||||||||||
Mortgage backed securities |
479 | 23 | 6.42 | 571 | 28 | 6.60 | ||||||||||||||||||
Obligations of states and political subdivisions |
201,887 | 8,104 | 5.35 | 217,706 | 8,840 | 5.41 | ||||||||||||||||||
U.S. government agency obligations |
15,753 | 337 | 2.86 | 42,953 | 607 | 1.89 | ||||||||||||||||||
Other securities |
3,707 | 203 | 7.32 | 7,376 | 320 | 5.79 | ||||||||||||||||||
Federal funds sold and interest bearing bank deposits |
86,723 | 140 | 0.22 | 5,883 | 8 | 0.18 | ||||||||||||||||||
Loans, net of allowance for loan losses |
||||||||||||||||||||||||
Commercial, financial & agricultural loans |
246,009 | 10,300 | 5.58 | 258,371 | 11,460 | 5.91 | ||||||||||||||||||
Commercial real estate mortgages |
437,311 | 20,552 | 6.27 | 394,155 | 19,531 | 6.61 | ||||||||||||||||||
Real estate construction loans |
74,270 | 3,143 | 5.64 | 121,034 | 5,570 | 6.14 | ||||||||||||||||||
Residential mortgages (1st and 2nd liens) |
176,721 | 7,979 | 6.02 | 203,507 | 9,261 | 6.07 | ||||||||||||||||||
Home equity loans |
82,298 | 2,425 | 3.93 | 84,117 | 2,656 | 4.21 | ||||||||||||||||||
Consumer loans |
59,422 | 3,089 | 6.93 | 76,418 | 4,067 | 7.10 | ||||||||||||||||||
Other loans (overdrafts) |
426 | | | 1,812 | | | ||||||||||||||||||
|
|
|
|
|
|
|
|
|
|
|
|
|||||||||||||
Total interest-earning assets |
$ | 1,542,302 | $ | 60,928 | 5.27 | % | $ | 1,607,497 | $ | 68,490 | 5.68 | % | ||||||||||||
|
|
|
|
|
|
|
|
|
|
|
|
|||||||||||||
Cash and due from banks |
$ | 36,574 | $ | 43,512 | ||||||||||||||||||||
Other non-interest-earning assets |
30,631 | 61,554 | ||||||||||||||||||||||
|
|
|
|
|||||||||||||||||||||
Total assets |
$ | 1,609,507 | $ | 1,712,563 | ||||||||||||||||||||
INTEREST-BEARING LIABILITIES |
||||||||||||||||||||||||
Saving, N.O.W. and money market deposits |
$ | 608,396 | $ | 1,618 | 0.35 | % | $ | 602,044 | $ | 2,551 | 0.56 | % | ||||||||||||
Time deposits |
292,843 | 2,561 | 1.17 | 329,926 | 3,636 | 1.47 | ||||||||||||||||||
|
|
|
|
|
|
|
|
|
|
|
|
|||||||||||||
Total saving and time deposits |
901,239 | 4,179 | 0.62 | 931,970 | 6,187 | 0.89 | ||||||||||||||||||
Federal funds purchased and securities sold under agreement to repurchase |
171 | 1 | 0.49 | 561 | 2 | 0.48 | ||||||||||||||||||
Other borrowings |
26,930 | 654 | 3.24 | 109,884 | 1,322 | 1.60 | ||||||||||||||||||
|
|
|
|
|
|
|
|
|
|
|
|
|||||||||||||
Total interest-bearing liabilities |
$ | 928,340 | $ | 4,834 | 0.69 | % | $ | 1,042,415 | $ | 7,511 | 0.96 | % | ||||||||||||
|
|
|
|
|
|
|
|
|
|
|
|
|||||||||||||
Rate spread |
4.58 | % | 4.72 | % | ||||||||||||||||||||
Non-interest-bearing deposits |
$ | 513,418 | $ | 494,627 | ||||||||||||||||||||
Other non-interest-bearing liabilities |
32,790 | 34,483 | ||||||||||||||||||||||
|
|
|
|
|||||||||||||||||||||
Total liabilities |
$ | 1,474,548 | $ | 1,571,525 | ||||||||||||||||||||
Stockholders equity |
134,959 | 141,038 | ||||||||||||||||||||||
|
|
|
|
|||||||||||||||||||||
Total liabilities and stockholders equity |
$ | 1,609,507 | $ | 1,712,563 | ||||||||||||||||||||
Net-interest income (taxable-equivalent basis) and effective interest rate differential |
$ | 56,094 | 4.85 | % | $ | 60,979 | 5.06 | % | ||||||||||||||||
Less: taxable-equivalent basis adjustment |
(2,774 | ) | (3,022 | ) | ||||||||||||||||||||
|
|
|
|
|||||||||||||||||||||
Net-interest income |
$ | 53,320 | $ | 57,957 | ||||||||||||||||||||
|
|
|
|
Page 31
The table below presents a summary of changes in interest income, interest expense, and the resulting net interest income on a taxable-equivalent basis for the quarterly periods presented. Because of numerous, simultaneous changes in volume and rate during the period, it is not possible to allocate precisely the changes between volumes and rates. In the following table changes not due solely to volume or to rate have been allocated to these categories based on percentage changes in average volume and average rate as they compare to each other: (in thousands)
In Third Quarter of 2011 over Third Quarter of 2010, Changes Due to |
||||||||||||
Volume | Rate | Net Change | ||||||||||
Interest-earning assets |
||||||||||||
U.S. Treasury securities |
$ | (34 | ) | $ | (36 | ) | $ | (70 | ) | |||
Collateralized mortgage obligations |
(377 | ) | (98 | ) | (475 | ) | ||||||
Mortgage-backed securities |
(2 | ) | | (2 | ) | |||||||
Obligations of states & political subdivisions |
(630 | ) | (30 | ) | (660 | ) | ||||||
U.S. government agency obligations |
(248 | ) | 90 | (158 | ) | |||||||
Other securities |
(53 | ) | 17 | (36 | ) | |||||||
Federal funds sold & interest bearing bank deposits |
77 | (1 | ) | 76 | ||||||||
Loans, including non-accrual loans |
(1,323 | ) | (1,041 | ) | (2,364 | ) | ||||||
|
|
|
|
|
|
|||||||
Total interest-earning assets |
$ | (2,590 | ) | $ | (1,099 | ) | $ | (3,689 | ) | |||
|
|
|
|
|
|
|||||||
Interest-bearing liabilities |
||||||||||||
Saving, N.O.W., & money market deposits |
$ | (26 | ) | $ | (366 | ) | $ | (392 | ) | |||
Time deposits |
(142 | ) | (225 | ) | (367 | ) | ||||||
Other borrowings |
(194 | ) | (168 | ) | (362 | ) | ||||||
|
|
|
|
|
|
|||||||
Total interest-bearing liabilities |
$ | (362 | ) | $ | (759 | ) | $ | (1,121 | ) | |||
|
|
|
|
|
|
|||||||
Net change in net interest income (taxable-equivalent basis) |
$ | (2,228 | ) | $ | (340 | ) | $ | (2,568 | ) | |||
|
|
|
|
|
|
The table below presents a summary of changes in interest income, interest expense, and the resulting net interest income on a taxable-equivalent basis for the years-to-date presented. Because of numerous, simultaneous changes in volume and rate during the period, it is not possible to allocate precisely the changes between volumes and rates. In the following table changes not due solely to volume or to rate have been allocated to these categories based on percentage changes in average volume and average rate as they compare to each other: (in thousands)
In First Nine Months of 2011 over First Nine Months of 2010, Changes Due to |
||||||||||||
Volume | Rate | Net Change | ||||||||||
Interest-earning assets |
||||||||||||
U.S. Treasury securities |
$ | (21 | ) | $ | (94 | ) | $ | (115 | ) | |||
Collateralized mortgage obligations |
(1,085 | ) | (309 | ) | (1,394 | ) | ||||||
Mortgage-backed securities |
(4 | ) | (1 | ) | (5 | ) | ||||||
Obligations of states & political subdivisions |
(662 | ) | (74 | ) | (736 | ) | ||||||
U.S. government agency obligations |
(494 | ) | 224 | (270 | ) | |||||||
Other securities |
(187 | ) | 70 | (117 | ) | |||||||
Federal funds sold & interest bearing bank deposits |
130 | 2 | 132 | |||||||||
Loans, including non-accrual loans |
(2,832 | ) | (2,225 | ) | (5,057 | ) | ||||||
|
|
|
|
|
|
|||||||
Total interest-earning assets |
$ | (5,155 | ) | $ | (2,407 | ) | $ | (7,562 | ) | |||
|
|
|
|
|
|
|||||||
Interest-bearing liabilities |
||||||||||||
Saving, N.O.W., & money market deposits |
$ | 27 | $ | (960 | ) | $ | (933 | ) | ||||
Time deposits |
(379 | ) | (696 | ) | (1,075 | ) | ||||||
Other borrowings |
(1,431 | ) | 762 | (669 | ) | |||||||
|
|
|
|
|
|
|||||||
Total interest-bearing liabilities |
$ | (1,783 | ) | $ | (894 | ) | $ | (2,677 | ) | |||
|
|
|
|
|
|
|||||||
Net change in net interest income (taxable-equivalent basis) |
$ | (3,372 | ) | $ | (1,513 | ) | $ | (4,885 | ) | |||
|
|
|
|
|
|
Other income decreased to $2,390,000 for the quarter compared to $2,667,000 the previous year, down 10.4 percent. Service charges on deposits were down 21.6 percent. Service charges, including commissions and fees other than for deposits, were virtually unchanged. Fiduciary fees were down 12.3 percent and other operating income increased by 16.8 percent. Other income increased $917,000 for the nine months ended September 30, 2011 compared to the nine months ended September 30, 2010 up 11.8 percent. This increase is primarily due to a net gain on sale of securities of $1,645,000 in the second quarter of 2011. Offsetting this increase was a decrease in service charges on deposit accounts of $781,000, or 20.9 percent.
Page 32
Other expense for the third quarter of 2011 was $14,927,000, up 14.6 percent from $13,021,000 for the comparable period in 2010. Other increases include employee compensation of 9.2 percent, net occupancy expense of 7.4 percent, and other operating expense of 26.1 percent. Equipment expense decreased by 1.0 percent and FDIC assessments decreased by $307,000 or 35.6 percent. Other expense increased $6,427,000, or 17.2 percent, for the nine months ended September 30, 2011 compared to the nine months ended September 30, 2010. Salaries and employee benefits was up $1,776,000, or 8.2 percent, occupancy expense was up $361,000, or 9.0 percent, outside services, including consulting expenses, increased $1,777,000, or 108.0 percent, FDIC assessments increased $452,000, or 21.6 percent, and other operating expenses were up $865,000, or 13.8 percent.
Stockholders equity totaled $140,204,000 on September 30, 2011, an increase of 2.47 percent from $136,820,000 on December 31, 2010. This was the result of an increase in the market value of securities available for sale which was partially offset by a net loss. The ratio of equity to assets was 9.21 percent at September 30, 2011 and 8.51 percent at December 31, 2010, respectively.
The following table details amounts and ratios of Suffolks regulatory capital: (in thousands of dollars except ratios)
Actual | For capital adequacy |
To be well capitalized under prompt corrective |
||||||||||||||||||||||
Amount | Ratio | Amount | Ratio | Amount | Ratio | |||||||||||||||||||
As of September 30, 2011 |
||||||||||||||||||||||||
Total Capital (to risk-weighted assets) |
$ | 148,097 | 13.88 | % | $ | 85,344 | 8.00 | % | $ | 106,680 | 10.00 | % | ||||||||||||
Tier 1 Capital (to risk-weighted assets) |
134,382 | 12.60 | % | 42,672 | 4.00 | % | 64,008 | 6.00 | % | |||||||||||||||
Tier 1 Capital (to average assets) |
134,382 | 8.57 | % | 62,747 | 4.00 | % | 78,433 | 5.00 | % | |||||||||||||||
As of December 31, 2010 (restated) |
||||||||||||||||||||||||
Total Capital (to risk-weighted assets) |
$ | 153,442 | 12.62 | % | $ | 97,276 | 8.00 | % | $ | 121,595 | 10.00 | % | ||||||||||||
Tier 1 Capital (to risk-weighted assets) |
138,075 | 11.36 | % | 48,638 | 4.00 | % | 72,957 | 6.00 | % | |||||||||||||||
Tier 1 Capital (to average assets) |
138,075 | 8.26 | % | 66,848 | 4.00 | % | 83,560 | 5.00 | % |
The Bank is subject to individual minimum capital ratios (IMCRs) established by the OCC requiring Tier 1 Leverage Capital equal to at least 8.00 percent of adjusted total assets; Tier 1 Risk-based Capital equal to at least 10.50 percent of risk-weighted assets; and Total Risk Based Capital equal to at least 12.00 percent of risk-weighted assets. At September 30, 2011, management believes the Bank met all of the IMCRs: Tier 1 Leverage Capital was 8.50 percent of adjusted total assets; Tier 1 Capital was 12.53 percent of risk-weighted assets; and Total Risk Based Capital was 13.82 percent of risk-weighted assets.
Suffolk makes loans based on its evaluation of the creditworthiness of the borrower. Even with careful underwriting, some loans may not be repaid as originally agreed. To provide for this possibility, Suffolk maintains an allowance for loan losses based on an analysis of the performance of the loans in its portfolio. The analysis includes subjective factors based on managements judgment as well as quantitative evaluation. Estimates should produce an allowance that will provide for a range of losses. According to U.S. GAAP, a financial institution should record its best estimate. Appropriate factors contributing to the estimate may include changes in the composition of the institutions assets, or potential economic slowdowns or downturns. Also important is the geographical or political environment in which the institution operates.
Suffolks management considers all of these factors when determining the provision for loan losses. As required by the Agreement with the OCC, Suffolk is in the process of establishing a program to improve credit risk management and implementing an asset diversification program. Please refer to the discussion of the allowance for loan losses below.
Suffolk has financial and performance letters of credit. Financial letters of credit require Suffolk to make payments if the customers financial condition deteriorates, as defined in the agreements. Performance letters of credit require Suffolk to make payments if the customer fails to perform certain non-financial contractual obligations. The maximum potential undiscounted amount of future payments of these letters of credit as of September 30, 2011 is $19,791,000 and they expire as follows: (in thousands)
2011 |
$ | 14,438 | ||
2012 |
4,883 | |||
2013 |
44 | |||
2014 |
| |||
Thereafter |
426 | |||
|
|
|||
$ | 19,791 | |||
|
|
Page 33
Amounts due under these letters of credit would be reduced by any proceeds that Suffolk would be able to obtain in liquidating the collateral for the loans, which varies depending on the customer. The allowance for contingent liabilities includes a provision of $179,000 for losses based on the letters of credit outstanding as of September 30, 2011.
Critical Accounting Policies, Judgments and Estimates
Suffolks accounting and reporting policies conform to U.S. GAAP and general practices within the financial services industry. The preparation of the financial statements in conformity with U.S. GAAP requires management to make estimates and assumptions that affect the amounts reported in the financial statements and the accompanying notes. Actual results could differ from those estimates
In August 2011, in consultation with the Audit Committee, Suffolks management determined it was not properly identifying loan losses in the period incurred. This was the result of deficiencies in Suffolks internal controls with respect to credit administration and credit risk management, primarily with regard to risk-rating as well as with respect to the timing and recognition of charge-offs, impaired loans, and classified loans. As a result, certain loans should have been considered impaired, charged-off, or classified. The effect of these errors was recorded in the consolidated financial statements as of and for the year ended December 31, 2010 and the quarter ended September 30, 2010.
Suffolk takes into account applicable guidance under U.S. GAAP, including particularly ASC 855 - Subsequent Events. Under this statement, subsequent events are defined as events or transactions that occur after the balance sheet date but before financial statements are issued or are available to be issued. This statement requires that entities recognize in the financial statements the effects of all subsequent events that provide additional evidence about conditions that existed as of the balance sheet date, including any estimates underlying the financial statements. The entity should not recognize subsequent events that provide evidence about conditions that arose after the balance sheet date, but should disclose those events which are so important that nondisclosure would make the financial statements misleading.
Suffolk considers the determination of the allowance for loan losses to involve a higher degree of judgment and complexity than its other significant accounting policies. The allowance for loan losses (ALLL) is determined by continuous analysis of the loan portfolio. That analysis includes changes in the size and composition of the portfolio, historical loan losses, industry-wide losses, current and anticipated economic trends, and details about individual loans. It also includes estimates of the actual value of collateral and other possible sources of repayment. Suffolk maintains an ALLL at a level management believes will be adequate to absorb probable losses on existing loans that may become uncollectible, based on an evaluation of their collectibility. However, the determination of the allowance is inherently subjective, as it requires estimates, all of which may be subject to significant change. This happens when it is well past due and the borrower has not shown the ability or intent to make the loan current, or the borrower does not have enough assets to pay the debt, or the value of the collateral is less than the balance of the loan and not likely to improve soon. Residential real estate and consumer loans are analyzed as a group and not individually because of the large number of loans, small balances, and historically low losses. In the future, the provision for loan losses may change as a percentage of total loans. The percentage of net charge-offs to average net loans during the three months ended September 30, 2011 was 2.87 percent compared to 3.18 percent in 2010 and 0.05 percent in 2009 for the respective three month periods ended September 30th. The ratio of the allowance for loan losses to loans, net of discounts, was 4.31 percent at September 30, 2011, compared to 2.56 percent at the end of 2010, and 1.06 percent at the end of 2009.
Page 34
A summary of transactions follows: (in thousands)
Period Ended: |
Nine Months Ended September 30, 2011 |
Year Ended December 31, 2010 Restated |
||||||
Allowance for loan losses, January 1, |
$ | 28,419 | $ | 12,333 | ||||
Loans charged-off: |
||||||||
Commercial, financial & agricultural loans |
6,537 | 8,501 | ||||||
Commercial real estate mortgages |
1,832 | 2,788 | ||||||
Real estate construction loans |
232 | 3,548 | ||||||
Residential mortgages (1st and 2nd liens) |
411 | 769 | ||||||
Home equity loans |
191 | 315 | ||||||
Consumer loans |
178 | 317 | ||||||
Other loans |
| | ||||||
|
|
|
|
|||||
Total Charge-offs |
$ | 9,381 | $ | 16,238 | ||||
|
|
|
|
|||||
Loans recovered after being charged-off |
Nine Months Ended September 30, 2011 |
Year Ended December 31, 2010 Restated |
||||||
Commercial, financial & agricultural loans |
551 | 69 | ||||||
Commercial real estate mortgages |
| | ||||||
Real estate construction loans |
| | ||||||
Residential mortgages (1st and 2nd liens) |
1 | | ||||||
Home equity loans |
| | ||||||
Consumer loans |
65 | 118 | ||||||
Other loans |
| | ||||||
|
|
|
|
|||||
Total recoveries |
$ | 617 | $ | 187 | ||||
|
|
|
|
|||||
Net loans charged-off |
8,764 | 16,051 | ||||||
Reclass (to) from allowance for contingent liabilities |
(50 | ) | 51 | |||||
Provision for loan losses |
24,088 | 32,086 | ||||||
|
|
|
|
|||||
Allowance for loan losses, Ending Balance |
$ | 43,693 | $ | 28,419 | ||||
|
|
|
|
Suffolks underwriting standards generally require a loan-to-value ratio of 75 percent or less, and when applicable, a debt coverage ratio of at least 120 percent, at the time a loan is originated. Suffolk has not been directly affected by the increase in defaults of sub-prime mortgages as Suffolk does not originate, or hold in portfolio, sub-prime mortgages. The allowance for loan loss analysis includes changes in the size and composition of the portfolio, Suffolks own historical loan losses, current and anticipated economic trends, and details about individual loans. It also includes estimates of the actual value of collateral, other possible sources of repayment and estimates that are susceptible to significant changes due to changes in appraisal values of collateral, national and regional economic conditions, and other factors. The analysis also considers the loan loss history of Suffolks peers with similar characteristics. In assessing the adequacy of the allowance, Suffolk reviews its loan portfolio by separate categories which have similar risk and collateral characteristics; e.g. commercial loans, commercial real estate, construction loans, residential mortgages, home equity loans, and consumer loans. Management conducts a monthly analysis of the loan portfolio which evaluates any loan designated as having a high risk profile including but not limited to, loans classified as Substandard or Doubtful as defined by regulation, loans criticized internally or designated as Special Mention, delinquencies, expirations, overdrafts, loans to customers having experienced recent operating losses and loans identified by management as impaired. The analysis is performed to determine the amount of the allowance which would be adequate to absorb probable losses contained in the loan portfolio. The analytical process is regularly reviewed and adjustments may be made based on the assessments of internal and external influences on credit quality. See Note (6), Allowance for Loan Losses, to the notes to the unaudited financial statements.
Page 35
The following tables summarize the allowance for loan losses by category for the periods presented: (in thousands)
Impaired Allocation September 30, 2011 |
Remaining Allocation September 30, 2011 |
Total Allocation September 30, 2011 |
% of Total | |||||||||||||
Commercial, financial & agricultural loans |
$ | 6,249 | $ | 17,497 | $ | 23,746 | 54.3 | % | ||||||||
Commercial real estate mortgages |
4,654 | 9,056 | 13,710 | 31.5 | % | |||||||||||
Real estate construction loans |
1,695 | 325 | 2,020 | 4.6 | % | |||||||||||
Residential mortgages (1st and 2nd liens) |
| 2,097 | 2,097 | 4.8 | % | |||||||||||
Home equity loans |
| 1,718 | 1,718 | 3.9 | % | |||||||||||
Consumer loans |
| 402 | 402 | 0.9 | % | |||||||||||
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Allowance for loan losses |
$ | 12,598 | $ | 31,095 | $ | 43,693 | 100 | % | ||||||||
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Impaired Allocation December 31, 2010 Restated |
Remaining Allocation December 31, 2010 Restated |
Total Allocation December 31, 2010 Restated |
% of Total | |||||||||||||
Commercial, financial & agricultural loans |
$ | 2,845 | $ | 10,981 | $ | 13,826 | 48.6 | % | ||||||||
Commercial real estate mortgages |
5,636 | 3,590 | 9,226 | 32.5 | % | |||||||||||
Real estate construction loans |
935 | 2,242 | 3,177 | 11.2 | % | |||||||||||
Residential mortgages (1st and 2nd liens) |
| 519 | 519 | 1.8 | % | |||||||||||
Home equity loans |
| 1,392 | 1,392 | 4.9 | % | |||||||||||
Consumer loans |
| 279 | 279 | 1.0 | % | |||||||||||
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Allowance for loan losses |
$ | 9,416 | $ | 19,003 | $ | 28,419 | 100 | % | ||||||||
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Suffolk believes the allowance is adequate to absorb inherent and known losses in the loan portfolio; however, the determination of the allowance is inherently subjective, as it requires estimates, all of which may be subject to significant changes. When a loan, in full or in part, is deemed uncollectible, it is charged against the allowance. This happens when it is past due and the borrower has not shown the ability or intent to make the loan current, or the borrower does not have enough assets to pay the debt, or the value of the collateral is less than the balance of the loan and not likely to improve soon. In the future, the allowance for loan losses may change as a percentage of total loans. To the extent actual performance differs from managements estimates, additional provisions for loan losses may be required that would reduce or may substantially reduce earnings in future periods, and no assurances can be given that Suffolk will not sustain loan losses, in any particular period, that are sizable in relation to the allowance for loan losses.
Additional analysis of charged-off loans for the quarter ended September 30, 2011 is provided below: (in thousands)
September 30, 2011 | ||||||||||||||||
Non-performing Loans |
Impaired Loans | Restructured Loans |
Total | |||||||||||||
Commercial, financial & agricultural loans |
$ | 2,468 | $ | 509 | $ | 2,112 | $ | 5,089 | ||||||||
Commercial real estate mortgages |
1,242 | | 590 | 1,832 | ||||||||||||
Real estate construction loans |
232 | | | 232 | ||||||||||||
Residential mortgages (1st and 2nd liens) |
| | | | ||||||||||||
Home equity loans |
121 | | | 121 | ||||||||||||
Consumer loans |
34 | | | 34 | ||||||||||||
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Total Charge-offs (1) |
$ | 4,097 | $ | 509 | $ | 2,702 | $ | 7,308 | ||||||||
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(1) | Does not include $159 of loans charged-off that were neither non-performing or imparied at time of charge-off. |
Net charge-offs for the nine months ended September 30, 2011 were $8,764,000 compared to $12,271,000 of net charge-offs for the nine months ended September 30, 2010. The decreased net charge-offs are primarily attributable to charge-offs of $3,620,000 of real estate construction loans during the first nine months of 2010 compared to $232,000 during the first nine months of 2011.
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The following table presents information concerning loan balances and asset quality: (dollars in thousands)
Nine Months Ended September 30, 2011 |
Twelve Months Ended December 31, 2010 Restated |
|||||||
Loans, net of discounts: |
||||||||
Average |
$ | 1,076,457 | $ | 1,129,917 | ||||
At end of period |
1,012,888 | 1,112,279 | ||||||
Non-performing loans/total loans, net of discounts |
9.09 | % | 2.61 | % | ||||
Non-performing assets/total assets (1) |
6.16 | 2.16 | ||||||
Net charge-offs (recoveries)/average net loans |
1.09 | 1.42 | ||||||
Net charge-offs (recoveries)/net loans |
1.15 | 1.44 | ||||||
Allowance for loan losses/loans, net of discounts |
4.31 | 2.56 |
(1) | Non-performing assets include non-performing loans and other real estate owned (OREO), ratios annualized where appropriate. |
Generally, recognition of interest income is discontinued when reasonable doubt exists as to whether interest can be collected. Ordinarily, loans no longer accrue interest when 90 days past due. When a loan stops accruing interest, all interest accrued in the current year, but not collected, is reversed against interest income in the current year. Loans start accruing interest again when they become current as to principal and interest, and when, in the opinion of management, they can be collected in full.
The following table shows non-accrual, past due, and restructured loans past due, collectively non-accrual loans, at September 30, 2011 and December 31, 2010: (in thousands)
September 30, 2011 |
December 31, 2010 Restated |
|||||||
Loans accruing but past due contractually |
$ | | $ | | ||||
Loans not accruing interest |
92,070 | 28,991 | ||||||
Restructured loans past due |
| 493 | ||||||
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Total |
$ | 92,070 | $ | 29,484 | ||||
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Interest on loans that are no longer accruing interest would have amounted to about $1,571,000 and $3,335,000, respectively, for the three and nine months ended September 30, 2011 under the contractual terms of those loans. Suffolk records the payment of interest on such loans as a reduction of principal. Suffolk has a formal procedure for internal credit review to more precisely identify risk and exposure in the loan portfolio.
Impaired loans are segregated and reviewed separately. Impaired loans secured by collateral are reviewed based on their collateral and the estimated time required to recover Suffolks investment in the loan as well as the cost of doing so, and the estimate of the recovery anticipated. Reserves are allocated to impaired loans based on this review. The allocated reserve is an estimation of losses specific to individual impaired loans. Allocated reserves are established based on an analysis of the most probable sources of repayment and liquidation of collateral. Reserves allocated to impaired loans were $12.6 million and $9.4 million as of September 30, 2011 and December 31, 2010, respectively. While every non-performing loan is evaluated individually, not every loan requires an allocated reserve. Allocated reserves fluctuate based on changes in the underlying loans, anticipated sources of repayment, and charge-offs.
See also summary of impaired loans in Note (6), Allowance for Loan Losses in the financial statements.
Impairment reserves were assigned to approximately $45,698,000 or 34 percent of our impaired loans as of September 30, 2011 with the assistance of a third-party appraisal. As of December 31, 2010, impairment reserves were assigned to approximately $49,097,000 or 49 percent of our impaired loans. Collateral-dependent loans are evaluated for impairment when a loan becomes 90 days past due or another impairment indicator is identified. At the time a loan is evaluated for impairment, an appraisal is ordered from an independent third-party licensed appraiser for loans in excess of $250,000. Typically, it takes approximately 30-90 days to receive and review the appraisal on a commercial real estate mortgage. To
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date, Suffolk has not experienced any significant delays between ordering appraisals and recognizing charge-offs. While waiting for an updated appraisal, we continue to contact the borrower to arrange a payment plan and monitor for any payment. Since the majority of the collateral securing impaired loans are within our local market, an officer of the Bank may drive by to make an initial assessment of the propertys condition.
At September 30, 2011 and December 31, 2010, impaired loans totaling $87,643,000 and $51,144,000, respectively, require no associated valuation allowance. For these loans, an evaluation for impairment was completed but, due the banks collateral position, no valuation allowance was required. The required allowance is calculated based upon the appraisal methodology described above for collateral-dependent loans. For non-collateral-dependent loans, the allowance is based on the present value of future cash flows. As measuring impairment is an estimate which requires judgment, future results of operations may be negatively affected by outcomes different from those estimated.
Suffolk evaluates classified and criticized loans that are not impaired by categorizing loans by type of risk and applying reserves based on loan type and corresponding risk. Suffolk also records reserves on Suffolks non-criticized and non-classified loan balances. This represents a general allowance for homogeneous loan pools where the loans are not individually evaluated for impairment, though rated according to loan product type and risk rating.
The following table summarizes Suffolks non-performing loans by category: (in thousands of dollars except for ratios)
Non-performing Loans | ||||||||||||||||||||||||||||||||
9/30/2011 | % of Total |
Total Loans 9/30/2011 |
% of Total Loans |
12/31/2010 Restated |
% of Total |
Total Loans 12/31/2010 |
% of Total Loans |
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Commercial, financial & agricultural |
$ | 17,197 | 18.7 | % | $ | 213,569 | 8.05 | % | $ | 2,382 | 8.2 | % | $ | 248,750 | 0.96 | % | ||||||||||||||||
Commercial real estate |
45,687 | 49.6 | % | 433,057 | 10.55 | % | 11,601 | 40.0 | % | 431,179 | 2.69 | % | ||||||||||||||||||||
Real estate construction loans |
17,976 | 19.5 | % | 62,023 | 28.98 | % | 10,481 | 36.2 | % | 82,720 | 12.67 | % | ||||||||||||||||||||
Residential mortgages (1st & 2nd liens) |
6,578 | 7.1 | % | 171,515 | 4.61 | % | 3,466 | 12.0 | % | 195,993 | 1.77 | % | ||||||||||||||||||||
Home equity loans |
3,912 | 4.3 | % | 80,704 | 4.85 | % | 986 | 3.4 | % | 84,696 | 1.16 | % | ||||||||||||||||||||
Consumer loans |
720 | 0.8 | % | 51,516 | 1.40 | % | 75 | 0.3 | % | 67,814 | 0.11 | % | ||||||||||||||||||||
Other loans |
| 0.0 | % | 504 | 0.00 | % | | 0.0 | % | 1,127 | 0.00 | % | ||||||||||||||||||||
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Total non-performing loans |
$ | 92,070 | 100 | % | $ | 1,012,888 | 9.09 | % | $ | 28,991 | 100 | % | $ | 1,112,279 | 2.61 | % | ||||||||||||||||
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The following table details the collateral value securing non-performing loans: (in thousands)
September 30, 2011 | December 31,
2010 Restated |
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Non-performing Loans Principal Balance |
Collateral Value | Non-performing Loans Principal Balance |
Collateral Value | |||||||||||||
Commercial, financial & agricultural loans |
$ | 17,197 | $ | | $ | 2,382 | $ | | ||||||||
Commercial real estate mortgages |
45,687 | 64,670 | 11,601 | 16,002 | ||||||||||||
Real estate construction loans |
17,976 | 32,900 | 10,481 | 14,455 | ||||||||||||
Residential mortgages (1st and 2nd liens) |
6,578 | 14,030 | 3,466 | 10,023 | ||||||||||||
Home equity loans |
3,912 | 10,916 | 986 | 4,384 | ||||||||||||
Consumer loans |
720 | | 75 | | ||||||||||||
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Total |
$ | 92,070 | $ | 122,516 | $ | 28,991 | $ | 44,864 | ||||||||
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During the nine months ended September 30, 2011 and 2010, interest income totaling $3,681,000 and $2,556,000, respectively, was recognized on impaired loans. Cash basis interest income recognized on those loans during that period was immaterial.
Restructured loans totaled $29,360,000 at September 30, 2011 and $24,044,000 at December 31, 2010 are considered impaired loans. Included in non-performing loans are restructured loans of $27,855,000 at September 30, 2011 that are no longer accruing interest. Subsequent to restructure, there has been $853,000 in advances funded on non-performing restructured loans outstanding as of September 30, 2011.
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The loans that have been restructured have been modified as to interest rate, due dates, or extension of the maturity date. Restructured loans are considered to be non-accrual loans, if at the time of restructuring the loan was deemed non-accrual. Once a sufficient amount of time has passed, generally nine months, if the restructured loan has performed under the modified terms, the loan is returned to accrual status. In addition to the passage of time, we also consider the collateral value and the ability of the borrower to continue to make payments in accordance with the modified terms. During the nine months ended September 30, 2011, there were no restructured loans returned to accrual status.
As of both September 30, 2011 and December 31, 2010, we have not performed any commercial real estate (CRE) or other type of loan workouts whereby an existing loan was restructured into multiple new loans.
The total balance of OREO, which is recorded at fair value, less estimated selling costs, was $1,800,000 at September 30, 2011.
As of September 30, 2011, classified loans amounted to 21.7 percent of total loans, as compared with 15.6 percent at December 31, 2010. The increase is attributable to the prolonged national and regional economic slowdown, along with a more objective review of the portfolio noted elsewhere in this filing.
Real estate construction loans amounted to $62,023,000 as of September 30, 2011. Non-performing real estate construction loans totaled $17,976,000, which is 28.9 percent of the real estate construction portfolio.
The following table presents information regarding real estate construction loans: (in thousands)
Non-performing Real Estate Construction Loans | ||||||||||||||||||||||||||||||||
September 30, 2011 | December 31,
2010 Restated |
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Balance Outstanding |
Non- performing Balance |
Impaired Balance |
Allowance Allocation |
Balance Outstanding |
Non- performing Balance |
Impaired Balance |
Allowance Allocation |
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Real estateconstruction loans |
$ | 62,023 | $ | 17,976 | $ | 25,135 | $ | 2,020 | $ | 82,720 | $ | 10,481 | $ | 26,897 | $ | 3,177 | ||||||||||||||||
All loans |
$ | 1,012,888 | $ | 92,070 | $ | 133,341 | $ | 43,693 | $ | 1,112,279 | $ | 28,991 | $ | 100,241 | $ | 28,419 | ||||||||||||||||
Real estate construction loans as % of all loans |
6.12 | % | 19.52 | % | 18.85 | % | 4.62 | % | 7.44 | % | 36.15 | % | 26.83 | % | 11.18 | % |
The following table presents non-performing and collateral value information on real estate construction loans: (in thousands)
September 30, 2011 | December 31,
2010 Restated |
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Non- performing Balance |
Total Collateral Value |
Loan to Value Ratio |
Non- performing Balance |
Total Collateral Value |
Loan to Value Ratio |
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Real estate construction loans |
$ | 17,976 | $ | 32,900 | 55 | % | $ | 10,481 | $ | 14,455 | 73 | % | ||||||||||||
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Real estate construction loans as a percentage of the loan portfolio have decreased since December 31, 2010. The non-performing balance of real estate construction loans as a percentage of all non-performing loans has also decreased from 36.15 percent at December 31, 2010 to 19.52 percent at September 30, 2011.
Page 39
The following table summarizes as of September 30, 2011 loans that have been restructured during the periods presented (dollars in thousands):
For the three months ended September 30, 2011 |
For the nine months ended September 30, 2011 |
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Troubled Debt Restructurings |
# of Loans |
Pre- Modification Outstanding Recorded Investment |
Post- Modification Outstanding Recorded Investment |
# of Loans |
Pre- Modification Outstanding Recorded Investment |
Post- Modification Outstanding Recorded Investment |
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Commercial, financial, and agricultural |
4 | $ | 578 | $ | 579 | 28 | $ | 3,714 | $ | 3,738 | ||||||||||||||
Commercial, secured by real estate |
1 | 1,210 | 1,210 | 7 | 8,071 | 8,071 | ||||||||||||||||||
Real estate construction loans |
0 | | | 0 | | | ||||||||||||||||||
Residential mortgages |
1 | 100 | 100 | 5 | 1,437 | 1,622 | ||||||||||||||||||
Home Equity |
0 | | | 1 | 291 | 291 | ||||||||||||||||||
Consumer |
0 | | | 2 | 34 | 34 | ||||||||||||||||||
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6 | $ | 1,888 | $ | 1,889 | 43 | $ | 13,547 | $ | 13,756 | |||||||||||||||
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The following table summarizes as of September 30, 2011, loans that were restructured that have subsequently defaulted within the last twelve months: (dollars in thousands)
Defaulted Troubled Debt Restructurings |
Number of Loans |
Recorded Investment |
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Commercial, financial, and agricultural |
37 | $ | 440 | |||||
Commercial, secured by real estate |
4 | 9,677 | ||||||
Real estate construction loans |
1 | 4,598 | ||||||
Residential mortgages |
2 | 671 | ||||||
Home Equity |
1 | | ||||||
Consumer |
0 | | ||||||
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45 | $ | 15,386 | ||||||
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Defaulted restructured loans include 30 contracts with zero balances: 28 commercial, financial, and agricultural loans , one commercial loan secured by real estate and one home equity loan. The home equity loan and one commercial, financial, and agricultural loan were paid off, the remaining 28 were charged off.
See also Note (6) Allowance for Loan Losses in the financial statements.
Deferred Tax Assets and Liabilities
Suffolk recognizes deferred tax assets and liabilities. Deferred income taxes occur when income taxes are allocated through time. Some items are temporary, resulting from differences in the timing of a transaction under generally accepted accounting principles, and for the computation of income tax. Examples would include the future tax effects of temporary differences for such items as deferred compensation and the provision for loan losses. Estimates of deferred tax assets are based upon evidence available to management that future realization is more likely than not. If management determines that Suffolk may be unable to realize all or part of net deferred tax assets in the future, a direct charge to income tax expense may be required to reduce the recorded value of the net deferred tax asset to the amount that management expects to realize. At September 30, 2011, Suffolk believes the deferred tax asset is fully realizable.
Suffolk evaluates unrealized losses on securities to determine if any reduction in the fair value is other than temporary. This amount will continue to be dependent on market conditions, the occurrence of certain events or changes in circumstances of the issuer of the security, and Suffolks intent and ability to hold the impaired investment at the time the valuation is made. If management determines that impairment in the investments value is other than temporary, earnings would be charged.
Page 40
Item 3 - Quantitative and Qualitative Disclosures about Market Risk
Suffolk originates and invests in interest-earning assets and solicits interest-bearing deposit accounts. Suffolks operations are subject to market risk resulting from fluctuations in interest rates to the extent that there is a difference between the amounts of interest-earning assets and interest-bearing liabilities that are prepaid, withdrawn, mature, or re-priced in any given period of time. Suffolks earnings or the net value of its portfolio (the present value of expected cash flows from liabilities) will change when interest rates change. The principal objective of Suffolks asset/liability management program is to maximize net interest income while keeping risks acceptable. These risks include both the effect of changes in interest rates, and risks to liquidity. The program also provides guidance to management in funding Suffolks investment in loans and securities. Suffolks exposure to interest-rate risk has not changed substantially since December 31, 2010.
Business Risks and Uncertainties
This report contains some statements that look to the future. These may include remarks about Suffolk Bancorp, the banking industry, the economy in general, expectations of the business environment in which Suffolk operates, projections of future performance, and potential future credit experience. These forward-looking statements are based upon current management expectations, and may, therefore, involve risks and uncertainties that cannot be predicted or quantified and are beyond Suffolks control and are subject to a variety of uncertainties that could cause future results to vary materially from Suffolks historical performance, or from current expectations. Factors affecting Suffolk include particularly, but are not limited to: changes in interest rates; increases or decreases in retail and commercial economic activity in Suffolks market area; variations in the ability and propensity of consumers and businesses to borrow, repay, or deposit money, or to use other banking and financial services; results of regulatory examinations; any failure by us to comply with our written agreement with the OCC or the individual minimum capital ratios for the Bank established by the OCC; the cost of compliance with the Agreement; failure by us to restore and maintain effective internal controls over financial reporting and disclosure controls and procedures; potential litigation or regulatory action relating to the matters resulting in our failure to file this Form 10-Q on time or resulting from the revisions to our earnings previously announced on April 12, 2011 or the restatement of our financial statements for the quarterly period ended September 30, 2011 and year ended December 31, 2010; and the potential that net charge-offs are higher than expected. Further, it could take Suffolk longer than anticipated to implement its strategic plans to increase revenue and manage non-interest expense, or it may not be possible to implement those plans at all. Finally, new and unanticipated legislation, regulation, or accounting standards may require Suffolk to change its practices in ways that materially change the results of operations.
Item 4 - Controls and Procedures
Suffolks Chief Executive Officer who is also Acting Chief Financial Officer (collectively, the Certifying Officers) evaluated the effectiveness of Suffolks disclosure controls and procedures (as defined in Rules 13a-15(e) of the Securities Exchange Act of 1934) as of September 30, 2011 in connection with the filing of the initial Form 10-Q for that period.
The Certifying Officers evaluated the effectiveness of disclosure controls and procedures as of September 30, 2011. Based on that evaluation, and in light of material weaknesses in internal control over financial reporting that existed throughout this quarter as described below, management concluded that Suffolks disclosure and procedures were not effective as of September 30, 2011.
Suffolks management is responsible for establishing and maintaining adequate internal control over financial reporting, as such term is defined in Rule 13a-15(f) under the Exchange Act.
Because of their inherent limitations, systems of internal control over financial reporting may not prevent or detect misstatements. Therefore, even those systems determined to be effective can only provide reasonable assurance with respect to financial statement preparation and presentation.
A material weakness in internal control over financial reporting is a deficiency, or a combination of deficiencies, in internal control over financial reporting, such that there is a reasonable possibility that a material misstatement of a companys annual or interim financial statements will not be prevented or detected in a timely basis by Suffolks internal controls.
Page 41
Material Weaknesses In Internal Control
Allowance for Loan and Lease Losses
Estimating the allowance for loan losses requires credit administration staff to identify and evaluate borrowers ability to repay their obligations through periodic evaluation and reevaluation of cash flow and/or collateral, and, when necessary, making provision for the amount deemed being likely not to be repaid. Suffolk identified deficiencies within the credit administration function which compromised the operational effectiveness of the internal controls, particularly in making timely reevaluations of credit and/or collateral. This led to managements determination that there was a material weakness in internal control over financial reporting in estimating the allowance for loan losses.
Financial Reporting Staffing Resources
Management concluded that a material weakness exists due to insufficient staffing resources that are in dedicated permanent positions within the accounting function with sufficient skills and industry knowledge of U.S. GAAP and regulatory accounting, which resulted in insufficient documentation and monitoring over the financial reporting cycle, including preparing financial statements and disclosures. Among other factors identified, approximately six months have passed since the prior Chief Financial Officer resigned as of June 24, 2011 and Suffolk has yet to fill the position. Suffolk immediately engaged an interim accounting consultant to assist with financial reporting in the meantime; however, the individual is not an officer of Suffolk. Suffolks President and Chief Executive Officer was appointed as Acting Chief Financial Officer until a permanent Chief Financial Officer is hired, representing a significant concentration of authority in one individual.
Interdepartmental Communications
A material weakness exists due to insufficient communications at the interdepartmental levels. There was inconsistent exchange of important financial information between Suffolks accounting and operating functions that led to errors in classifying loans as performing loans when the loans were non-performing. That was one factor resulting in the allowance for loan and lease losses to be understated as of September 30, 2010 and December 31, 2010, as described above at Allowance for Loan and Lease Losses.
Governance and Management Accountability
The Board of Directors is responsible for competent and effective oversight and leadership of the Companys management and to ensure accountability of management. The material weaknesses related to the allowance for loan and lease losses, financial reporting staffing resources and interdepartmental communications, as well as delays in processes surrounding the completion of restated and current financial statements, and the untimely correction of deficiencies previously identified by regulators, are reflective of a material weakness in the Board of Directors as it relates to the foregoing matters.
Suffolk has implemented certain changes in its internal controls as of the date of this report to address the material weaknesses. Specifically, management took the following steps to remediate the material weaknesses set forth above:
Allowance for Loan and Lease Losses
1. | Hired a new Chief Lending Officer during the second quarter of 2011. |
2. | Improved staff by hiring a new loan administrator, additional underwriting staff and a loan workout specialist. |
3. | Reorganized the credit department to ensure appropriate separation of duties and developed expanded training for Suffolks lenders. |
4. | Hired a senior credit officer to run a newly created separate loan review and workout department. |
5. | Changed Suffolks credit policy to require identification of concentrations of risk, analysis of our customers global cash flows, reappraisal and re-evaluation of collateral, more accurate and timely credit-risk rating procedures and improved underwriting processes and standards. |
6. | Incorporated the results of a systematic re-appraisal of commercial real estate which secures loans in excess of $1 million. |
Page 42
7. | Engaged qualified outside consultants to assist in re-evaluating risk ratings. |
8. | Improved the processes for identifying impaired loans and the determination of the amount of impairment. |
9. | Augmented Suffolks credit policy to govern loan workout. |
10. | Implemented a new procedure to ensure that OREO was accounted for in accordance with US GAAP. |
Financial Reporting Staffing Resources
11. | Initiated a search for a qualified Chief Financial Officer with sufficient knowledge of US GAAP, regulatory accounting and the banking industry and the skills to effectively implement that knowledge. |
12. | Engaged a qualified consultant in financial reporting and the function of the Chief Financial Officer to assist the Acting Chief Financial Officer in maintaining and improving controls. |
13. | Increased oversight of the financial reporting process through the Audit Committee and the Compliance Committee, the latter of which meets at least monthly or more often. |
14. | Created and filled the new position of Treasurer to further relieve the Chief Financial Officer of day-to-day duties in asset liability management, investment portfolio management and additional treasury functions. |
15. | Enhanced procedures to ensure that all reconciliations of all departments are completed and reviewed to ensure accuracy. |
16. | Compiled individual policies into comprehensive written policies and procedures for the accounting function which will include specific policies, procedures and controls for financial reporting. |
17. | Increased automation of the accounting and financial reporting process to free staff resources to focus on financial reporting. |
Interdepartmental Communications
18. | Established a process for both credit and finance staff to review the computation of specific impairment allowances under ASC 310-10 Receivables Impairment of a Loan and establishing enhanced reporting from core systems available directly to personnel in accounting and finance. |
Governance and Management Accountability
19. | Formed a Compliance Committee of the Board to oversee compliance and, later, to respond to the Formal Agreement. |
20. | Implemented procedures to track all regulatory compliance through structured matrices. |
21. | Engaged qualified independent consultants to assist with compliance with the Formal Agreement, including an assessment of key management roles. |
22. | Outsourced the internal audit function to a qualified risk management firm to provide greater independence and depth to the function. |
23. | Appointed a Vice Chairman of the Board to provide daily oversight of management on behalf of the full Board and to communicate back to the Board. |
24. | Engaged a qualified independent consultant to advise the Board on various regulatory, strategic and operational issues. |
In connection with the remediation referred to above, certain changes to the internal control over financial reporting have occurred during the third quarter of 2011 that are reasonably likely to materially affect Suffolks internal control over financial reporting. These changes included the implementation of remediation steps 3, 4, and 12 described above.
Suffolk cannot determine the impact of the remediation steps at this time.
Page 43
On July 11, 2011 a shareholder derivative action, Robert J. Levy v. J. Gordon Huszagh, et al., No. 11 Civ. 3321 (JS), was filed in the U.S. District Court for the Eastern District of New York against the directors of Suffolk and a former officer of Suffolk. Suffolk was named as a nominal defendant. The complaint seeks damages against the individual defendants in an unspecified amount, and alleges that the individual defendants breached their fiduciary duties by making improper statements regarding the sufficiency of Suffolks allowance for loan losses and loan portfolio credit quality, and by failing to establish sufficient allowances for loan losses and to establish effective credit risk management policies. On September 30, 2011, Suffolk and the directors filed a motion to dismiss the complaint.
On October 28, 2011, a separate shareholder derivative action, Susan Forbush v. Edgar F. Goodale, et al., No. 33538/11, was filed in the Supreme Court of the State of New York for the County of Suffolk, against the directors of Suffolk and a former officer of Suffolk. Suffolk was named as a nominal defendant. The complaint asserts claims that are substantially similar to those asserted in the Levy action.
On October 20, 2011, a putative shareholder class action, James E. Fisher v. Suffolk Bancorp, et al., No. 11 Civ. 5114 (SJ), was filed in the U.S. District Court for the Eastern District of New York against Suffolk, its chief executive officer, and a former chief financial officer of Suffolk. The complaint alleges that the defendants violated Sections 10(b) and 20(a) of the Securities Exchange Act of 1934 by knowingly or recklessly making false statements about, or failing to disclose accurate information about, Suffolks financial results and condition, loan loss reserves, impaired assets, internal and disclosure controls, and banking practices. The complaint seeks damages in an unspecified amount on behalf of purchasers of Suffolks common stock between March 12, 2010 and August 10, 2011.
The foregoing matters are in their preliminary phases and it is not possible to ascertain whether there is a reasonable possibility of a loss from these matters. Therefore we have concluded that an amount for a loss contingency is not to be accrued or disclosed at this time. Suffolk believes that it has substantial defenses to the claims filed against it in these lawsuits and, to the extent that these actions proceed, Suffolk intends to defend itself vigorously.
Suffolk has been informed that the SECs New York regional office is conducting an informal inquiry to determine whether there have been violations of the federal securities laws in connection with Suffolks financial reporting. The SEC has not asserted that any federal securities law violation has occurred. Suffolk believes it is in compliance with all federal securities laws and believes it has cooperated fully with the SECs informal inquiry. Although the ultimate outcome of the informal inquiry cannot be ascertained at this time, based upon information that presently is available to it, Suffolk does not believe that the informal inquiry, when resolved, will have a material adverse effect on Suffolks results of operations or financial condition.
There are no material changes from any of the risk factors previously disclosed in Suffolks 2010 Form 10-K in response to Part I, Item 1A, except as follows:
As of June 30 2011, the Bank failed to maintain a Tier 1 leverage capital ratio of at least equal to 8.00 percent of adjusted total assets as required by the OCC; further increases to Suffolks allowance for loan losses could negatively impact its capital levels, causing the Bank to fail to be in compliance with the ratios established by the OCC, which could result in further regulatory enforcement actions.
The Bank is subject to individual minimum capital ratios (IMCRs) established by the OCC requiring Tier 1 Leverage Capital equal to at least 8.00 percent of adjusted total assets; Tier 1 Risk-based Capital equal to at least 10.50 percent of risk-weighted assets; and Total Risk Based Capital equal to at least 12.00 percent of risk-weighted assets. At June 30, 2011, the Bank met two of the three IMCRs: Tier 1 Capital was 11.63 percent of risk-weighted assets and Total Risk Based Capital was 12.93 percent of risk-weighted assets. The Bank did not meet the IMCR for the Tier 1 Leverage ratio as Tier 1 Capital was 7.98 percent of adjusted total assets at June 30, 2011. The Bank met all three IMCRs at September 30, 2011: Tier 1 Capital was 8.50 percent of adjusted total assets, Tier 1 Capital was 12.53 percent of risk-weighted assets, and Total Risk Based Capital was 13.82 percent of risk-weighted assets. Further increases to Suffolks allowance for loan losses, however, would negatively impact the Banks capital levels and make it difficult to maintain the capital levels directed by the OCC. If the Bank fails to maintain the required capital levels, it could be subject to further regulatory enforcement actions.
Page 44
The revisions to Suffolks earnings previously announced on April 12, 2011, and the restatement of Suffolks financial statements for the period ended September 30, 2010 and the year ended December 31, 2010, has resulted in additional costs to Suffolk and may cause Suffolk to incur further costs or result in regulatory action or litigation against Suffolk which could adversely affect its results of operation or financial condition.
On April 12, 2011, Suffolk released preliminary earnings for the first quarter of 2011. Following that release, but prior to the regulatory deadline to file its Form 10-Q, management identified possible deficiencies and/or weaknesses in Suffolks internal controls with respect to credit administration and credit risk management, primarily with respect to the timing of the recognition of credit risk, as well as with regard to risk rating which affected the computation of the allowance for loan losses. On May 11, 2011, Suffolk announced that it would be delayed in filing its Form 10-Q. Suffolk retained independent consultants specializing in the evaluation and computation of the allowance for loan losses that conducted an independent review of Suffolks loan files with respect to the correct risk-rating of credits, and to the extent possible, to evaluate when that rating might correctly have been determined, and finally, where applicable, what the correct specific impairment allowance should be. The result of the reevaluation and re-computation of the allowance for loan losses was an increase in the specific impairment allowances, offset by a decrease in the qualitative reserve percentages, resulting in an overall increase in the total allowance over that announced on April 12, 2011. On August 12, 2011, Suffolk announced that the Audit Committee of the Board of Directors had concluded that Suffolks previously issued financial statements as of and for the year ended December 31, 2010, the quarter ended December 31, 2010 and the quarter ended September 30, 2010, as reported in Suffolks Annual Report on Form 10-K and Quarterly Report on Form 10-Q, respectively, should no longer be relied upon due to an understatement of its allowance for loan losses in such periods. The reevaluation and restatement process has resulted in additional costs to Suffolk and may cause Suffolk to incur further costs that could adversely affect its results of operation or financial condition. The revisions to our earnings previously announced on April 12, 2011 and the restatement of our financial statements may also result in regulatory action or litigation against Suffolk, which could adversely affect our results of operation or financial condition.
A failure to restore and maintain effective internal controls over financial reporting and disclosure controls and procedures could have a material adverse effect on our results of operation or financial condition
During April of 2011, management identified possible deficiencies and/or weaknesses in Suffolks internal controls related to the design and implementation of policies to promptly identify problem loans and to quantify the elements of risk in problem loans. After conducting an internal review, management determined that there were material weaknesses related to the allowance for loan and lease losses, financial reporting staffing resources, interdepartmental communications and governance and management accountability. See Part I, Item 4Controls and Procedures. Suffolk has incurred costs and implemented certain changes in its internal controls over financial reporting and disclosure controls and procedures to address these material weaknesses. It is too early to determine the impact of these remediation steps and Suffolk has not yet determined that it has restored effective internal controls over financial reporting and disclosure controls and procedures. It is possible that additional deficiencies or weaknesses could be identified A failure to restore and maintain effective internal controls over financial reporting and disclosure controls and procedures could have a material adverse effect on our results of operation or financial condition.
Potential impairment in the carrying value of our goodwill could negatively impact our earnings and capital.
At September 30, 2011, we had goodwill totaling $814,000. Goodwill is reviewed for impairment at least annually or more frequently if events or changes in circumstances indicate that the carrying value may not be recoverable. Given the current economic environment, we could be required to evaluate the recoverability of goodwill prior to our normal annual assessment if we experience disruption in our business and/or sustained market capitalization declines. These types of events and the resulting analyses could result in goodwill impairment charges in the future. These non-cash impairment charges could adversely affect our results of operations in future periods.
Page 45
Item 2 - Unregistered Sales of Equity Securities and Use of Proceeds
The following table presents information about repurchases of common stock:
For the three months ended | ||||||||||||||||||||
For the last 12 months |
Sep. 30, 2011 |
Jun. 30, 2011 |
Mar. 31, 2011 |
Dec. 31, 2010 |
||||||||||||||||
Average price per share of quarterly repurchases |
$ | 2.50 | $ | | $ | | $ | 2.50 | $ | | ||||||||||
Aggregate cost of quarterly repurchases |
$ | 7,780 | $ | | $ | | $ | 7,780 | $ | | ||||||||||
Repurchases of common stock |
||||||||||||||||||||
Treasury stock, beginning balance |
4,002,158 | 4,005,270 | 4,005,270 | 4,002,158 | 4,002,158 | |||||||||||||||
Repurchases (1) |
3,112 | | | 3,112 | | |||||||||||||||
|
|
|
|
|
|
|
|
|
|
|||||||||||
Treasury stock, ending balance |
4,005,270 | 4,005,270 | 4,005,270 | 4,005,270 | 4,002,158 | |||||||||||||||
|
|
|
|
|
|
|
|
|
|
(1) | Shares repurchased in payment of exercised employee incentive stock options. No shares were repurchased in market transactions. |
CERTIFICATION OF PERIODIC REPORT - Exhibit 31.1
CERTIFICATION OF PERIODIC REPORT - Exhibit 31.2
CERTIFICATION OF PERIODIC REPORT - Exhibit 32.1
CERTIFICATION OF PERIODIC REPORT - Exhibit 32.2
Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
SUFFOLK BANCORP | ||
Date: December 20, 2011 | /s/ J. Gordon Huszagh | |
J. Gordon Huszagh | ||
President & Chief Executive Officer | ||
Date: December 20, 2011 | ||
/s/ J. Gordon Huszagh | ||
J. Gordon Huszagh | ||
Acting Chief Financial Officer |
Page 46
Exhibit 31.1
CERTIFICATION OF PERIODIC REPORT
I, J. Gordon Huszagh, certify that:
1. | I have reviewed this Quarterly Report on Form 10-Q of Suffolk 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 registrants 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)) and internal control over financial reporting (as defined in Exchange Act Rules 13a-15(f) and 15d-15(f)) 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. | Designed such internal control over financial reporting, or caused such internal control over financial reporting to be designed under our supervision, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles; |
c. | Evaluated the effectiveness of the registrants 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 |
d. | Disclosed in this report any change in the registrants internal control over financial reporting that occurred during the registrants most recent fiscal quarter (the registrants fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonably likely to materially affect, the registrants internal control over financial reporting; and |
5. | The registrants other certifying officer(s) and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrants auditors and the audit committee of the registrants 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 registrants 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 registrants internal control over financial reporting. |
Dated: December 20, 2011 |
/s/ J. Gordon Huszagh |
J. Gordon Huszagh |
President & Chief Executive Officer |
Exhibit 31.2
CERTIFICATION OF PERIODIC REPORT
I, J. Gordon Huszagh, certify that:
1. | I have reviewed this Quarterly Report on Form 10-Q of Suffolk 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 registrants 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)) and internal control over financial reporting (as defined in Exchange Act Rules 13a-15(f) and 15d-15(f)) 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. | Designed such internal control over financial reporting, or caused such internal control over financial reporting to be designed under our supervision, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles; |
c. | Evaluated the effectiveness of the registrants 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 |
d. | Disclosed in this report any change in the registrants internal control over financial reporting that occurred during the registrants most recent fiscal quarter (the registrants fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonably likely to materially affect, the registrants internal control over financial reporting; and |
5. | The registrants other certifying officer(s) and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrants auditors and the audit committee of the registrants 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 registrants 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 registrants internal control over financial reporting. |
Dated: December 20, 2011 |
/s/ J. Gordon Huszagh |
J. Gordon Huszagh |
Acting Chief Financial Officer |
CERTIFICATION OF PERIODIC REPORT
Exhibit 32.1
I, J. Gordon Huszagh, President & Chief Executive Officer of Suffolk Bancorp (the Company), certify, pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, 18 U.S.C. Section 1350, that: (1) the Quarterly Report on Form 10-Q of the Company for the quarterly period ended September 30, 2011 (the Report) fully complies with the requirements of Section 13(a) or 15(d) of the Securities Exchange Act of 1934 (15 U.S.C. 78m or 78o(d)); and (2) the information contained in the Report fairly presents, in all material respects, the financial condition and results of operations of the Company.
Dated: December 20, 2011 |
/s/ J. Gordon Huszagh |
J. Gordon Huszagh |
President & Chief Executive Officer |
CERTIFICATION OF PERIODIC REPORT
Exhibit 32.2
I, J. Gordon Huszagh, Acting Chief Financial Officer of Suffolk Bancorp (the Company), certify, pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, 18 U.S.C. Section 1350, that: (1) the Quarterly Report on Form 10-Q of the Company for the quarterly period ended September 30, 2011 (the Report) fully complies with the requirements of Section 13(a) or 15(d) of the Securities Exchange Act of 1934 (15 U.S.C. 78m or 78o(d)); and (2) the information contained in the Report fairly presents, in all material respects, the financial condition and results of operations of the Company.
Dated: December 20, 2011 |
/s/ J. Gordon Huszagh |
J. Gordon Huszagh |
Acting Chief Financial Officer |
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