News Column

CAPE BANCORP, INC. - 10-Q - Management's Discussion and Analysis of Financial Condition and Results of Operations

May 7, 2014

Forward Looking Statements

Certain statements contained herein are "forward-looking statements" within the meaning of Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934. Such forward-looking statements may be identified by reference to a future period or periods, or by the use of forward-looking terminology, such as "may," "will," "believe," "expect," "estimate," "anticipate," "continue," or similar terms or variations on those terms, or the negative of those terms. Forward-looking statements are subject to numerous risks and uncertainties, including, but not limited to, those related to the economic environment, particularly in the market areas in which the Company operates, competitive products and pricing, fiscal and monetary policies of the U.S. Government, changes in government regulations affecting financial institutions, including regulatory fees and capital requirements, changes in prevailing interest rates, acquisitions and the integration of acquired businesses, credit risk management, asset-liability management, the financial and securities markets and the availability of and costs associated with sources of liquidity. Cape Bancorp wishes to caution readers not to place undue reliance on any such forward-looking statements, which speak only as of the date made. The Company wishes to advise readers that the factors listed above could affect the Company's financial performance and could cause the Company's actual results for future periods to differ materially from any opinions or statements expressed with respect to future periods in any current statements.



Overview

Cape Bancorp, Inc. ("Cape Bancorp" or the "Company") is a Maryland corporation that was incorporated on September 14, 2007 for the purpose of becoming the holding company of Cape Bank (the "Bank").

Cape Bank is a New Jersey chartered savings bank originally founded in 1923. We are a community bank focused on providing deposit and loan products to retail customers and to small and mid-sized businesses from fourteen full service branch offices located in Atlantic and Cape May Counties, New Jersey, including our main office located at 225 North Main Street, Cape May Court House, New Jersey 08210, one drive-up teller/ATM operation in Atlantic County and our two market development offices ("MDOs") located in Burlington County, New Jersey and in Radnor, Pennsylvania, which serves the five county Philadelphia market area. We attract deposits from the general public and use those funds to originate a variety of loans, including commercial mortgages, commercial business loans, residential mortgage loans, home equity loans and lines of credit ("HELOC") and construction loans. Effective December 31, 2013, the Company exited the residential mortgage loan origination business which will allow for more resources to be focused on commercial lending. Our retail and business banking deposit products include checking accounts, money market accounts, savings accounts, and certificates of deposit with terms ranging from 30 days to 84 months. At March 31, 2014, the Company had total assets of $1.091 billion compared to $1.093 billion at December 31, 2013. For the three months ended March 31, 2014 and 2013, the Company had total revenues (interest income plus non-interest income) of $13.4 million and $11.8 million, respectively. Net income for each of the three months ended March 31, 2014 totaled $2.0 million or $0.18 per common and fully diluted share compared to net income of $1.5 million, or $0.12 per common and fully diluted share for the three months ended March 31, 2013. We offer banking services to individuals and businesses predominantly located in our primary market area of Cape May and Atlantic Counties, New Jersey and through our MDOs. Our business and results of operations are significantly affected by local and national economic conditions, as well as market interest rates. With the local and national economic conditions continuing to improve during 2013 and through the first quarter of 2014, the Bank experienced significant declines in its level of non-performing assets as well as making progress in improving its credit quality ratios. At March 31, 2014, non-performing loans as a percentage of total gross loans totaled 0.99% compared to 0.93% of total gross loans at December 31, 2013 and 2.46% of total gross loans at March 31, 2013. The Company's Adversely Classified Asset Ratio (Classified Assets/Tier I Capital plus the allowance for loan losses) at March 31, 2014 was 18%, an improvement from 26% at December 31, 2013 and 27% at March 31, 2013. Non-performing assets (non-performing loans, other real estate owned and non-accruing investment securities) as a percentage of total assets decreased to 1.31% at March 31, 2014 from 1.35% at December 31, 2013, and 2.38% at March 31, 2013. For the periods ended, and as of March 31, 2014 and December 31, 2013, loans held for sale ("HFS") are excluded from delinquencies, non-performing loans, non-performing assets, impaired loans and all related ratio calculations. The ratio of our allowance for loan losses to total loans increased to 1.24% at March 31, 2014, from 1.18% at December 31, 2013, while the ratio of our allowance for loan losses to non-performing loans decreased to 125.62% at March 31, 2014 from 127.05% at December 31, 2013. For the three months ended March 31, 2014, loan charge-offs and write-downs on loans transferred to held for sale totaled $2.0 million compared to loan charge-offs of $497,000 for the three months ended March 31, 2013. Of the $2.0 million of loan charge-offs and write-downs on loans transferred during the first quarter of 2014, none of these were fully reserved for as of December 31, 2013. Our total loan portfolio decreased from $789.5 million at December 31, 2013 to $782.3 million at March 31, 2014 resulting from a decrease in commercial loans totaling $3.5 million, decreases in residential mortgage loans totaling $2.6 million and a decline in consumer loans totaling $1.1 million. Commercial loan closings totaling $19.7 million during the quarter were more than offset by the following: transfer of $5.3 million of classified commercial loans to loans held 35 -------------------------------------------------------------------------------- for sale, charge-offs and write-downs of loans transferred to loans held for sale totaling $2.0 million, normal amortizations, and early payoffs (including the payoff of a $6.5 million classified loan relationship). The decline in residential mortgage loans reflects the effect of the Company exiting the residential mortgage loan origination business effective December 31, 2013. At March 31, 2014, 92.2% of our loan portfolio was secured by real estate and 61.6% of our portfolio was commercial related loans. We believe our existing loan underwriting practices are appropriate in the current market environment while continuing to address the local credit needs of our customers. Total deposits increased $3.6 million from $798.4 million at December 31, 2013 to $802.0 million at March 31, 2014 primarily resulting from an increase of $12.6 million in certificates of deposit, partially offset by decreases in interest-bearing checking accounts and money market deposit accounts of $7.2 million and $2.7 million, respectively. We also maintain an investment portfolio. Our principal business is acquiring deposits from individuals and businesses in the communities surrounding our offices and using these deposits to fund loans and other investments. We currently offer personal and business checking accounts, commercial mortgage loans, construction loans, home equity loans and lines of credit and other types of commercial loans



2014 Outlook

Our market area has been affected by the recession and the modest recovery. Unemployment in Atlantic and Cape May County was 13.1% and 16.1%, respectively, as of February 2014, an improvement from 2013 levels of 14.8% and 18.8%, respectively. The number of residential building permits issued remained flat in Atlantic County from February 2013 to February 2014 while the values of those permits increased. In Cape May County, both the number of residential permits and the values increased from February 2013 to February 2014. Median sale prices of single-family homes sold during the twelve month periods ended February 2014 and 2013 remained relatively flat in both Atlantic and Cape May Counties. The number of homes sold during those same periods increased 7.1% and 1.7% for Atlantic and Cape May Counties, respectively while the number of new listings increased 19.7% in Atlantic County and 8.5% in Cape May County. During 2013 and continuing through the first quarter of 2014, Cape Bank was able to make significant strides in reducing non-performing assets and classified items. Many troubled credits finally made their way through the slow foreclosure process, permitting the bank to take title and sell the collateral. This helped reduce non-earning assets and the costs relating to problem loans. Management intends to continue these efforts for the remainder of 2014 with the goal of reducing classified items to levels that would fall more within industry norms. Management believes that more effort needs to be placed on expense control. In this regard, if management is successful in reducing troubled credits as planned, there will be a corresponding reduction in the costs related to these loans as they work through the foreclosure process.



During 2014, Cape Bank will focus on the following initiatives:

- Core deposit gathering, both retail and commercial

- Continue building commercial loan relationships

- Continue efforts to effectively manage the Bank's capital

- Build core earnings

- Continue efforts to reduce non-performing assets

- Effectively utilize new core processors functionality with an emphasis on digital delivery



Core deposit gathering, both retail and commercial:

The Company recognizes the value associated with strong core deposits and has built company-wide incentive programs to achieve this initiative. Both retail and commercial deposits will be focused on through advertising, branch programs, commercial loan calling officers and digital media. Deposit products will be designed to attract new deposit customers and retain existing ones. 36 --------------------------------------------------------------------------------



Continue building commercial loan relationships:

Cape Bank has had good success in building strong commercial loan relationships during the past several years. This has been the result of building a seasoned group of professional and knowledgeable staff combined with market driven products. The Company's expansion into Burlington County in 2010 and the Philadelphia metro market in 2013 has produced better than anticipated results. Efforts will be made to continue to attract quality commercial lending staff as well as maximizing the efforts of the existing staff, while remaining flexible with product structure to adapt to market conditions.



Continue efforts to effectively manage the Company's capital:

Despite the Company's problems with credit since the recession, we were able to maintain a strong capital position. With troubled assets posing a reduced concern, the Company reassessed the level of capital and believed a continued active management would be appropriate. The Company began paying a quarterly cash dividend in the fourth quarter of 2012 and increased that dividend from $.05 per share to $.06 per share in the fourth quarter of 2013. Additionally, during 2013, the Company completed two 5% stock buyback programs and announced a third 5% buyback program in December 2013. On January 20, 2014, the Company, with the approval of the regulators, declared a $0.06 per common share cash dividend to shareholders of record on February 3, 2014. The dividend was paid on February 17, 2014. Build core earnings: During the economic downturn, Bank values were often a reflection of the perceived adequacy of equity often through the metric of tangible book value. Uncertainty with the economy in general, and with credit in particular, made capital a handy heuristic to gauge the soundness of a Bank.



These macro concerns have been receding as more institutions have gotten on sounder footing. As a result, valuations have begun to focus on earnings as a driver of value. In particular, core earnings are becoming an increasingly important metric.

Management recognizes this development and has made growth in core earnings an integral part of the 2014 Strategic Plan.

Continue efforts to reduce non-performing assets:

Management was able to reduce the level of non-performing assets during 2013 and believes that continued efforts to reduce them further will provide value to the shareholders. Several of the larger troubled credits have moved to OREO as the Bank attempts to move these properties promptly. This area will continue to receive attention in 2014.



Effectively utilize new core processors functionality with an emphasis on digital delivery:

The Bank made a smooth transition to our new core processor, FISERV, in the 4th quarter of 2013. The Bank believes that customers are requiring access to, and communication from, their financial service providers through a multitude of both physical and electronic delivery channels. During 2014, the Bank will maximize its opportunities to provide products and services via multiple delivery channels offered through FISERV and other available sources.



Comparison of Financial Condition at March 31, 2014 and December 31, 2013

At March 31, 2014, the Company's total assets were $1.091 billion, a decrease of $1.8 million, or 0.17%, from the December 31, 2013 level of $1.093 billion.

Cash and cash equivalents decreased $4.0 million, or 16.02%, to $20.9 million at March 31, 2014 from $24.9 million at December 31, 2013.

Interest-bearing time deposits increased $207,000, or 2.25%, from $9.2 million at December 31, 2013 to $9.4 million at March 31, 2014. The Company invests in time deposits of other banks generally for terms of one year to five years and not to exceed $250,000, which is the amount currently insured by the Federal Deposit Insurance Corporation. Total loans decreased to $782.3 million at March 31, 2014 from $789.5 million at December 31, 2013, a decrease of $7.2 million, or 0.91%. Net loans decreased $7.6 million, net of an increase in the allowance for loan losses of $406,000, primarily resulting from a decrease in commercial loans totaling $3.5 million, decreases in residential mortgage loans totaling $2.6 million and a decline in consumer loans totaling $1.1 million. Commercial loan closings totaling $19.7 million during the quarter were more than offset by the following: transfer of $5.3 million of classified commercial loans to loans held for sale, charge-offs and write-downs of loans transferred to loans held for sale totaling $2.0 million, normal amortizations, and early payoffs (including the payoff of a $6.5 37 -------------------------------------------------------------------------------- million classified loan relationship). The decline in residential mortgage loans reflects the effect of the Company exiting the residential mortgage loan origination business effective December 31, 2013. Delinquent loans increased $109,000 to $9.9 million, or 1.27% of total gross loans, at March 31, 2014 from $9.8 million, or 1.24% of total gross loans at December 31, 2013. Total delinquent loans by portfolio at March 31, 2014 were $6.7 million of commercial mortgage and $303,000 commercial business loans, $2.2 million of residential mortgage loans and $662,000 of home equity loans. At March 31, 2014, delinquent loan balances by number of days delinquent were: 31 to 59 days - $2.4 million; 60 to 89 days - $603,000; and 90 days and greater - $6.9 million. At March 31, 2014, the Company had $7.7 million in non-performing loans, or 0.99% of total gross loans, an increase of $407,000 from $7.3 million, or 0.93% of total gross loans at December 31, 2013. Non-performing loans do not include loans held for sale. Loans held for sale include $6.1 million of loans that are on non-accrual status. At March 31, 2014, non-performing loans by loan portfolio category were as follows: $6.4 million of commercial loans, $823,000 of residential mortgage loans, and $465,000 of consumer loans. Of these stated delinquencies, the Company had $390,000 of loans that were 90 days or more delinquent and still accruing (6 residential mortgage loans for $316,000 and 3 consumer loans for $74,000). These loans are well secured, in the process of collection and we anticipate no losses will be incurred. At March 31, 2014, commercial non-performing loans had collateral type concentrations of $352,000 (1 loan or 5%) secured by commercial buildings and equipment, $982,000 (6 loans or 15%) secured by residential related commercial loans, $1.0 million (3 loans or 16%) secured by restaurant properties, $759,000 (3 loans or 12%) secured by land and building lots, and $3.4 million (8 loans or 52%) secured by retail stores. The three largest commercial non-performing loan relationships are $1.8 million, $773,000 and $666,000. We believe we have appropriately charged-off, written-down or established adequate loss reserves on problem loans that we have identified. For 2014, we anticipate a gradual decrease in the amount of problem assets. This improvement is due, in part, to our disposing of assets collateralizing loans that have gone through foreclosure. We are aggressively managing all loan relationships, and where necessary, we will continue to apply our loan work-out experience to protect our collateral position and actively negotiate with mortgagors to resolve these non-performing loans. Total investment securities increased $6.5 million, or 3.88%, to $172.7 million at March 31, 2014 from $166.3 million at December 31, 2013. At March 31, 2014, AFS securities totaled $155.0 million and HTM securities totaled $17.7 million. At December 31, 2013, AFS securities totaled $157.2 million and HTM securities totaled $9.1 million. Investment securities are classified as HTM when management has the positive intent and ability to hold them to maturity. In March 2014, the Bank reclassified $7.6 million of its AFS securities as HTM, as these securities may be particularly susceptible to changes in fair value in the near term, as a result of market volatility. On February 27, 2014, the Company sold its remaining portion of collateralized debt obligation securities ("CDOs") with a book value of zero, resulting in $1.9 million gain. Other real estate owned ("OREO") decreased $919,000 from $7.4 million at December 31, 2013 to $6.5 million at March 31, 2014, and consisted at March 31, 2014 of eleven commercial properties and fifteen residential properties (including seven building lots). During the quarter ended March 31, 2014, the Company added one residential property to OREO with an aggregate carrying value of $56,000. In addition, nine residential OREO properties with an aggregate carrying value totaling $885,000 were sold during the quarter ended March 31, 2014 with recognized net losses of $8,000. In addition, in the second quarter of 2014, to date, the Company has sold four residential OREO properties, including two building lots, with an aggregate carrying value of $824,000 resulting in net gains totaling $67,000. As of the date of this filing, the Company has agreements of sale for six OREO properties with an aggregate carrying value of $1.7 million. Total deposits increased $3.6 million, or 0.45%, from $798.4 million at December 31, 2013 to $802.0 million at March 31, 2014 primarily resulting from increases in certificates of deposit of $12.6 million partially offset by decreases in interest-bearing checking accounts of $7.2 million and money market accounts of $2.7 million. Noninterest-bearing deposit accounts increased $776,000 and savings accounts increased $124,000. At March 31, 2014, certificates of deposit totaled $281.8 million, an increase of $12.6 million, or 4.68%, from the December 31, 2013 total of $269.2 million. Interest-bearing checking accounts declined $7.2 million, or 3.42%, to $204.4 million at March 31, 2014 from $211.6 million at December 31, 2013. Money market accounts declined $2.7 million, or 1.94%, to $136.4 million at March 31, 2014 from $139.1 million at December 31, 2013.



Borrowings decreased $4.4 million from $143.9 million at December 31, 2013 to $139.5 million at March 31, 2014.

Cape Bancorp's total equity increased $670,000, or 0.48%, to $141.1 million at March 31, 2014 from $140.4 million at December 31, 2013 primarily resulting from a net increase of $1.3 million (earnings less dividends declared) in retained earnings and a decrease of $960,000 in the accumulated other comprehensive loss, partially offset by a $1.8 million decrease related to the Company's stock repurchase program. Tangible equity to tangible assets increased to 11.07% at March 31, 2014 compared to 10.99% at December 31, 2013. At March 31, 2014, Cape Bank's regulatory capital ratios for Tier I Leverage Ratio, Tier I Risk-Based Capital and Total Risk-Based Capital were 9.56%, 13.16% and 14.41%, respectively, all of which exceed well capitalized status. 38 -------------------------------------------------------------------------------- The following tables set forth average balance sheets, average yields and costs, and certain other information for the periods indicated. All average balances are daily average balances. Non-accrual loans and loans held for sale were included in the computation of average balances, but have been reflected in the table as loans carrying a zero yield. The yields set forth below include the effect of deferred fees, discounts and premiums that are amortized or accreted to interest income or expense. Yields and rates have been annualized. For the three months ended March 31, 2014 2013 Interest Interest Income/ Average Income/ Average Average Balance Expense Yield Average Balance Expense Yield (dollars in thousands) Assets Interest-earning deposits $ 22,722 $ 23 0.41 % $ 25,639 $ 28 0.44 % Investments 181,104 945 2.09 % 175,741 1,004 2.29 % Loans 791,858 9,331 4.78 % 726,380 9,076 5.07 % Total interest-earning assets 995,684 10,299 4.19 % 927,760 10,108 4.42 % Noninterest-earning assets 105,394 110,170 Allowance for loan losses (9,360 ) (9,945 ) Total assets $ 1,091,718$ 1,027,985 Liabilities and Stockholders' Equity Interest-bearing demand accounts $ 214,957 97 0.18 % $ 190,055 120 0.26 % Savings accounts 95,731 13 0.06 % 95,485 16 0.07 % Money market accounts 139,535 62 0.18 % 173,992 90 0.21 % Certificates of deposit 264,785 432 0.66 % 231,093 613 1.08 % Borrowings 146,946 598 1.65 % 95,354 610 2.59 % Total interest-bearing liabilities 861,954 1,202 0.57 % 785,979 1,449 0.75 % Noninterest-bearing deposits 80,262 84,082 Other liabilities 7,248 6,402 Total liabilities 949,464 876,463 Stockholders' equity 142,254 151,522 Total liabilities and stockholders' equity $ 1,091,718$ 1,027,985 Net interest income $ 9,097$ 8,659 Net interest spread 3.62 % 3.67 % Net interest margin 3.71 % 3.79 % Net interest income and margin (tax equivalent basis) (1) $ 9,169 3.73 % $ 8,731 3.82 % Ratio of average interest-earning assets to average interest-bearing liabilities 115.51 % 118.04 %



(1) In order to present pre-tax income and resultant yields on tax-exempt

investments on a basis comparable to those on taxable investments, a tax

equivalent yield adjustment is made to interest income. The tax equivalent

adjustment has been computed using a Federal income tax rate of 35%, and has

the effect of increasing interest income by $46,000 and $72,000 for the

three month period ended March 31, 2014 and 2013, respectively. The average

yield on investments decreased to 2.19% from 2.09% for the three month

period ended March 31, 2014 and increased to 2.45% from 2.29% for the three

month period ended March 31, 2013. 39

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Rate/Volume Analysis

The following table presents the effects of changing rates and volumes on our net interest income for the periods indicated. The average rate column shows the effects attributable to changes in rate (changes in rate multiplied by prior volume). The average volume column shows the effects attributable to changes in volume (changes in volume multiplied by prior rate). The net change column represents the sum of the prior columns. For purposes of this table, changes attributable to both rate and volume, which cannot be segregated, have been allocated proportionately, based on the changes due to rate and the changes due to volume. For the three months ended March 31, 2014 compared to the three months ended March 31, 2013 Increase (decrease) due to changes in: Average Average Net Volume Rate Change (in thousands) Interest Earning Assets Interest-earning deposits $ (3 ) $ (2 ) $ (5 ) Investments 25 (84 ) (59 ) Loans 789 (534 ) 255 Total interest income 811 (620 ) 191 Interest-Bearing Liabilities Interest-bearing demand accounts 14 (37 ) (23 ) Savings accounts - (3 ) (3 ) Money market accounts (16 ) (12 ) (28 ) Certificates of deposit 80 (261 ) (181 ) Borrowings 258 (270 ) (12 ) Total interest expense 336 (583 ) (247 ) Total net interest income $ 475 $ (37 ) $ 438



Comparison of Operating Results for the Three Months Ended March 31, 2014 and 2013

General. Net income for the three months ended March 31, 2014 was $2.0 million, or $0.18 per common and fully diluted share, compared to net income of $1.5 million, or $0.12 per common and fully diluted share for the three months ended March 31, 2013. The loan loss provision for the first quarter of 2014 totaled $2.2 million compared to $297,000 for the first quarter ended March 31, 2013. Net interest income increased $438,000 to $9.1 million in the first quarter of 2014 from $8.7 million in the first quarter of 2013. The net interest margin decreased 8 basis points from 3.79% for the quarter ended March 31, 2013 to 3.71% for the quarter ended March 31, 2014. The first quarter of 2014 included net gains on sales of investment securities of $1.9 million compared to $290,000 for the same period in 2013. On February 27, 2014, the Company sold its remaining portion of collateralized debt obligations ("CDOs") with a book value of zero, resulting in the $1.9 million gain. Net gains on the sales of loans totaled $116,000 for the three months ended March 31, 2014 compared to $270,000 for the same period in 2013. Gains on the sale of Small Business Administration ("SBA") loans increased $91,000, while net gains on the sale of residential loans declined $245,000 reflecting the Company's decision to exit the residential mortgage origination business effective December 31, 2013. Other income for the three months ended March 31, 2014 included life insurance proceeds totaling $185,000 from bank owned life insurance, and the three months ended March 31, 2013 included an $83,000 write-down on an asset held for sale. Salaries and employee benefits totaled $3.6 million for the first quarter of 2014, a reduction of $315,000 from the first quarter 2013 of $3.9 million. Loan related expenses (real estate taxes, insurance, legal and other) totaled $225,000 for the first quarter ended March 31, 2014 compared to $341,000 for the same period in 2013. The 2013 first quarter included higher real estate tax expense ($34,000), higher insurance expenses ($33,000), and higher other loan related expenses ($42,000). Interest Income. Interest income increased $191,000, or 1.89%, to $10.3 million for the three months ended March 31, 2014, from $10.1 million for the three months ended March 31, 2013. The increase consists of a $256,000 increase in interest income on loans, partially offset by a $65,000 decrease in interest income on investment securities. Average loan balances for the three month period ended March 31, 2014 increased $65.5 million, or 9.01%, to $791.9 million from $726.4 million for the three month period ended March 31, 2013. The average yield on the loan portfolio declined 29 basis points to 4.78% for the three months ended March 31, 2014 from 5.07% for the three months ended March 31, 2013, reflecting a lower interest rate environment and the impact of non-accruing loans on interest income. 40 -------------------------------------------------------------------------------- The average balance of the investment portfolio increased $5.4 million, or 3.05%, to $181.1 million for the three month period ended March 31, 2014 from $175.7 million for the three month period ended March 31, 2013. The average yield on the investment portfolio decreased 20 basis points to 2.09% for the three months ended March 31, 2014 from 2.29% for the three months ended March 31, 2013. The decline in the investment portfolio yield is largely due to the impact of reinvesting proceeds from higher yielding securities into securities that have lower coupon rates. Interest Expense. Interest expense decreased $247,000, or 17.05%, to $1.2 million for the three months ended March 31, 2014, from $1.4 million for the three months ended March 31, 2013. The decrease resulted primarily from lower interest rates being paid on deposits. The average rate paid on certificates of deposit decreased 42 basis points to 0.66% for the three months ended March 31, 2014 from 1.08% for the three months ended March 31, 2013 while the average balance of certificates of deposit increased $33.7 million, or 14.58%, to $264.8 million from $231.1 million for the same period, resulting in a combined interest expense savings of $181,000. The average rate paid on interest-bearing demand accounts declined 8 basis points during the same period while the average balance increased $24.9 million and the average rate paid on money market accounts declined 3 basis points while the average balance declined $34.5 million during the same period. The average balance of borrowings increased $51.6 million, or 54.11%, to $147.0 million for the three months ended March 31, 2014 from $95.4 million for the three months ended March 31, 2013, and the average cost of borrowings declined 94 basis points from 2.59% for the three months ended March 31, 2013 to 1.65% for the three months ended March 31, 2014. The increase in the average borrowings balance reflects the increased funding needs resulting from the increase in the average loan volume of $65.5 million. Net Interest Income. Net interest income increased $438,000, or 5.06%, to $9.1 million for the three months ended March 31, 2014, from $8.7 million for the three months ended March 31, 2013. The net interest margin decreased 8 basis points from 3.79% for the quarter ended March 31, 2013 to 3.71% for the quarter ended March 31, 2014. The ratio of average interest-earning assets to average interest-bearing liabilities decreased to 115.51% for the three months ended March 31, 2014, from 118.04% for the three months ended March 31, 2013. Provision for Loan Losses. In accordance with FASB ASC Topic No. 450 Contingencies, we establish provisions for loan losses which are charged to operations in order to maintain the allowance for loan losses at a level we consider necessary to absorb credit losses incurred in the loan portfolio that are both probable and reasonably estimable at the balance sheet date. In determining the level of the allowance for loan losses, we consider, among other things, past and current loss experience, evaluations of real estate collateral, current economic conditions, volume and type of lending, external factors such as competition and regulations, adverse situations that may affect a borrower's ability to repay a loan and the levels of delinquent loans. The amount of the allowance is based on management's judgment of probable losses, and the ultimate losses may vary from such estimates as more information becomes available or conditions change. We assess the allowance for loan losses and make provisions for loan losses on a quarterly basis. The Company recorded a provision for loan losses of $2.2 million for the three months ended March 31, 2014 compared to $297,000 for the three months ended March 31, 2013. Loan charge-offs and write-downs on loans transferred to loans held for sale for the first quarter of 2014 totaled $2.0 million compared to loan charge-offs of $497,000 for the first quarter of 2013. The ratio of the allowance for loan losses to non-performing loans (coverage ratio) totaled 125.62% at March 31, 2014, a slight decrease from 127.05% at December 31, 2013 and a significant increase from 53.79% at March 31, 2013. The amount of non-performing loans for which the full loss has been charged-off to total gross loans is 0.13%. The amount of non-performing loans for which the full loss has been charged-off to total non-performing loans is 13.48%. Loan loss recoveries for the three months ended March 31, 2014 were $229,000 compared to $29,000 for the three months ended March 31, 2013. The allowance for loan losses increased $406,000, or 4.35%, to $9.736 million at March 31, 2014, from $9.330 million at December 31, 2013. The ratio of our allowance for loan losses to total loans increased to 1.24% at March 31, 2014 from 1.18% of total loans at December 31, 2013. Certain impaired loans (troubled debt restructurings) have a valuation allowance determined by discounting expected cash flows at the respective loan's effective interest rate. Included in the allowance for loan losses at March 31, 2014 was an impairment reserve for TDRs in the amount of $158,000 compared to $127,000 at December 31, 2013. 41 -------------------------------------------------------------------------------- Non-Interest Income. Non-interest income increased $1.4 million, or 84.54% to $3.1 million for the three months ended March 31, 2014 from $1.7 million for the three months ended March 31, 2013. The first quarter of 2014 included net gains on sales of investment securities of $1.9 million compared to $290,000 for the same period in 2013. On February 27, 2014, the Company sold its remaining portion of collateralized debt obligations ("CDOs") with a book value of zero, resulting in the $1.9 million gain. Net gains on the sales of loans totaled $116,000 for the three months ended March 31, 2014 compared to $270,000 for the same period in 2013. Gains on the sale of Small Business Administration ("SBA") loans increased $91,000, while net gains on the sale of residential loans declined $245,000 reflecting the Company's decision to exit the residential mortgage origination business effective December 31, 2013. Other income for the three months ended March 31, 2014 included life insurance proceeds totaling $185,000 from bank owned life insurance and the three months ended March 31, 2013 included an $83,000 write-down on an asset held for sale. Non-Interest Expense. Non-interest expense decreased $837,000, or 11.05%, to $6.7 million for the three months ended March 31, 2014 from $7.6 million for the three months ended March 31, 2013. Salaries and employee benefits totaled $3.6 million for the first quarter of 2014, a reduction of $315,000 from the first quarter 2013 total of $3.9 million, primarily resulting from reduced staffing levels related to the exiting of the residential loan origination business. Federal deposit insurance premiums totaled $208,000 for the first quarter of 2014, a decline of $96,000 from $304,000 for the first quarter of 2013. Loan related expenses (real estate taxes, insurance, legal and other) totaled $225,000 for the first quarter ended March 31, 2014 compared to $341,000 for the same period in 2013. The 2013 first quarter included higher real estate tax expense ($34,000), higher insurance expenses ($33,000), and higher other loan related expenses ($42,000). OREO expenses totaled $252,000 for the three months ended March 31, 2014 compared to $325,000 for the three months ended March 31, 2013, a decline of $73,000 resulting from higher OREO write-downs in the 2013 period. Other operating expenses declined $242,000 from $977,000 for the three months ended March 31, 2013 to $735,000 for the three months ended March 31, 2014, primarily resulting from a higher level of consulting related expenses in the 2013 period.



Income Tax Expense. For the three months ended March 31, 2014, the Company recorded a net tax expense of $1.2 million compared to a net tax expense of $969,000 for the three months ended March 31, 2013.

Liquidity and Capital Resources

Liquidity refers to our ability to meet the cash flow requirements of depositors and borrowers as well as our operating cash needs with cost-effective funding. We generate funds to meet these needs primarily through our core deposit base and the maturity or repayment of loans and other interest-earning assets, including investments. Proceeds from the call, maturity, redemption, and return of principal of investment securities totaled $20.5 millionMarch 31, 2014 and were used either for liquidity, to reduce borrowings, or to invest in securities of similar quality as our current investment portfolio. We also have available unused wholesale sources of liquidity, including overnight federal funds and repurchase agreements, advances from the FHLB of New York, borrowings through the discount window at the Federal Reserve Bank of Philadelphia and access to certificates of deposit through brokers. We can also raise cash through the sale of earning assets, such as loans and marketable securities. As of March 31, 2014, the Company's investment portfolio consisted of AFS securities with a fair market value of $155.0 million and HTM securities at amortized cost of $17.7 million. The Company has no intention to sell these securities, nor is it more likely than not that we will be required to sell any securities prior to their recovery in fair market value. Liquidity risk arises from the possibility that we may not be able to meet our financial obligations and operating cash needs or may become overly reliant upon external funding sources. In order to manage this risk, our Board of Directors has approved a Liquidity Management Policy and Contingency Funding Plan that identifies primary sources of liquidity, establishes procedures for monitoring and measuring liquidity, and quantifies minimum liquidity requirements based on approved limits. This policy designates our Asset/Liability Committee ("ALCO") as the body responsible for meeting these objectives. The ALCO, which includes members of executive management, reviews liquidity on a periodic basis and approves significant changes in strategies that affect balance sheet or cash flow positions. Liquidity is centrally managed on a daily basis by our Chief Financial Officer and our Treasury function. Liquidity stress testing is performed annually, unless circumstance dictates more frequently, and all testing results are reported to the Board of Directors through the ALCO minutes. Cape Bank's long-term liquidity source is a large core deposit base and a strong capital position. Core deposits are the most stable source of liquidity a bank can have due to the long-term relationship with a deposit customer. The level of deposits during any period is sometimes influenced by factors outside of management's control, such as the level of short-term and long-term market interest rates and yields offered on competing investments, such as money market mutual funds. Deposits increased $3.6 million, or 0.45%, during the first three months of 2014, and comprised 84.42% of total liabilities at March 31, 2014, as compared to 83.83% at December 31, 2013. 42 -------------------------------------------------------------------------------- Regulatory Matters. Banks and bank holding companies are subject to regulatory capital requirements administered by federal banking agencies. Capital adequacy guidelines and, additionally for banks, prompt corrective action regulations, involve quantitative measures of assets, liabilities, and certain off-balance-sheet items calculated under regulatory accounting practices. Capital amounts and classifications are also subject to qualitative judgments by regulators. Failure to meet capital requirements can initiate regulatory action. Management believes as of March 31, 2014, the Company and Bank meet all capital adequacy requirements to which it is subject. The Bank is subject to various regulatory capital requirements administered by the federal banking agencies. Failure to meet minimum capital requirements can initiate certain mandatory, and possibly additional discretionary actions by regulators that, if undertaken, could have a direct material effect on the Bank's financial statements. Under capital adequacy guidelines and the regulatory framework for prompt corrective action, the Bank must meet specific capital guidelines that involve quantitative measures of the Bank's assets, liabilities and certain off-balance sheet items as calculated under regulatory accounting practices. The Bank's capital amounts and classification are also subject to qualitative judgments by the regulators about components, risk weightings and other factors. The Bank's Board of Directors has established a Capital Plan to ensure the Bank is managed to provide an appropriate level of capital. This plan includes strategies which enable the Bank to maintain targeted capital ratios in excess of the regulatory definition of "well capitalized", identify sources of additional capital and evaluate on a quarterly basis the impact on capital resulting from certain potential significant financial events (stress testing). Additionally, a Contingency Plan exists which identifies scenarios that require specific actions in the event capital falls below certain levels. Quantitative measures established by regulation to ensure capital adequacy require the Bank to maintain minimum amounts and ratios (set forth in the table below) of total and Tier I capital (as defined in the regulations) to risk-weighted assets (as defined), and of Tier I capital (as defined) to average assets (as defined). As of March 31, 2014, the Bank was categorized as well-capitalized under the regulatory framework for prompt corrective action. To be categorized as well-capitalized, the Bank must maintain minimum total risk-based, Tier I risk-based, and Tier I leverage ratios as set forth in the table. There are no conditions or events since that notification that management believes have changed the institution's category as of March 31, 2014.



On January 20, 2014, the Company declared a cash dividend of $0.06 per common share to shareholders of record as of the close of business February 3, 2014. The dividend was paid on February 17, 2014.

The actual capital amounts, ratios and minimum regulatory guidelines for Cape Bank are as follows: Per Regulatory Guidelines Actual Minimum "Well Capitalized" Amount Ratio Amount Ratio Amount Ratio (dollars in thousands) March 31, 2014 Risk based capital ratios: Tier I risk based capital $ 101,227 13.16 % $ 30,768 4.00 % $ 46,152 6.00 % Total risk based capital $ 110,841 14.41 % $ 61,536 8.00 % $ 76,920 10.00 % Tier I leverage ratio $ 101,227 9.56 % $ 42,354 4.00 %



$ 52,943 5.00 %

December 31, 2013 Risk based capital ratios: Tier I risk based capital $ 101,008 13.07 % $ 30,913 4.00 % $ 46,369 6.00 % Total risk based capital $ 110,427 14.29 % $ 61,821 8.00 % $ 77,276 10.00 % Tier I leverage ratio $ 101,008 9.53 % $ 42,396 4.00 %



$ 52,995 5.00 %

Critical Accounting Policies. In the preparation of our consolidated financial statements, we have adopted various accounting policies that govern the application of accounting principles generally accepted in the United States. Our significant accounting policies are described in Note 2- Summary of Significant Accounting Policies - of the Notes to Consolidated Financial Statements. Certain accounting policies involve significant judgments and assumptions by us that have a material impact on the carrying value of certain assets and liabilities. We consider these accounting policies to be critical accounting policies. The judgments and assumptions we use are based on historical experience and other factors, which we believe to be reasonable under the circumstances. Actual results could differ from these judgments and estimates under different conditions, resulting in a change that could have a material impact on the carrying values of our assets and liabilities and our results of operations. 43

-------------------------------------------------------------------------------- Allowance for Loan Losses. We consider the allowance for loan losses to be a critical accounting policy. The allowance for loan losses is the amount estimated by management as necessary to cover losses inherent in the loan portfolio at the balance sheet date. The allowance is established through the provision for loan losses, which is charged to income. Determining the amount of the allowance for loan losses necessarily involves a high degree of judgment. In evaluating the allowance for loan losses, management considers historical loss factors, the mix of the loan portfolio (types of loans and amounts), geographic and industry concentrations, current national and local economic conditions and other factors related to the collectability of the loan portfolio, including underlying collateral values and estimated future cash flows. All of these estimates are susceptible to significant change. Groups of homogeneous loans are evaluated in the aggregate under FASB ASC Topic No. 450 Contingencies, using historical loss factors adjusted for economic conditions and other environmental factors. Other environmental factors include trends in delinquencies and classified loans, loan concentrations by loan category and by property type, seasonality of the portfolio, internal and external analysis of credit quality, and single and total credit exposure. Certain loans that indicate underlying credit or collateral concerns may be evaluated individually for impairment in accordance with FASB ASC Topic No. 310 Receivables. If a loan is impaired and repayment is expected solely from the collateral, the difference between the outstanding balance and the value of the collateral will be charged-off. For potentially impaired loans where the source of repayment may include other sources of repayment from third parties, the evaluation may include these potential sources of repayment and indicate the need for a specific reserve for any potential shortfall. This evaluation is inherently subjective, as it requires estimates that are susceptible to significant revision as more information becomes available or as projected events change. Management reviews the level of the allowance quarterly. Although we believe that we use the best information available to establish the allowance for loan losses, future adjustments to the allowance may be necessary if economic conditions differ substantially from the assumptions used in making the evaluation. In addition, the FDIC and the New Jersey Department of Banking and Insurance, as an integral part of their examination process, periodically review our allowance for loan losses. Such agencies may require us to recognize adjustments to the allowance based on judgments about information available to them at the time of their examination. A large loss could deplete the allowance and require increased provisions to replenish the allowance, which would adversely affect earnings. See Note 2 - Summary of Significant Accounting Policies - of the Notes to Consolidated Financial Statements. Securities Impairment. In December 2013, the Bank sold all of its CDO securities principally issued by insurance companies as well as three remaining CDO securities that had been principally issued by bank holding companies. At the time of sale, these securities had an aggregate book value of $8.3 million and the Bank recorded an $851,000 loss on the sale. Additionally, on February 27, 2014, the Bank sold its remaining portion of CDOs with a book value of zero, resulting in the $1.9 million gain. Securities that are in a loss position for 12 months or longer are reviewed to determine if there is other-than-temporary impairment (OTTI). If the market value of the security is equal to or greater than 90% of the book value, no action will be taken. If the market value of the security is less than 90% of the book value, management will research the security and evaluate the cause of the persistently depressed market value and document the findings. At March 31, 2014, there were no securities to be evaluated. Income Taxes. The Company is subject to the income and other tax laws of the United States and the State of New Jersey. These laws are complex and are subject to different interpretations by the taxpayer and the various taxing authorities. In determining the provisions for income and other taxes, management must make judgments and estimates about the application of these inherently complex laws, related regulations and case law. In the process of preparing the Company provision and tax returns, management attempts to make reasonable interpretations of applicable tax laws. These interpretations are subject to challenge by the taxing authorities upon audit or to reinterpretation based on management's ongoing assessment of facts and evolving case law. The Company and its subsidiaries file a consolidated federal income tax return and separate entity state income tax returns. The provision for federal and state income taxes is based on income and expenses, as reported in the consolidated financial statements, rather than amounts reported on the Company's federal and state income tax returns. When income and expenses are recognized in different periods for tax purposes than for book purposes, applicable deferred tax assets and liabilities are recognized for the future tax consequences attributable to the differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. The effect on deferred tax assets and liabilities of a change in tax rates is recognized as income or expense in the period that includes the enactment date. Deferred federal and state tax assets are reduced by a valuation allowance when, in the opinion of management, it is more likely than not that some portion or all of the deferred tax assets will not be realized. As of March 31, 2014, a valuation allowance of approximately $1.9 million had been established against the Company's deferred tax assets representing no change from December 31, 2013. See Note 9 to the Financial Statements for further details in determining the amount of the deferred tax asset that was more likely than not realizable. 44 -------------------------------------------------------------------------------- On a quarterly basis, management assesses the reasonableness of its effective federal and state tax rate based upon its current best estimate of net income and the applicable taxes expected for the full year.



Effect of Newly Issued Accounting Standards: See Note 2 - Summary of Significant Accounting Policies - of the Notes to Consolidated Financial Statements.


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