UNITED STATES
                       SECURITIES AND EXCHANGE COMMISSION
                             WASHINGTON, D.C. 20549



                                    FORM 10-Q

(MARK ONE)
( X )           QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(D)
                     OF THE SECURITIES EXCHANGE ACT OF 1934

                  For the Quarterly Period Ended September 30, 2004March 31, 2005

                                       OR

(   )           TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(D)
                     OF THE SECURITIES EXCHANGE ACT OF 1934

           For the transition period from             to
                                          .
                                                ----------    -------------------    -----------.


                         Commission File Number 0-25923


                               EAGLE BANCORP, INC
             (Exact name of registrant as specified in its charter)

             Maryland                                           52-2061461
(State or other jurisdiction of                               (I.R.S. Employer
incorporation or organization)                               Identification No.)

7815 Woodmont Avenue, Bethesda, Maryland                           20814
(Address of principal executive offices)                         (Zip Code)

                                 (301) 986-1800
              (Registrant's telephone number, including area code)

                                       N/A
              (Former name, former address and former fiscal year,
                         if changed since last report)

         Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days.       Yes (X)__(x)___     No ( )
                                                 -----        -----__(__)__

         Indicate by check mark whether the registrant is an accelerated filer
(
as(as defined in Rule 12b-2 of the Exchange Act   Yes ( )__(x)___     No (X)
                                                 -----        -----_____ -

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

         As of November 4, 2004,April 25, 2005, the registrant had 5,408,1697,093,201 shares of Common
Stock outstanding.


Item 1 - Financial Statements

                               EAGLE BANCORP, INC.
                           Consolidated Balance Sheets
                      September 30, 2004March 31, 2005 and December 31, 20032004
                             (dollars in thousands)

September 30, 2004March 31, December 31, ASSETS 2005 2004 -------------------- -------------------- (unaudited) 2003 ----------- ----------- Cash and cash equivalents $ 38,204 $ 25,103due from banks 23,193 31,100 Interest bearing deposits with banks and other banks 9,612 4,332short term investments 17,504 9,594 Federal funds sold 26,064 15,035 Investment securities available for sale, 77,606 82,581at fair value 65,449 64,098 Loans held for sale 3,138 3,6493,671 2,208 Loans 363,824 317,533437,117 415,509 Less allowance for credit losses (4,176) (3,680) --------- ---------(4,663) (4,240) -------------------- -------------------- Loans, net 359,648 313,853432,454 411,269 Premises and equipment, net 5,425 4,259 Deferred income6,176 5,726 Accrued interest, taxes 936 862 Otherand other assets 13,118 8,358 --------- ---------15,339 14,423 -------------------- -------------------- TOTAL ASSETS $ 507,687589,850 $ 442,997 ========= =========553,453 ==================== ==================== LIABILITIES AND STOCKHOLDERS' EQUITY LIABILITIES Deposits: Noninterest bearing demand $ 113,730 $ 90,468146,376 130,309 Interest bearing transaction 51,602 44,09352,613 57,063 Savings and money market 116,529 104,429136,330 126,299 Time, $100,000 or more 78,362 54,99298,860 99,882 Other time 50,798 41,532 --------- ---------48,731 48,734 -------------------- -------------------- Total deposits 411,021 335,514 Federal482,910 462,287 Customer repurchase agreements and federal funds purchased and securities sold under agreement to repurchase 27,370 38,45439,498 23,983 Other short-term borrowings 3,333 4,000 Long-term borrowings 8,110 10,5885,333 6,333 Other liabilities 1,375 1,429 --------- ---------2,469 2,316 -------------------- -------------------- Total liabilities 451,209 389,985 --------- ---------530,210 494,919 -------------------- -------------------- STOCKHOLDERS' EQUITY Common stock, $.01 par value; shares authorized 20,000,000, shares issued and outstanding 5,407,8897,088,651 (2005) and 5,421,730 (2004) and 5,359,153 (2003) 5471 54 Additional paid in capital 46,802 46,40647,433 47,014 Retained earnings 9,533 6,28112,525 11,368 Accumulated other comprehensive (loss) income 89 271 --------- ---------(389) 98 -------------------- -------------------- Total stockholders' equity 56,478 53,012 --------- ---------59,640 58,534 -------------------- -------------------- TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $ 507,687589,850 $ 442,997 ========= =========553,453 ==================== ====================
See notes to consolidated financial statements. 2 EAGLE BANCORP, INC. CONSOLIDATED STATEMENTS OF OPERATIONS NINE AND THREE MONTHS ENDED SEPTEMBER 30,Consolidated Statements of Operations For the Three Month Periods Ended March 31, 2005 and 2004 AND 2003(unaudited) (dollars in thousands, except per share amounts-unaudited)data)
Nine Months Nine Months Three Months Three Months Ended Ended Ended Ended Sept 30,2005 2004 Sept 30, 2003 Sept 30, 2004 Sept 30, 2003 ------------- ------------- ------------- ----------------------------- ---------------- INTEREST INCOME:INCOME Interest and fees on loans $ 15,1576,997 $ 11,894 $ 5,407 $ 4,1114,787 Taxable interest and dividends on investment securities 1,639 1,280 584 364487 527 Interest on balances with other banks 98 149 37 5442 26 Interest on federal funds sold /other cash equivalents 241 37 118 12 -------- -------- -------- -------- 17,135 13,360 6,146 4,541 -------- -------- -------- --------184 36 --------------- ----------------- Total interest income 7,710 5,376 --------------- ----------------- INTEREST EXPENSE: 2,689 2,360 973 704EXPENSE Interest on deposits 1,141 811 Interest on customer repurchase agreements and federal funds purchased and securities sold under agreement to repurchase 61 68 27 1033 30 Interest on short-term borrowings 112 25761 27 113 Interest on long-term borrowings 266 363 88 79 -------- -------- -------- --------- 101 --------------- ----------------- Total interest expense 3,128 3,048 1,115 906 -------- -------- -------- --------1,235 969 --------------- ----------------- NET INTEREST INCOME 14,007 10,312 5,031 3,6356,475 4,407 PROVISION FOR CREDIT LOSSES 457 730 227 305 -------- -------- -------- --------417 154 --------------- ----------------- NET INTEREST INCOME AFTER PROVISION FOR CREDIT LOSSES 13,550 9,582 4,804 3,330 -------- -------- -------- --------6,058 4,253 --------------- ----------------- NONINTEREST INCOME:INCOME Service charges on deposit accounts 1,014 892 305 313deposits 269 346 Gain (loss)on sale of loans 495 172 Gain on sale of investment securities 193 214 (60) -- Gain on sale of loans 561 545 172 199- 253 Other income 836 482 280 175 -------- -------- -------- --------275 311 --------------- ----------------- Total noninterest income 2,604 2,133 697 687 -------- -------- -------- --------1,039 1,082 --------------- ----------------- NONINTEREST EXPENSES:EXPENSE Salaries and employee benefits 6,016 4,202 2,115 1,4562,560 1,954 Premises and equipment expenses 1,971 1,498 701 564801 598 Advertising 212 203 53 7996 56 Outside data processing 469 407 183 143181 142 Other expenses 2,418 1,610 910 562 -------- -------- -------- --------837 743 --------------- ----------------- Total noninterest expenses 11,086 7,920 3,962 2,804 -------- -------- -------- -------- NETexpense 4,475 3,493 --------------- ----------------- INCOME BEFORE INCOME TAXES 5,068 3,795 1,539 1,213TAX EXPENSE 2,622 1,842 INCOME TAXES 1,816 1,395 539 435 -------- -------- -------- --------TAX EXPENSE 969 663 --------------- ----------------- NET INCOME $ 3,2521,653 $ 2,400 $ 1,000 $ 778 ======== ======== ======== ======== INCOME1,179 =============== ================= EARNINGS PER SHARE:SHARE Basic $ 0.60 $ 0.70 $ 0.180.23 $ 0.17 Diluted $ 0.58 $ 0.65 $ 0.180.22 $ 0.16
See notes to consolidated financial statementsstatements. 3 EAGLE BANCORP, INC. CONSOLIDATED STATEMENTS OF CASH FLOWS FOR THE NINE MONTHS ENDED SEPTEMBER 30,Consolidated Statements of Cash Flows For the Three Month Periods Ended March 31, 2005 and 2004 and 2003(unaudited) (dollars in thousands-unaudited)thousands)
Nine Months Ended Nine Months Ended September 30,2005 2004 September 30, 2003 ------------------ --------------------------------- ----------------- CASH FLOWS FROM OPERATING ACTIVITIES: Net income $ 3,2521,653 $ 2,4001,179 Adjustments to reconcile net income to net cash Provided (used)provided by (used in) operating activities: Decrease in deferred income taxes (74) (219) Provision for credit losses 457 730417 154 Depreciation and amortization 727 504 Gain260 209 Gains on sale of loans (561) (545)(495) (172) Origination of loans held for sale (18,412) (17,644)(10,661) (7,470) Proceeds from sale of loans held for sale 19,484 21,8059,693 6,950 Gain on sale of investment securities (193) (214)- (253) Increase in other assets (760) (609) Decrease (increase)(640) (410) Increase in other liabilities 203 (505) --------- ---------153 206 --------------- ----------------- Net cash provided by operating activities 4,123 5,703 --------- ---------380 393 --------------- ----------------- CASH FLOWS FROM INVESTING ACTIVITIES: (Increase) decreaseIncrease in interest bearing deposits with other banks (5,280) 1,758(7,910) (649) Purchases of available for sale investment securities (190,580) (156,409)(3,349) (63,060) Proceeds from maturities of available for sale securities 155,720 140,7461,293 45,251 Proceeds from sale of available for sale securities 39,667 14,577 Decrease- 30,340 Increase in federal funds sold -- 1,012(11,029) (17,026) Net increase in loans (46,330) (50,400)(21,602) (12,804) Bank premises and equipment acquired (1,893) (1,129) Increase in(710) (813) Purchase of BOLI contracts (4,000)- (2,000) --------- ------------------------ ----------------- Net cash used byin investing activities (52,696) (51,845) --------- ---------(43,307) (20,761) --------------- ----------------- CASH FLOWS FROM FINANCING ACTIVITIES: Increase in deposits 75,507 34,870 Decrease20,623 50,126 Increase (decrease) in customer repurchase agreements and federal funds purchased and securities sold under agreement to repurchase (11,084) (5,045)15,515 (24,496) Decrease in other short termshort-term borrowings (667) (4,600) Decrease in(1,000) - Proceeds from long-term borrowings (2,478) (2,701)- (1,037) Issuance of common stock 396 29,887 --------- ---------382 331 Payment of dividends (500) --------------- ----------------- Net cash provided by financing activities 61,674 52,411 --------- ---------35,020 24,924 --------------- ----------------- NET (DECREASE) INCREASE IN CASH 13,101 6,269(7,907) 4,556 CASH AND DUE FROM BANKS AT BEGINNING OF PERIODYEAR 31,100 25,103 18,569 --------- ------------------------ ----------------- CASH AND DUE FROM BANKS AT END OF PERIODYEAR $ 38,20423,193 $ 24,838 ========= ========= Supplemental cash flow information:29,659 =============== ================= SUPPLEMENTAL CASH FLOWS INFORMATION: Interest paid $ 2,9961,180 $ 2,958916 =============== ================= Income taxes paid $ 1,520710 $ 1,372400 =============== =================
See notes to consolidated financial statementsstatements. 4 EAGLE BANCORP, INC CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY FOR THE NINE MONTHS ENDED SEPTEMBER 30, unaudited)INC. Consolidated Statements of Changes in Stockholders' Equity For the Three Month Periods Ended March 31, 2005 and 2004 (unaudited) (dollars in thousands)
Accumulated Additional Other Total Common Paid in Retained Comprehensive StockholdersStockholders' Stock in Capital Earnings Income (loss)(Loss) Equity ----- ------- -------- ------------- ------------------- -------------- -------------- -------------- Balances atBalance, January 1, 2005 $ 54 $ 47,014 $ 11,368 $ 98 $ 58,534 Net Income 1,653 1,653 Cash Dividend ($ .07 per share) (4) (496) (500) 1.3 to one stock split in the form of a 30% stock dividend 17 (17) - - - Exercise of options for 41,468 shares of common stock - 382 - - 382 Tax benefit on non-qualified options exercise 58 58 Other Comprehensive Income Unrealized loss on securities available for sale (net of taxes) - - - (487) (487) ------------- ------------- -------------- -------------- -------------- Balance, March 31, 2005 $ 71 $ 47,433 $ 12,525 $ (389) $ 59,640 ============= ============= ============== ============== ============== Balance, January 1, 2004 $ 54 $ 46,406 $ 6,281 $ 271 $ 53,012 Net income 3,252 3,252Income 1,179 1,179 Exercise of options for 42,464 shares of common stock - 331 - - 331 Other comprehensive income:Comprehensive Income Unrealized lossgain on securities available for sale (net of related tax) (182) (182) -------- Total other comprehensive income 3,070 --------------------------------------------------------------------------- Exercise of options for 48,866 shares of common stock 396 396 --------------------------------------------------------------------------- Balances at September 30,taxes) - - - 134 134 ------------- ------------- -------------- -------------- -------------- Balance, March 31, 2004 $ 54 $ 46,80246,737 $ 9,5337,460 $ 89405 $ 56,478 =========================================================================== Balances at January 1, 2003 $ 29 $ 16,541 $ 3,066 $ 392 $ 20,028 Net income 2,400 2,400 Other comprehensive income: Unrealized loss on investment securities available for sale (net of related tax) (414) (414) -------- Total comprehensive income 1,986 --------------------------------------------------------------------------- Proceeds from sale of 2,448,979 shares of common stock 24 29,744 29,768 Exercise of options for 9,470 shares of common stock 119 119 --------------------------------------------------------------------------- Balances at September 30, 2003 $ 53 $ 46,404 $ 5,466 $ (22) $ 51,901 ===========================================================================54,656 ============= ============= ============== ============== ==============
See notes to consolidated financial statements. 5 EAGLE BANCORP, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS For the three months ended March 31, 2005 and 2004 (unaudited) 1. BASIS OF PRESENTATION General - The financial statements of Eagle Bancorp, Inc. (the "Company") included herein are unaudited; however, they reflect all adjustments consisting only of normal recurring accruals that, in the opinion of Management, are necessary to present fairly the results for the periods presented. The amounts as of December 31, 20032004 were derived from audited consolidated financial statements. Certain information and note disclosures normally included in financial statements prepared in accordance with accounting principles generally accepted in the United States of America have been condensed or omitted pursuant to the rules and regulations of the Securities and Exchange Commission. There have been no significant changes to the Company's Accounting Policies as disclosed in the 20032004 Annual Report. The Company believes that the disclosures are adequate to make the information presented not misleading. The results of operations for the ninethree months ended September 30, 2004March 31, 2005 are not necessarily indicative of the results of operations to be expected for the remainder of the year, or for any other period. 2. NATURE OF BUSINESS The Company, through its bank subsidiary, provides domestic financial services primarily in Montgomery County, Maryland and Washington, DC. The primary financial services include real estate, commercial and consumer lending, as well as traditional demand depositsdeposit and savingsrepurchase agreement products. The Bank is also active in the origination and sale of residential mortgages and small business loans. A new noninterest income business was organized in the first quarter of 2005, which provides professional services in connection with loan settlement processes. 3. INVESTMENT SECURITIES Amortized cost and estimated fair value of securities available - for - sale are summarized as follows:
(in thousands)
September 30, 2004 ------------------------------------------------------------------ Gross Gross Estimated Amortized Unrealized Unrealized Estimated Fair MARCH 31, 2005 Cost Gains Losses Value --------- ---------- ---------- ---------- -------------- ------------------ ----------------- ---------------- ------------------ U. S. Government Agencyagency securities $ 46,57237,472 $ 8- $ (103) 46,477 Mortgage610 $ 36,862 GNMA mortgage backed securities 21,418 84 (131) 21,37121,884 10 423 21,471 Federal Reserve Bank and Federal Home Loan Bank stock 1,6342,215 - - 1,6342,215 Other equity investments 7,847 380 (103) 8,124 -------- -------- -------- --------4,435 474 8 4,901 ------------------ ----------------- ---------------- ------------------ $ 77,47166,006 $ 472484 $ (337)1,041 $ 77,606 ======== ======== ======== ======== December 31, 2003 ------------------------------------------------------------------65,449 ================== ================= ================ ================== Gross Gross Estimated Amortized Unrealized Unrealized Estimated Fair DECEMBER 31, 2004 Cost Gains Losses Value --------- ---------- ---------- --------- - ----------------- ------------------ ----------------- ---------------- ------------------ U. S. Government Agencyagency securities $ 25,35534,478 $ 76- $ (38)294 $ 25,373 Mortgage34,184 GNMA mortgage backed securities 51,887 101 (246) 51,84223,177 77 188 23,066 Federal Reserve Bank and Federal Home Loan Bank stock 1,6701,956 - - 1,6701,956 Other equity investments 3,282 421 (7) 3,696 -------- -------- -------- --------4,339 555 2 4,892 ------------------ ----------------- ---------------- ------------------ $ 82,17463,950 $ 698632 $ (291)484 $ 82,581 ======== ======== ======== ========64,098 ================== ================= ================ ==================
6 Gross unrealized losses and fair value by length of time that the individual available securities have been in a continuous unrealized loss position as of September 30, 2004March 31, 2005 are as follows: (in thousands)
TotalGross Estimated Less than More than Unrealized MARCH 31, 2005 (IN THOUSANDS) Fair Value 12 Monthsmonths 12 Monthsmonths Losses --------------------------------------------------------------------------- ------------------------------ ----------------- -------------- -------------- ---------------- U. S. Government Agencyagency securities $ 34,48036,862 $ (61)476 $ (42)134 $ (103) Mortgage610 GNMA mortgage backed securities 15,830 (31) (100) (131)21,471 178 245 423 Federal Reserve and Federal Home Loan Bank stock 2,215 - - - Other equity investments 1,049 (98) (5) (103) -------- -------- -------- -------- Total4,901 - 8 8 ----------------- -------------- -------------- ---------------- $ 51,35965,449 $ (190)654 $ (147)387 $ (337)1,041 ================= ============== ============== ================ Gross Estimated Less than More than Unrealized DECEMBER 31, 2004 (IN THOUSANDS) Fair Value 12 months 12 months Losses - --------------------------------- ----------------- -------------- -------------- ---------------- U. S. Government agency securities $ 34,184 $ 221 $ 73 $ 294 GNMA mortgage backed securities 23,066 21 167 188 Federal Reserve and Federal Home Loan Bank stock 1,956 - - - Other equity investments 4,892 - 2 2 ----------------- -------------- -------------- ---------------- $ 64,098 $ 242 $ 242 $ 484 ================= ============== ============== ================
The unrealized losses that exist are the result of market changes in interest rates since the original purchases. All of the bonds are rated AAA. These factors coupled with the Company's ability and intent to hold these investments for a period of time sufficient to allow for any anticipated recovery in fair value substantiates that the unrealized losses are temporary. 4. INCOME TAXES The Company uses the liability method of accounting for income taxes as required by SFASStatement of Financial Accounting Standards No. 109 (SFAS109), "Accounting for Income Taxes." Under the liability method, deferred-tax assets and liabilities are determined based on differences between the financial statement carrying amounts and the tax bases of existing assets and liabilities (i.e., temporary differences) and are measured at the enacted rates that will be in effect when these differences reverse. 5. EARNINGS PER SHARE Earnings per common share are computed by dividing net income by the weighted average number of common shares outstanding during the period. Diluted net income per common share is computed by dividing net income by the weighted average number of common shares outstanding during the period, including any potential dilutive common shares outstanding, such as options and warrants. As of September 30, 2004March 31, 2005 there were 54,360no shares excluded from the diluted net income per share computation because their inclusion would be anti-dilutiveanti-dilutive. Earnings per share for the three months ended March 31, 2004 have been adjusted to reflect a 1.3 for one stock split in the form of a 30% stock dividend effected on February 28, 2005. 7 6. STOCK-BASED COMPENSATION The Company has adopted the disclosure-only provisions of SFAS No. 123 "Accounting for Stock-Based Compensation" and SFAS No. 148 "Accounting for Stock-Based Compensation-Transitionapplies the intrinsic value method of recognition and Disclosure", but appliesmeasurement principles of Accounting Principles Board Opinion No. 25No.25 and related interpretations in accounting for its Plan. No compensation expense related to the Plan was recorded during the three and nine months ended September 30, 2004March 31, 2005 and 2003.2004. If the Company had elected to recognize compensation cost based on fair value at the grant dates for awards under the Plan consistent with the method prescribed by SFAS No. 123, net income and earnings per share would have been changed to the pro forma amounts as follows for the three month ended March 31, 2005 and nine months ended September 30. 7
Nine Months Three Months Ended September 30, Ended September 30, ---------------------------- --------------------------- 2004 2003 2004 2003 ------------- -------------- ------------- ------------- Net income, as reported $ 3,252 $ 2,400 $ 1,000 $ 778 Less pro forma stock-based compensation expense determined under the fair value method, net of related tax effects (724) (173) (6) - ------------- -------------- ------------- ------------- Pro forma net income $ 2,528 $ 2,227 $ 994 $ 778 ============= ============== ============= ============= Net income per share: Basic - as reported $ 0.60 $ 0.70 $ 0.18 $ 0.17 Basic - pro forma $ 0.52 $ 0.65 $ 0.18 $ 0.17 Diluted - as reported $ 0.47 $ 0.65 $ 0.18 $ 0.16 Diluted - pro forma $ 0.44 $ 0.61 $ 0.18 $ 0.16
2004. Three Months Ended March 31, ------------------ 2005 2004 --------- -------- Net income, as reported $ 1,653 $1,179 Less pro forma stock-based compensation expense determined under the fair value method, net of related tax effects (432) (718) --------- -------- Pro forma net income $1,221 $ 461 ========= ======== Net income per share: Basic - as reported $ .23 $ .17 Basic - pro forma $ .17 $ .07 Diluted - as reported $ .22 $ .16 Diluted - pro forma $ .16 $ .06 8 ITEMItem 2 - MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATION.Management's Discussion and Analysis of Financial Condition and Results of Operation. The following discussion provides information about the results of operations, and financial condition, liquidity, and capital resources of the Company and its subsidiary, the Bank. This discussion and analysis should be read in conjunction with the unaudited Consolidated Financial Statements and Notes thereto, appearing elsewhere in this report.report and the Management Discussion and Analysis in the Company's Annual Report on Form 10-K for the year ended December 31, 2004. This report contains forward looking statements within the meaning of the Securities Exchange Act of 1934, as amended, including statements of goals, intentions, and expectations as to future trends, plans, events or results of Company operations and policies and regarding general economic conditions. In some cases, forward looking statements can be identified by use of such words as "may", "will", "anticipate", "believes", "expects", "plans", "estimates", "potential", "continue", "should", and similar words or phases. These statements are based upon current and anticipated economic conditions, nationally and in the Company's market, interest rates and interest rate policy, competitive factors and other conditions which, by their nature, are not susceptible to accurate forecast, and are subject to significant uncertainty. Because of these uncertainties and the assumptions on which this discussion and the forward looking statements are based, actual future operations and results in the future may differ materially from those indicated herein. Readers are cautioned against placing undue reliance on any such forward looking statements. GENERAL Eagle Bancorp, Inc. is a growing,growth oriented, one-bank holding company headquartered in Bethesda, Maryland. We provide general commercial and consumer banking services through our wholly owned banking subsidiary EagleBank, a Maryland chartered bank which is a member of the Federal Reserve System. We were organized in October 1997 to be the holding company for the Bank. The Bank was organized as an independent, community oriented, full-servicefull service banking alternative to the super regional financial institutions, which dominate our primary market area. The cornerstone of our philosophy is to provide superior, personalized service to our customers. We focus on relationship banking, providing each customer with a number of services, becoming familiar with and addressing customer needs in a proactive, personalized fashion. The Bank currently has five offices serving Montgomery County and twothree offices in the District of Columbia. In February 2004, the Company executed a lease for a new office to be opened in 2006 in Friendship Heights, Montgomery County, Maryland, on the District of Columbia line. Most recently the Company executed a lease for a third District of Columbia office to be located at 1425 K Street NW, Washington, D. C. This office will become the District of Columbia regional office and is expected to open in the first quarter of 2005.2006 in Chevy Chase, Montgomery County, Maryland. In February 2005, Eagle Land Title, LLC, a Bank subsidiary which performs professional services in connection with loan settlements, commenced operations. The Company offers fulla broad range of commercial banking services to our business and professional clients as well as completefull service consumer banking services to individuals living and/or working in the service area. We emphasize providing commercial banking services to sole proprietors, small and medium-sized businesses, partnerships, corporations, non-profit organizations and associations, and investors living and working in and near our primary service area. A full range of retail banking services are offered to accommodate the individual needs of both corporate customers as well as the community we serve. These services include the usual deposit functions of commercial banks, including business and personal checking accounts, "NOW" accounts and savings accounts, business, construction, and commercial loans, equipment leasing, residential mortgages and consumer loans and cash management services. We have developed significant expertise and commitment as an SBA lender, have been designated a Preferred Lender by the Small Business Administration (SBA), and are one of the largest community bank SBA lenders, in dollar volume, in the Washington Metropolitan area. In June 2003, the Company formed a second wholly owned subsidiary, Bethesda Leasing, LLC ("Bethesda Leasing"). Bethesda Leasing was formed for the purpose of acquiring an impaired loan from the Bank in order to effect more efficient administration and collection procedures. CRITICAL ACCOUNTING POLICIES The Company's consolidated financial statements are prepared in accordance with accounting principles generally accepted in the United States of America ("GAAP") and follow general practices within the banking industry. Application of these principles requires management to make estimates, assumptions, and judgments that affect the amounts reported in the financial statements and accompanying notes. These estimates, assumptions and judgments are based on information available as of the date of the financial statements; accordingly, as this information changes, the financial statements could reflect different estimates, assumptions, and judgments. Certain policies inherently have a greater reliance on the use of estimates, assumptions and judgments and as such have a greater possibility of producing results that could be materially different than originally reported. Estimates, assumptions, and judgments are necessary when assets and liabilities are required to be recorded at fair value, when a decline in the value of an asset not carried on the financial statements at fair value warrants an impairment write-down or valuation reserve to be established, or when an asset or liability needs to be recorded contingent upon a future event. Carrying assets and liabilities at fair value inherently results in more financial statement volatility. The fair values and the information used to record valuation adjustments for certain assets and liabilities are based either on quoted market prices or are provided by other third-party sources, when available. 9 The allowance for credit losses is an estimate of the losses that may be sustained in our loan portfolio. The allowance is based on two principles of accounting: (a) Statement on Financial Accounting Standards ("SFAS") 5, "Accounting for Contingencies", which requires that losses be accrued when they are probable of occurring and are estimable and (b) SFAS No. 114, "Accounting by Creditors for Impairment of a Loan", which requires that losses be accrued when it is probable that the Company will not collect all principal and interest payments according to the contractual terms of the loan. The loss, if any, iscan be determined by the difference between the loan balance and the value of collateral, the present value of expected future cash flows, or values observable in the secondary markets. Three basic components comprise our allowance for credit losses: a specific allowance, a formula allowance and a nonspecific allowance. Each component is determined based on estimates that can and do change when the actual events occur. The specific allowance is used to individually allocateallocates an allowance to loans identified as impaired. An impairedloans. A loan for which reserves are individually allocated may show deficiencies in the borrower's overall financial condition, payment record, support available from financial guarantors and/and or the fair market value of collateral. When a loan is identified as impaired, a specific reserve is established based on the Company's assessment of the loss that may be associated with the individual loan. The formula allowance is used to estimate the loss on internally risk rated loans, exclusive of those identified as impaired.requiring specific reserves. Loans identified as special mention, substandard, doubtful and loss, as well as impaired, are segregated from performingnon-rated loans. Remaining loans are then grouped by type (commercial, commercial real estate, construction, home equity or consumer). Each loan type is assigned an allowance factor based on management's estimate of the risk, complexity and size of individual loans within a particular category. Classified loans are assigned higher allowance factors than non-rated loans due to management's concerns regarding collectibility or management's knowledge of particular elements regarding the borrower. Allowance factors growincrease with the worsening of the internal risk rating. The nonspecific formula is used to estimate the loss of non-classifiedremaining loans stemming from(those not identified as either requiring specific reserves or having classified risk ratings). The loss estimates are based on more global factors incident to the overall portfolio, such as delinquencies,delinquency trends, loss history, trends in the volume and termssize of loans,individual credits, effects of changes in lending policy, the experience and depth of management, national and local economic trends, any concentrations of credit, the quality of loan review system and the effect of external factors such as competition and regulatory requirements. The nonspecific allowance captures losses whose impact on the portfolio may have occurred but have yet to be recognized in either the formula or specific allowance. Management has significant discretion in making the judgments inherent in the determination of the provision and allowance for credit losses, including, in connection with the valuation of collateral, a borrower's prospects of repayment, and in establishing allowance factors on the formula allowance and nonspecific allowance components of the allowance. The establishment of allowance factors is a continuing exercise,evaluation, based on management's continuingongoing assessment of the global factors discussed above and their impact on the portfolio, andportfolio. The allowance factors may change from period to period, resulting in an increase or decrease in the amount of the provision or allowance, based upon the same volume and classification of loans. Changes in allowance factors will have a direct impact on the amount of the provision, and a related, after tax effect on net income. Errors in management's perception and assessment of the global factors and their impact on the portfolio could result in the allowance not being adequate to cover losses in the portfolio, and may result in additional provisions or charge-offs. For additional information regarding the allowance for credit losses, refer to the discussion under the caption "Allowance for Credit Losses" below. RESULTS OF OPERATIONS The Company reported net income of $3.3 million for the nine months and $1.0$1.7 million for the three months ended September 30, 2004,March 31, 2005, as compared to net income of $2.4$1.2 million for the nine months and $ 778 thousand for the three months ended September 30, 2003.March 31, 2004. Income per basic share was $0.60 for the nine months and $0.18$0.23 for the three months ended September 30, 2004,March 31, 2005, as compared to $0.70 and $0.17 for the same periodsperiod in 2003.2004. Income per diluted share was $0.58 for the nine months and $0.18$0.22 for the three months ended September 30, 2004,March 31, 2005, as compared to $0.65 and $0.16 for the same periodsperiod in 2003.2004. Earnings per share for the three months ended March 31, 2004 have been adjusted to reflect a 1.3 for one stock spilt in the form of a 30% stock dividend effected on February 28, 2005. 10 The Company had aan annualized return on average assets of 0.9%1.20% and an annualized return on average equity of 7.9%11.32% for the first ninethree months of 2004,2005, as compared to returns on average assets and average equity of 0.9%1.08% and 11.5%8.78%, respectively, for the same ninethree months of 2003. 10 2004. The increase in net income for the ninethree months ended September 30, 2004March 31, 2005 as compared to the same period in 2003,2004, can be attributed substantially to an increase of 35.8%47% in net interest income, resulting from an increase of 29.7%28% in average earning assets and an increase in the net interest spread of 59 basis points and the net interest margin of 1865 basis points. Net interest income increased from $10.3 million to $14.0 million and average earning assets increased from $337 million to $438 million. Net interest margin increased from 4.09% forpoints between the first nine months of 2003 to 4.27% for the same period in 2004 as market interest rates began to rise after falling through most of 2003. Oncomparable periods. Since June 30, 2004, the Federal Reserve Bank announced its first increase inhas increased the federal funds target rate by 1.75% to 2.75% in over two years. Thatseven interest rate increases of 25 basis point increase was followed by 25 basis point increases in August and September.points. The impact of these increases has contributed to the improvement in the Company's margin.margin in the past several quarters. While short terminterest rates on earning assets have risen by 65 basis points, the cost of short term core, NOWinterest bearing liabilities has increased by only 6 basis points. Additionally, the growth in average noninterest bearing funding sources for the first quarter of 2005 as compared to 2004 has been $52.6 million or 49%. This significant growth in noninterest bearing funding sources has increased the value of noninterest sources funding earning assets from 34 basis points for the first three months in 2004 to 40 basis points for the three months ended March 31, 2005. Thus, the Company has been able to increase its primary source of funds (core deposits) at rates which have allowed its net interest spread and MMA accounts,margin to increase in the first quarter of 2005 as compared to the same period in 2004. As a result of competitive pressures, rates paid on deposits, which have not increased as much or as rapidly as interest rates on earning assets, may result in a higher cost of funding in future periods, which may not be offset by comparable basis points. The percentagefurther increases in interest rates on earning assets. As a result of loans,such potential margin compression, the Company's earnings could be adversely effected. Loans, which generally have higher yields than securities and other earning assets, increased from 76%79% of average earning assets in the nine month periodfirst three months of 20032004 to 78%81% of average earning assets infor the same period of 2004. Noninterest income increased 22%,2005. Investment securities in the first quarter of 2005 amounted to $2.6 million12% of average earning assets as compared to 16% for the first ninethree months in 2004. This decline was directly related to average loan growth over the past twelve month period exceeding the growth of 2004, from $2.1 million in the same period of 2003.average deposit and other funding sources. The net incomeprovision for credit losses was $417 thousand for the three months ended September 30, 2004, represents an increase of 28% fromfirst quarter in 2005 as compared to $154 thousand for the same period in 2003, $1 million as compared2004. This increase was largely attributable to $778 thousand. The combination of an increase in net interest income, a lower provision for credit losses, and an increase in noninterest income resultedthe growth in the significant improvement in reported income. For the nine months ended September 30, 2004, the Company recorded a provision for credit lossesloan portfolio in the amount of $457 thousand compared to $730 thousand for the first nine months of 2003. The provision for the third quarter of 20042005, which was $227 thousand compared to $305 thousand for the same quarter in 2003.very favorable. As discussed in the section on Allowance for Credit Losses, the Company had significant$6 thousand of net recoveries on previously charged off loans andin the Company's loss experience continuedfirst quarter of 2005. This compared to be very favorable allowingnet charge-offs of $84 thousand for an adjustment in factors influencing the levelfirst three months of the allowance.2004. At September 30, 2004,March 31, 2005, the allowance for credit losses was $4.2$4.7 million or 1.07% of total loans, as compared to $3.7 million or 1.14% of total loans at March 31, 2004 and $ 4.2 million or 1.02% of total loans at December 31, 2003. The Company had net recoveries of $39 thousand during the first nine months of 2004. This comparedNoninterest income decreased 4%, to net charge-offs of $259 thousand$1.0 million for the first ninethree months of 2003. While2005, from $1.1 million in the resultssame period of operations2004. However, noninterest income for the first ninethree months of 2004 included investment securities gains of $253 thousand, while no securities gains were recognized in the first quarter of 2005. Excluding gains on the sale of investment securities, noninterest income was $1.0 million in 2005 versus $0.8 million for 2004, an increase of 25%. This increase was due primarily to increased gains on the sale of SBA loans ($385 thousand versus $97 thousand), and thirdresidential mortgage loans ($110 thousand versus $75 thousand). Noninterest expenses increased from $3.5 million in the first quarter of 2004 compared to the first nine months and to the third quarter of 2003 were up, $3.3 million from $2.4$4.5 million for the nine month periodsfirst quarter of 2005, an increase of 28%. The increase was attributable primarily to increases in staff levels, and $1 million from $778 thousandrelated personnel cost increases, to increased occupancy costs, due in part to new banking offices, and to higher marketing, data processing, and professional fees associated with a larger organization. The efficiency ratio improved in the first quarter of 2005 to 59.56% as compared to 63.64% for the quarterly periods, earnings per share were down, $0.60first quarter in 2004. The combination of increases in net interest income from $0.70both increased volume and favorable interest rate effects, offset in part by increases in the provision for credit losses, stable noninterest income and increases in noninterest expenses, resulted in the significant improvement in reported income for the nine month period but up for the quarter from $0.17 in 2003 to $0.18 in the thirdfirst quarter of 2005 versus 2004. The increase in earnings per share in the third quarter can be attributed to the commonality of share basis for the computation. In August 2003, the Company closed its stock offeringNet Interest Income and included an additional 2.4 million shares in its earnings per share computation giving the effect of a reduced earnings per share. For the nine month period return on average equity was down to 7.9% for 2004 from 11.5% for 2003. The reduction in this ratio is directly attributable to the increase in equity of approximately $30 million resulting from the stock offering closed in August 2003. The following table sets out the annualized returns on average assets, returns on average equity and equity to assets (average) for the nine months ended September 30, 2004 and 2003 and the year ended December 31, 2003:
September September December 2003 2003 2004 ---- ---- ---- Return on average assets 0.92% 0.88% 0.86% Return on average equity 7.91% 11.50% 9.45% Average equity to average assets 11.68% 7.66% 9.05%
NET INTEREST INCOME AND NET INTEREST MARGINNet Interest Margin Net interest income is the difference between interest income on earning assets and the cost of funds supporting those assets. Earning assets are composed primarily of loans and investment securities. The cost of funds represents interest expense on deposits, customer repurchase agreements and other borrowings. Noninterest bearing deposits and capital are other components representing funding sources. Changes in the volume and mix of assets and funding sources, along with the changes in yields earned and rates paid, determine changes in net interest income. Net interest income for the first ninethree months of 20042005 was $14.0$6.5 million compared to $10.3$4.4 million for the first ninethree months of 2003 and for the third quarter of 2004 was $5.0 compared to $3.6 million for the third quarter of 2003.2004. 11 The table labeled "Average Balances, Interest Yields and Rates and Net Interest Margin" presents the average balances and rates of the various categories of the Company's assets and liabilities. Included in the table is a measurement of interest rate spread and margin. Interest spread is the difference (expressed as a percentage) between the interest rate earned on earning assets less the cost of funds expressed as a percentage.interest expense on interest bearing liabilities. While net interest spread provides a quick comparison of earnings rates versus cost of funds, management believes that margin provides a better measurement of performance. Margin includes the effect of noninterest bearing liabilitiessources in its calculation and is net interest income expressed as a percentage of totalaverage earning assets. Interest spread increased in the nine months of 2004 from the first nine months of 2003 by 20 basis points, to 3.92% from 3.72%; and margin increased 18 basis points, to 4.27% from 4.09%. The increases by the Federal Reserve in the federal funds target rate, beginning June 30 and continuing in August and September, aggregated 75 basis points and contributed to and is expected to continue to contribute to improved spread and margin. Management is particularly pleased that the Company was able to maintain a relatively stable spread and margin following a long period of interest rate declines. Management was able to maintain stability by reducing the cost of funds, from 1.58% during the first nine months of 2003 to 1.31% for the same period in 2004, as it faced lower yields on its earning assets, which declined from 5.29% during the first nine months of 2003 to 5.23% in 2004. At the same time, the mix of earning assets improved as higher yielding loans increased from 76% of earning assets in 2003 to 78% in 2004. The declines in the yields on earning assets from the first nine months of 2003 to the first nine months of 2004 reflect the impact of the significant rate reductions effected by the Federal Reserve from 2001 through 2003 on loans, which comprise the vast majority of earning assets. After a long decline, the investment portfolio yield increased by 61 basis points from the first nine months of 2003 to the same period in 2004. The slowdown in mortgage refinancing caused by slightly higher rates helped improve the Bank's investment portfolio yield as premium amortizations on mortgage backed securities slowed. In order to keep the investment portfolio short for liquidity with expectations that rates would start to move upward, the Bank invested in interest bearing deposits with other banks, in amounts which made them eligible for FDIC insurance to obtain better short term yields. These CDs yielded 2.35% during the first nine months of 2004, a relatively attractive rate given their short term nature and low risk, as compared to the rates offered on federal funds and U. S. Treasury bills. At September 30, 2004, the Bank had $9.6 million of such deposits. The decline in yields on interest bearing liabilities is also reflective of the series of rate cuts by the Federal Reserve. The recent increases in the federal funds target rate are expected to have a positive impact on Company earnings. Management feels that the Company's earning assets are of a short enough duration to take full advantage of further increases in rates by the Federal Reserve System and other market forces, while increases in rates on deposits are expected to lag increases on earning assets. See the section addressing GAP and Asset/Liability Management. The decline in the yield on the loan portfolio, 28 basis points from September 2003 to September 2004, was less than might be expected in the general interest rate environment of 2003 leading into the 2004. Approximately 59% of the Bank's loan portfolio consists of loans which reprice in periods of one to twelve months, 11% in one to three years, 25% in three to five years and 5% reprice beyond five years. Management feels that this repricing frequency positions the Bank to improve its interest margin in the coming months, if interest rates continue to rise. Interest rate shock results are included under the section Asset/Liability Management. On the liability side, management aggressively reduced rates on deposit accounts. The reduction in the rate on total interest bearing liabilities from the first nine months of 2003 to the first nine months of 2004 was 27 basis points which compares to a reduction of 6 basis points in the yield on earning assets over the same period. 12 AVERAGE BALANCES, INTEREST YIELDS, AND RATES, AND NET INTEREST MARGIN NINE MONTHS ENDED SEPTEMBER 30,
AVERAGE BALANCES, INTEREST YIELDS, AND RATES, AND NET INTEREST MARGIN 2005 2004 2003 ----------------------------------- ------------------------------------------------------------------- ------------------------------- THREE MONTHS ENDED MARCH 31, Average Average Average Average Balance Interest Yield/Rate Balance Interest Yield/Rate ---------------- -------- ----------- ---------- ------- -------- --------------------- ASSETS: Interest earningsearning assets: Interest bearing deposits with other banks & other short-term investments $ 5,5717,280 $ 98 2.35%42 2.34% $ 8,8984,163 $ 149 2.24%26 2.56% Loans 341,559 15,160(1) 429,095 6,997 6.61% 324,942 4,787 5.93% 256,012 11,893 6.21% Investment securities 70,011 1,636 3.12% 67,941 1,280 2.51%available for sale 63,536 487 3.11% 65,869 527 3.20% Federal funds sold and cash equivalents 20,510 241 1.57% 4,472 37 1.10% ------- ------ ------- ------27,380 184 2.73% 14,094 36 1.03% --------- -------- ---------- -------- Total interest earning assets 437,651 17,135 5.23% 337,323 13,359 5.29%527,291 7,710 5.93% 409,068 5,376 5.28% --------- -------- ---------- -------- Total noninterest earning assets 35,587 28,65737,065 33,330 Less: allowance for credit losses 3,881 2,933 -------- --------4,375 3,764 --------- ---------- Total nonearningnoninterest earning assets 31,706 25,724 -------- --------32,690 29,566 --------- ---------- TOTAL ASSETS $469,357 $363,047 ======== ========$559,981 $ 438,634 ========= ========== LIABILITIES AND STOCKHOLDERS' EQUITY:EQUITY Interest bearing liabilities: NOW accountsInterest bearing transaction $ 49,512 5052,278 $ 19 0.15% $ 45,263 $ 14 0.13% $ 37,994 64 0.23% Savings and money market accounts 118,293 854 0.96% 99,063 916 1.24% Certificates of deposit 118,665 1,785 2.01% 77,392 1,380 2.38%136,155 338 1.01% 111,523 260 0.94% Time deposits 144,617 784 2.20% 109,774 537 1.97% Customer repurchase agreements 16,647and federal funds purchased 27,754 33 0.48% 21,263 30 0.56% Other short-term borrowings 6,756 61 0.49% 20,646 68 0.49% Short-term borrowing 6,248 112 2.39% 7,476 177 3.17% Long-term borrowing 9,128 266 3.89% 16,007 442 3.69% ------- ------ ------- ------3.66% 4,000 27 2.79% Long term borrowings - - 0.00% 10,170 101 4.00% --------- -------- ---------- -------- Total interest bearing liabilities 318,493 3,128 1.31% 258,578 3,047 1.58% ------- ------ ------- ------367,560 1,235 1.35% 301,993 969 1.29% --------- -------- ---------- -------- Noninterest bearing liabilities: Noninterest bearing deposits 94,396 68,779demand 130,254 81,438 Other liabilities 1,642 1,325 Escrowed subscriptions received - 6,539 -------- -------2,959 1,326 --------- ---------- Total noninterest bearing liabilities 96,038 76,643133,213 82,764 Stockholders' equity 54,826 27,826 -------- -------59,208 53,877 --------- ---------- TOTAL LIABILITIES AND STOCKHOLDERS'STOCKHOLDERS EQUITY $469,357 $363,047 ======== ========$559,981 $438,634 ========= ========== Net interest income $ 14,007 $ 10,3126,475 $4,407 ======== ======== Net interest spread 3.92% 3.72%4.58% 3.99% Net interest margin 4.27% 4.09%4.98% 4.33% (1) includes Loans held for Sale
1312 ALLOWANCE FOR CREDIT LOSSESAllowance for Credit Losses The provision for credit losses represents the amount of expense recognizedcharged to current earnings to fund the allowance for credit losses. The amount of the allowance for credit losses is based on many factors which reflect management's assessment of the risk in the loan portfolio. Those factors include economic conditions and trends, the value and adequacy of collateral, volume and mix of the portfolio, performance of the portfolio, and internal loan processes of the Company and Bank. Management has developed a comprehensive reviewanalytical process to monitor the adequacy of the allowance for credit losses. The reviewThis process and guidelines were developed utilizing among other factors, the guidance from federal banking regulatory agencies. The results of this review process, in combination with conclusions of the Bank's outside loan review consultant, support management's viewassessment as to the adequacy of the allowance as ofat the balance sheet date. During the first nine months of 2004, a provision for credit losses was made in the amount of $457 thousand after considering the impact of $39 thousand in net recoveries during the period. Please refer to the discussion under the caption "Critical Accounting Policies" for an overview of the underlying methodology management employs on a quarterly basis to maintainassess the allowance.adequacy of the allowance and the provisions charged to expense. Also, refer to the following table which reflects the comparative charge-offs and recoveries of prior loan charge-offs information. During the first three months of 2005, a provision for credit losses was made in the amount of $417 thousand and the allowance for credit losses increased $ 423 thousand, including the impact of $6 thousand in net recoveries during the period. The provision for credit losses of $417 thousand in the first three months of 2005 compared to a provision for credit losses of $154 thousand in the first three months of 2004. The higher level of the provision in 2005 is primarily attributable to growth in the loan portfolio in the first quarter of 2005. At September 30, 2004,March 31, 2005, the Company had three$151 thousand of loans classified as nonaccrual as compared to $156 thousand at December 31, 2004 and $561 thousand at March 31, 2004. The Company had no restructured loans at either, March 31, 2005, December 31, 2004 or March 31, 2004. Significant variation in these amounts may occur from period to period because the amount of $2.6 million (includes onenonperforming loans depends largely on the condition of a small number of individual credits and borrowers relative to the total loan portfolio. The Company had no other real estate owned at March 31, 2005, December 31, 2004 or March 31, 2004. The balance of impaired loans was $151 thousand at March 31, 2005, with specific reserves against those loans of $57 thousand, compared to $156 thousand at December 31, 2004 with specific reserves of $31 thousand. The allowance for loan losses represented 1.07% of total loans at March 31, 2005 as compared to 1.02% at December 31, 2004. This increase was due to a slight mix shift in the portfolio toward more commercial real estate loans (48% versus 46%) which has a US Government SBA guaranteecategory tends to have larger transactions in the assessment of $150 thousand) which are considered impaired under Statementrisk, resulting in an increase in the unallocated portion of Financial Accounting Standards ("SFAS No. 114").the allowance. As part of its comprehensive loan review process, the Bank'sCompany's Board of Directors and the Bank Director's Loan Committee and or Board of Director's Loan Committee and/or Board of Directors Credit Review CommitteeCommittees carefully evaluates loans over thirtywhich are past due 30 days past due.or more. The Committee(s) makesmake a thorough assessment of the conditions and circumstances surrounding each past duedelinquent loan. The Bank's loan policy requires that loans be placed on nonaccrual if they are ninety days past due, unless they are well secured and in the process of collection. The provision for credit losses of $457 thousand in the first nine months of 2004 compared to a provision for credit losses of $730 thousand in the first nine months of 2003. The higher level of the provision in 2003 is primarily attributable to a specific reserve set aside for a problem credit in 2003 which was not required when compared to 2004 and to two significant recoveries on previously charged-off loans. See the following table which reflects the comparative charge-off and recovery information. As the portfolio and allowance review process matures, there will be changes to different elements of the allowance and this may have an effect on the overall level of the allowance maintained. To date the Bank has enjoyed a very high quality portfolio with minimal net charge offs and very low delinquency. The maintenance of a high quality loan portfolio, with an adequate allowance for possible loan losses will continue to be management's primea primary management objective as it relates toin the lending process and to the allowance for credit losses. 14Company. 13 The following table sets forth activity in the allowance for credit losses for the periods indicated.
Nine Months Ended Year Ended (dollars in thousands) September 30, December 31, -------------------------------------------------------------- 2004 2003 2003 2002 2001Three Months Ended (dollars in thousands) March 31, ------------------------ 2005 2004 ----------- --------- Balance at beginning of year $ 4,240 $ 3,680 Charge-offs: Commercial (66) Real estate - commercial - - Construction - - Home equity - - Other consumer - (18) ----------- --------- Total 0 (84) ----------- --------- Recoveries: Commercial 6 - Real estate - commercial - - Construction - - Home equity - - Other consumer - - ----------- --------- Total 6 - ----------- --------- Net recoveries (charge-offs) 6 (84) ----------- --------- Additions charged to operations 417 154 ----------- --------- Balance at end of period $ 4,663 $ 3,750 =========== ========= Annualized ratio of net charge-offs during the period to average loans outstanding during the period (.01)% .10% ----------- --------- -------- --------- --------- Balance at beginning of year $ 3,680 $ 2,766 $ 2,766 $ 2,111 $ 1,142 Charge-offs: Commercial (95) (318) (319) (192) - Real estate - commercial - - - - - Construction - - - - - Home equity - - - - - Other consumer (18) (8) (14) (40) (23) ----------- --------- -------- --------- --------- Total (113) (326) (333) (232) (23) ----------- --------- -------- --------- --------- Recoveries: Commercial 152 64 68 26 - Real estate - commercial - - - - - Construction - - - - - Home equity - - - - - Other consumer - 3 4 18 13 ----------- --------- -------- --------- --------- Total 152 67 72 44 13 ----------- --------- -------- --------- --------- Net recoveries (charge-offs) 39 (259) (261) (188) (10) ----------- --------- -------- --------- --------- Additions charged to operations 457 730 1,175 843 979 ----------- --------- -------- --------- --------- Balance at end of period $ 4,l76 $ 3,237 $ 3,680 $ 2,766 $ 2,111 =========== ========= ======== ========= ========= Annualized ratio of net charge-offs during the during the period to average loans outstanding during the period N/A 0.13% 0.10% 0.09% 0.01% ----------- --------- -------- --------- ---------
The following table reflects the allocation of the allowance for credit losses at the dates indicated. The allocation of the allowance to each category is not necessarily indicative of future losses or charge-offs and does not restrict the use of the allowance to absorb losses in any category.
(dollars in thousands) As of September 30,March 31, As of December 31, ---------------------------- ------------------------------------------------------ -------------------------- 2005 2004 2003 ---------------------------- ------------------------------------------------------ -------------------------- Amount Percent% (1) Amount Percent% (1) ------------- -------------- ----------------------- --------------- ---------- Commercial $ 2,486 23.6%1,975 25% $ 1,689 29.3%1,963 25% Real estate 550 47.0 888 47.3- commercial 1,633 48% 1,426 46% Real estate - residential 84 0% 105 3% Construction 969 16.8 613 11.2532 15% 431 14% Home equity 108 11.8 171 10.7211 11% 223 11% Other consumer 63 0.8 72 1.5105 1% 58 1% Unallocated 123 -% 34 - - 247 - -------------% -------------- ----------------------- --------------- ---------- Total allowanceallowances for credit losses $ 4,1764,663 100% $ 3,6804,240 100% ============= ============== ======================= =============== ==========
(1) Represents the percent of loans in each category to grosstotal loans 1514 NON-PERFORMING ASSETSNon-performing Assets The Company's non-performing assets, which are comprised of loans delinquent 90 days or more, non-accrual loans, restructured loans and other real estate owned, totaled $2.6 million$151 thousand at September 30, 2004March 31, 2005 compared to $476$561 thousand at September 30, 2003 and $654 thousand at DecemberMarch 31, 2003.2004. The percentage of non-performing assets to total assets was 0.51%0.03% at September 30, 2004,March 31, 2005, compared to 0.12%0.17% at September 30, 2003 and 0.15% at DecemberMarch 31, 2003. Non-performing loans constituted all of the non-performing assets at September 30, 2004, September 30, 2003 and December 31, 2003. Non-performing loans at September 30, 2004 consist of $2.5 million loans on nonaccrual and one impaired loan in the amount of $109 thousand compared to one loan over ninety days delinquent of $210 thousand and one impaired loan of $266 thousand at September 30, 2003. The increase in nonperforming loans is primarily the result of one nonaccrual loan in the amount of $2.2 million. The Company believes that this loan is well secured, by real estate collateral, and that it will be resolved without loss to the Company in the fourth quarter of 2004. The Company had no other real estate owned at either September 30, 2004 or 2003. The following table shows the amounts of non-performing assets at the dates indicated.
September 30, December 31, ------------------------ ------------- (dollars in thousands) 2004 2003 2003 ---------- ---------- ------------- Nonaccrual Loans Commercial $ 380 $ 486 $ 554 Consumer - - 100 Real estate 2,200 - - Accrual loans-past due 90 days Commercial - - - Consumer - - - Real estate - - - Restructured loans - - - Real estate owned ---------- ---------- ------------- Total non-performing assets $ 2,580 $ 486 $ 654 ========== ========== =============
March 31, December 31 ------------------------ -------------- (dollars in thousands) 2005 2004 2004 ---------- ---------- -------------- Nonaccrual Loans Commercial $ 151 $ 470 $ 156 Consumer - 91 - Real estate - - - Accrual loans-past due 90 days Commercial - - - Consumer - - - Real estate - - - Restructured loans - - - Real estate owned - - - ---------- ---------- -------------- Total non-performing assets $ 151 $ 561 $ 156 ========== ========== ============== At September 30, 2004,March 31, 2005, there were no$3.8 million of performing loans considered potential problem loans, defined as loans which are not included in the past due, nonaccrual or restructured categories, but for which known information about possible credit problems causes management to be uncertain as to the ability of the borrowers to comply with the present loan repayment terms. NONINTEREST INCOMEterms which may in the future result in disclosure in the past due, nonaccrual or restructured loan categories. Noninterest Income Noninterest income consists primarily representsof deposit account service charges, and fees, gains on the sale of SBA and residential mortgage loans, other noninterest loan fees, income from bank owned life insurance ("BOLI") and other service fees. For the ninethree months ended September 30, 2004March 31, 2005, noninterest income was $2.6$1.0 million. This compared to $1.1 million of noninterest income for the three months ended March 31, 2004, which included $193$253 thousand in net gains on the sale of investment securities. This compared to $2.1 million of noninterest income for the nine months ended September 30, 2003, which included $214 thousand in net gains on the sale of investment securities. For the quarter ending September 30, 2004, the Company had $697 thousand in noninterest income compared to $687 thousand for the same period in 2003. During the third quarter of 2004 the Company sold securities recognizing a loss of $60 thousand compared to no gain or loss in the third quarter of 2003. The Company is an active originator of SBA loans and its current practice is to sell the insured portion of those loans at a premium. Income from this source was $346$385 thousand for the ninethree months ended September 30, 2004March 31, 2005 compared to $316$97 thousand for the ninethree months ended September 30, 2003. ForMarch 31, 2004, as the comparative third quarters ending September 30,Company emphasized this lending activity in the income from the salefirst three months of the insured portion of SBA loans was $105 thousand in 2004 and $153 thousand in 2003.2005. The Company also originates residential permanent mortgage loans on a pre-sold basis, servicing released. Sales of these mortgage loans yielded gains of $215$110 thousand in the ninefirst three months of 20042005 compared to $229$75 thousand in the same period in 2003. The decrease in2004. Income for the premiums realized onthree months ended March 31, 2005 was $269 thousand from deposit account service charges, $46 thousand from SBA loan service fees and $102 thousand from BOLI, versus $346 thousand from deposit account service charges, $32 thousand from SBA service fees and $83 thousand from BOLI for the salethree months ended March 31, 2004. Other noninterest income amounted to $127 thousand for the first three months of mortgage loans can be directly attributed2005, as compared to the rise in mortgage loan interest rates$196 thousand in the first quarter of 2004. The slow downdecline in this area could continue as mortgage rates rise. 16 Other itemsdeposit services was primarily related to a decline in noninterest income increased 36% from $1.4overdraft fees. Noninterest Expenses Noninterest expense was $4.5 million for the ninethree months ended September 30, 2003March 31, 2005 compared to $1.9$3.5 million for the ninethree months ended September 30,March 31, 2004, an increase of 28%. 15 Salaries and benefits were $2.6 million for the first quarter of 2005, as compared to $ 2.0 million for 2004, a 31% increase. This increase was due to staff additions and related personnel costs. Premises and equipment expenses amounted to $801 thousand for the quarter ended March 31, 2005 versus $598 thousand for the same period in 2004. This category includesincrease of 34% was due to a new banking office opened in the first quarter of 2005 and to ongoing operating expense increases associated with the Company's facilities, all of which are leased, and to increased equipment costs. Advertising costs increased from $56 thousand in the quarter ended March 31, 2004 to $96 thousand in the same period in 2005, the increases associated primarily with increased advertising for deposit account service charges and noninterest income fees such as documentation preparation and prepayment penalties. Incomeproducts. Outside data processing costs were $181 thousand for the nineinitial quarter in 2005, as compared to $142 thousand in 2004, or an increase of 27%. The higher than usual increase was due to special charges associated with the Company's conversion of certain core processing systems to new operating platforms. Other expenses, increased from $743 thousand in the first quarter of 2004 to $837 thousand for the three months ended September 30,March 31, 2005. The major components of costs in this category include professional fees, ATM expenses, telephone, courier, printing, business development, office supplies, charitable contributions, and dues. These costs have been managed to an increase of 13% in the first three months of 2005 as compared to 2004. FINANCIAL CONDITION Summary At March 31, 2005, assets were $589.8 million, loans were $ 437.1 million, deposits were $482.9 million and stockholders' equity was $ 59.6 million. As compared to December 31, 2004, was $1.0assets grew by $36.4 million from deposit account services charges, $109 thousand from SBA loan service fees(6.6%), loans by $21.6 million (5.2%), deposits by $20.6 million (4.5%) and $280 thousand from BOLI, versus $892 thousand from deposit account service charges, $59 thousand from SBA service fees and $180 thousand from BOLI for the nine months ended September 30, 2003. To increase noninterest income thestockholders' equity by $ 1.1 million (1.9%). The Company is planning on establishing, as a subsidiarypaid an initial cash dividend of the Bank, a title company service which can be offered to its many commercial borrowers. This venture is expected to begin operations$ .07 per share in the first quarter of 2005. NONINTEREST EXPENSE Noninterest expense was $11.0 million for the nine months ended September 30, 2004 compared to $7.9 million for the nine months ended September 30, 2003. This represented a period to period increase of 39%. The increase for the quarter ending September 30 of each year was 41%, increasing from $2.8 million to $4 million. Increases in noninterest expense primarily relate to increases in salaries and employee benefits which increased 43% from the first nine months of 2003 to the first nine months of 2004, from $4.2 million to $6 million. Salaries and benefits increased 45% in the third quarter of 2004 from the third quarter of 2003 to $2.1 million from $1.5 million. During the first quarter of 2004, to accommodate the growth in assets, customer accounts and offices experienced by the Bank in 2003 and to accommodate the growth anticipated in 2004, a number of additions to staff were made in the lending and operations (customer service) areas. Management felt that these additions and the associated expenses were necessary to assure a continued growth pattern and quality of service which characterized the Company since its inception. The increase of 33% in premises and equipment for the nine months ended September 30, 2004 compared to the nine months ended September 30, 2003, from $1.5 million to $2 million, and 24% for the third quarter from $564 thousand to $701 thousand, can be attributed to the expenses for the Bank's Rockville Pike Office, new deposit and loan operations offices in Silver Spring acquired to house an expanded support staff and the Bank's new office at 1228 Connecticut Avenue in Washington, DC. Other expenses, which increased 50% from $1.6 million to $2.4 million for the nine months ending September 30, 2004 compared to the nine months ended September 30, 2003 and 62%, from $562 thousand for the third quarter of 2003 to $910 thousand for the third quarter of 2004, represent a number of expense categories ranging from business development and office supplies to charitable contributions. Management monitors these expenses closely and believes that the increase in them is consistent with the needs of an aggressively growing Company. In future periods, noninterest expenses to which the Company has not been subject to date, such as deposit insurance premiums which may be required as a result of declines in the reserve ratios of the deposit insurance funds, may have an adverse effect on the results of operations of the Company. FINANCIAL CONDITION As of September 30, 2004, assets were $507.6 million and deposits were $411.0 million. Assets grew by $64.7 million from December 31, 2003, and deposits grew by approximately $75.5 million. Loans Total loans, excluding loans held for sale, increased approximately $46.3 million from December 31, 2003 to September 30, 2004, from $317.5 million to $363.8 million. 17 Loans, net of amortized deferred fees and costs, at September 30,March 31, 2005 and 2004 September 30, 2003 and December 31, 2003 are summarized by type as follows:
September 30, Percent September 30, Percent September 30, Percent 2004 of Total 2003 of Total 2003 of Total -------------31-Mar-05 % 31-Dec-04 % 31-Mar-04 % ------------ ------- ------------- ------- --------------------------- ------- Commercial $ 85,685 23.6%111,055 25% $ 70,087 26.8%101,911 25% $ 93,112 29.3%87,471 27% Real estate 171,110 47.0% 130,583 50.0% 149,783 47.3%- commercial 209,210 48% 189,708 46% 161,228 49% Real estate - residential 1,366 0% 11,717 3% 960 0% Construction 61,054 16.8% 24,111 9.2% 35,644 11.2%63,636 15% 60,258 14% 40,842 12% Home equity 42,961 11.8% 31,908 12.2% 34,092 10.7%47,360 11% 49,632 11% 36,140 11% Other consumer 3,014 0.8% 4,703 1.8% 4,902 1.5% ---------- ---- ---------- ---- ---------- ----4,490 1% 2,283 1% 3,612 1% ------------ ------- ------------- ------- -------------- ------- Total loans 363,824437,117 100% 261,392415,509 100% 317,533330,253 100% ==== ==== ==== Less: allowanceless: Allowance for credit losses (4,176) (2,952) (3,680) ---------- ---------- ----------Credit Losses (4,663) (4,240) (3,750) ------------ ------- ------------- ------- -------------- ------- Net Loans net $ 359,648432,454 $ 257,440411,269 $ 313,853 ========== ========== ==========326,503 ============ ======= ============= ======= ============== =======
Deposits Andand Other Borrowings The principal sources of funds for the Bank are core deposits, consisting of demand deposits, NOW accounts, money market accounts, savings accounts and relationship certificates of deposits from the local market areas surrounding the Bank's offices. The Bank's deposit base includes transaction accounts, time and savings accounts and accounts which customers use for cash management and which provide the Bank with a source of fee income and cross-marketing opportunities as well as a low-costan attractive source of lower cost funds. Time and savings accounts, including money market deposit accounts, also provide a relatively stable and low-cost source of funding. 16 For the ninethree months ending September 30, 2004 from DecemberMarch 31, 2003,2005 deposits grew $75.5$20.6 million, from $335.5$462.3 million to $411.0$482.9 million. Approximately 31%30% of the Bank's deposits are made up of certificates of deposits, which are generally the most expensive form of deposit because of their fixed rate and term. Certificates of deposit in denominations of $100 thousand or more can be more volatile and more expensive than certificates of less than $100 thousand. However, because the Bank focuses on relationship banking and does not accept brokered certificates, its historical experience has been that large certificates of deposit have not been more volatile or significantly more expensive than smaller denomination certificates. It has been the practice of the Bank to pay posted rates on its certificates of deposit whether under or over $100 thousand. The Bank has paid negotiated rates for deposits in excess of $500 thousand but the rates paid have rarely been more than 25 to 50 basis points higher than posted rates and deposits also have been negotiated at below market rates. From time to time, when appropriate in order to fund strong loan demand, the Bank accepts certificates of deposits, generally in denominations of less than $100 thousand on a non brokered basis, from bank and credit union subscribers to a wholesale deposit rate line. These deposits amounted to approximately $16 million or 3% of total deposits at March 31, 2005, as compared to approximately $33 million of deposits at March 31, 2004 and approximately $25 million at December 31, 2004. The Bank has found rates on these deposits to be generally competitive with rates in our market given the speed and minimal noninterest cost at which deposits can be acquired. Although it is possible for rates to significantly exceed local market rates it has not been the experience of the Bank. At September 30, 2004 the Bank held $28.9 million of these deposits at an average rate of 2.30% as compared to $28.8 million of these deposits, at an average rate of 3.43% at September 30, 2003. During the first quarter of 2004 management felt that there was an opportunity to acquire longer maturities of these deposits at attractive interest rates and again began accepting these deposits with maturities greater than one year. Also, during the first quarter of 2004, the Company introduced a new certificate of deposit program CDARS, which will provides its customers with access to greater FDIC insurance coverage. Using CDARS2005, the Bank can distribute customer funds among other FDIC-insured banks and thrifts, allowing customers to manage all their CDs through one relationship. Under this program, the Bank receives a comparable volume ofreduced its wholesale deposits from other participating institutions thereby gaining the full advantagein favor of its customers' deposits while providing a servicecore sources, which allows all of the customers' deposits to be insured. 18 provided adequate funding and liquidity and was in accordance with planned amounts. At September 30, 2004,March 31, 2005, the Company had approximately $113.7$146 million in noninterest bearing demand deposits, representing 27.6%30% of total deposits. This compared to $90.5approximately $130 million of these deposits at December 31, 2003.2004. These are primarily business checking accounts on which the payment of interest is prohibited by regulations of the Federal Reserve. Proposed legislation has been introduced in each of the last several sessions of Congress which would permit banks to pay interest on checking and demand deposit accounts established by businesses. If legislation effectively permitting the payment of interest on business demand deposits is enacted, of which there can be no assurance, it is likely that we may be required to pay interest on some portion of our noninterest bearing deposits in order to compete with other banks. Payment of interest on these deposits could have a significant negative impact on our net interest income and net interest margin, net income, interest margin,and the return on assets and equity, and indices of financial performance.equity. As an enhancement to the basic noninterest bearing demand deposit account, the Company offers a sweep account, or "customer repurchase agreement", allowing qualifying businesses to earn interest on short term excess funds which are not suited for either a CD investment or a money market account. The balances in these accounts were $20..2$39.5 million at September 30, 2004March 31, 2005 compared to $17.0$24.0 million at December 31, 2003.2004. Customer repurchase agreements are not deposits and are not FDIC insured but are securedcollateralized by US Treasury and/or USU.S. government agency securities. These accounts are particularly suitable to businesses with significant changefluctuation in the levels of cash flow over a very short time frame often measured in days.flows. Attorney and title company escrow accounts are an example of accounts which can benefit from this product, as are customers who may require collateral for deposits in excess of $100 thousand but do not qualify for other pledging arrangements. This program requires the Company to maintain a sufficient investment securities level to accommodate the fluctuations in balances which may occur in these accounts. At September 30, 2004,March 31, 2005, the Company had no outstanding balancebalances under its linelines of credit provided by a correspondent bank. The Bank had $11.3$5.3 million of FHLB short and long-term borrowings, as compared to $14.3$6.3 million at December 31, 2003.2004. These advances are secured 50% by USU.S. government agency securities and 50% by a blanket lien on qualifying loans in the Bank's commercial mortgage loan portfolio. At September 30, 2004, the Bank also had federal funds purchased of $7.0 million. This borrowing was paid in full the first week of October. Through another subsidiary of the Company, Bethesda Leasing LLC, there were outstanding long term borrowings of $110 thousand. This loan was obtained to fund the purchase of an impaired loan from the Bank. LIQUIDITY MANAGEMENTLiquidity Management Liquidity is thea measure of the Bank's ability to meet the demands required for the funding of loansloan demand and to meetsatisfy depositor withdrawal requirements for use of their funds.in an orderly manner. The Bank's sources of liquidity consist of cash and cash balances due from correspondent banks, loan repayments, federal funds sold and short term investments.investments, maturities and sales of investment securities and income from operations. These sources of liquidity are primary and are supplemented by the ability of the Company and Bank to borrow funds.funds, which are termed secondary sources. The Company maintains secondary sources of liquidity, which includes a $10 million line of credit with a correspondent bank, against which it has guaranteed a $110 thousand loan to its subsidiary Bethesda Leasing. Thethere were no outstandings at March 31, 2005. Additionally, the Bank can purchase up to $17.0$24 million in federal funds on an unsecured basis from its correspondents, against which there were no borrowings outstanding at March 31, 2005 and may enter into reverse repurchase agreements up to $10.0 million.$12.5 million, provided adequate collateral exists to secure the lending relationship. At September 30, 2004,March 31, 2005, the Bank was also eligible to take FHLBmake advances from the Federal Home of Atlanta (FHLB) up to $82$115 million, of which it had advances outstanding of $11.3$5.3 million. 17 The loss of deposits, through disintermediation, is one of the greater risks to liquidity. Disintermediation occurs most commonly when rates rise and depositors withdraw deposits seeking higher rates than the Bank may offer. The Bank was founded under a philosophy of relationship banking and, therefore, believes that it has less of an exposure to disintermediation and resultant liquidity concerns than do banks which build an asset base on non-core deposits and other borrowings. The history of the Bank includes a period of rising interest rates and significant competition for deposit dollars. During that period the Bank grew its core business without sacrificing its interest margin in higher deposit rates for non-core deposits.many banks. There is, however, a risk that some deposits would be lost if rates were to spike upincrease and the Bank elected not to meet the market.remain competitive with its deposit rates. Under those conditions, the Bank believes that it is well positioned to use other liability management instruments such as FHLB borrowing, reverse repurchase agreements and Bank lines to offset a decline in deposits in the short run. Over the long term, an adjustment in assets and change in business emphasis could compensate for a loss of deposits. Under these circumstances, further asset growth could be limited as theThe Bank utilizes its liquidity sourcesalso maintains a marketable investment portfolio to replace, rather than supplement, core deposits. 19 Certificates of deposit acquired through the subscription service may be more sensitive to rate changes and pose a greater risk of disintermediation than deposits acquiredprovide flexibility in the local community.event of significant liquidity needs. The Bank has limitedBank's Asset Liability Board Committee recently adopted policy guidelines which emphasize the amountimportance of suchcore deposits to 25% of total assets, an amount which it believes it could replace with alternative liquidity sources, although there can be no assurance of this. The mature earning pattern of the Bank is also a liquidity management resource. The earnings of the Bank are now at a level that allows it to pay higher rates to retain deposits over a short period, while it adjusts its asset base repricing to offset a higher cost of funds. The cost of retaining business in the short run and the associated reduction in earnings can be preferable to reducing deposit and asset levels and restrictingtheir continued growth. At September 30, 2004,March 31, 2005, under the Bank'sCompany's liquidity formula, it had $106$110 million of primary and secondary liquidity representing 22%19.6% of total Bank assets. ASSET/LIABILITY MANAGEMENT AND QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET RISKThe following is a schedule of significant funding commitments at March 31, 2005: (in thousands) Unused lines of credit (consumer) $ 47,523 Other commitments to extend credit 118,110 Standby letters of credit 3,965 ------------- $ 169,598 ============= Asset/Liability Management and Quantitative and Qualitative Disclosure about Market Risk A fundamental risk in banking outside of credit risk, is exposure to market risk, or interest rate risk, since a bank's net income is largely dependent on net interest income. The Bank's Asset Liability Committee (ALCO) of the Board of Directors formulates and monitors the management of interest rate risk withinthrough policies and guidelines established by it and the Board of Directors. In its consideration of establishing guidelines for levels and/orrisk limits, on market risk, the ALCO committee considers the impact on earnings and capital, the level and direction of interest rates, liquidity, local economic conditions, outside threats and other factors. Banking is generally a business of attempting to matchmanaging the maturity mismatch inherent in its asset and liability components to produce a spread sufficientcash flows and to provide net interest income togrowth consistent with the bank at nominal rate risk.Company's profit objectives. The Company, through its ALCO, continually monitors the interest rate environment in which it operates and adjusts the rates and maturities of its assets and liabilities to meet the market conditions.remain competitive and to achieve its overall financial objectives subject to established risk limits. In the current low interest rate environment, the Company is keepingmanaging its assets to be either variably priced or with relatively short term maturities, or short average lives.so as to mitigate the risk to earnings and capital should interest rates increase from current levels. At the same time, it strivesthe Bank seeks to attract longer term liabilitiesacquire longer-term core deposits to lock in therelatively lower cost of funds. In the current market, due to competitive factors and customer preferences, the effort to attract longer term fixed priced liabilities has not been as successful as the Company's best case asset liability mix would prefer. When interest rates begin to rise, the Company expects that it will seek to keep asset maturities and repricing periods short until rates appear to be nearing their peak and then extend maturities to extend the benefit of higher rates. There can be no assurance that the Company will be able to successfully carry out this intention, as a result of competitive pressures, customer preferences and the inability to perfectly forecast future interest rates. One of the tools used by the Company to manage its interest rate risksrisk is a static GAP analysis presented below. The Company also uses an earnings simulation model on a quarterly basis to closely monitor interest sensitivity and to exposemodel its balance sheet cash flows and its income statement toeffects in different interest rate scenarios. The model is based on current Company data and adjusted by assumptions as to growth, patterns, noninterest income and noninterest expense and interest rate sensitivity, based on historical data, for both assets and liabilities. The modeldata is then subjected to a "shock test" assuming, which assumes a suddensimultaneous change in interest rate increase ofup 200 basis points or a decrease ofdown 200 basis points, along the entire yield curve, but not below zero. The results are measured byanalyzed as to the effectimpact on net income.interest income, net income over the next twelve months and to the market value of equity. The Company in its latest model,analysis at March 31, 2005 shows a positive effect on income when interest rates immediately riseare shocked up 200 basis points, becausedue to the significant level of the short maturities of assets and avariable rate loans. A negative impact occurs if rates were to decline further.decline. With rates near historic lows, further reduction would reduce income on earning assets, which could not be offset by a corresponding reduction in the cost of funds.funds, resulting in significant net interest margin contraction. 18 The following table reflects the result of a "shock test"shock simulation on the September 30, 2004, earning assets and interest bearing liabilities and the change in net interest income resulting from the simulated immediate increase and decrease in interest of 100 and 200 basis points. Also shown is the change in the Market Value Portfolio Equity resulting from the simulation. The model as presented is projected for one year.March 31, 2005 balances.
Percentage change in Change in interest Percentage change in net Percentage change in Market Value of rates (basis points) interest income in net income Portfolio Equity -------------------- ------------------------ -------------------- --------------------- +200 + 15.4% + 39.0% + 17.2%+13.5% +28.9% +13.7% +100 + 7.9% + 19.9% + 9.2%+6.8% +14.4% +7.3% 0 - - - -100 - 10.3% - 25.9% - 11.6%-5.1% -10.8% -9.9% -200 - 24.8% - 62.7% - 25.2%-18.7% -39.9% -21.0%
20 Certain shortcomings are inherent in the method of analysis presented in the foregoing table. For example, although certain assets and liabilities may have similar maturities or repricing periods, they may react in different degrees to changes in market interest rates. Also, the interest rates on certain types of assets and liabilities may fluctuate in advance of changes in market interest rates, while interest rates on other types may lag behind changes in market rates. Additionally, certain assets, such as adjustable-rate mortgage loans, have features that restrictlimit changes in interest rates on a short-term basis and over the life of the loan. Further, in the event of a change in interest rates, prepayment and early withdrawal levels could deviate significantly from those assumed in calculating the tables. Finally, the ability of many borrowers to service their debt may decrease in the event of a significant interest rate increase. GAPGap Banks and other financial institutions are dependent upon net interest income, which is the difference between interest earned on interest earning assets and interest paidexpense on interest bearing liabilities. In falling interest rate environments, net interest income is maximized with longer term, higher yielding assets being funded by lower yielding short-term funds; however, when interest rates trend upward this asset/liability structure can resultfunds, or what is referred to as a negative mismatch or GAP. Conversely, in a significant adverse impact onrising interest rate environment, net interest income.income is maximized with shorter term, higher yielding assets being funded by longer-term liabilities or what is referred to as a positive mismatch or GAP. The current interest rate environment is signaling steady to possibly higher rates. Management has for a numberbeen emphasizing the acquisition of months shortened maturities in the Bank's investment portfoliovariable rate and where possible alsoshorter term assets and has shortened repricing opportunities for new loan requests.been attempting to secure longer-term core deposits. While management believes that this will help minimizeoverall position creates a good balance in managing its interest rate risk in a rising rate environment,and maximizing its net interest margin within plan objectives, there can be no assurance as to actual results. The GAP position, which is a measure of the difference in maturity and re-pricing volume between interest earning assets and interest bearing liabilities, is a means of monitoring the sensitivity of a financial institution to changes in interest rates. The chart below provides an indicatorindication of the rate sensitivity of the Company. A negative GAP indicates the degree to which the volume of repriceable liabilities exceeds repriceable assets in particulargiven time periods. At September 30, 2004,March 31, 2005, the Bank had a positive GAP of 28%36% out to three months and a cumulative positive GAP of 5%4% out to twelve months, as opposedcompared to a three month positive gapGAP of 11%38% and a cumulative twelve month negative gappositive GAP of (10%)8% at December 31, 2003.2004. If interest rates continue to rise at a measured pace, as forecasters are predicting, the Bank's interest income and margin are expected to risebe stable to slightly up because of the favorable GAPpresent positive mismatch position. Because competitive market behavior does not necessarily track the trend of interest rates but at times moves ahead of financial market influences, the rise in the cost of liabilities may be greater than anticipated by the GAP model. If this were to occur, the benefits of a rising interest rate environment would not be as significant as management is expecting. Management has carefully considered its strategy to maximize interest income by reviewing interest rate levels, economic indicators and call features of some ofwithin its assets.investment portfolio. These factors have been thoroughly discussed with the Board of Directors Asset Liability Committee and management believes that current strategies are appropriate to current economic and interest rate trends. The negative19 GAP position is carefully monitored and is adjusted as conditions change. The following GAP table is presented on the basis of the Bank only. 21
GAP ANALYSIS September 30, 2004ANALYSIS March 31, 2005 (dollars in thousands)
0-3 4-12 13-36 37-60 Over 60 Repriceable in: Months Months Months Months Months Total ------ ------ ------ ------ ------ --------------------------------------------------------------------------------- ASSETS: Investment securities $ 1,050 $ 20,522 $ 30,107 $ 9,996 $ 7,805 $ 69,480$1,050 $9,905 $28,070 $13,830 $12,594 $65,449 Interest bearing deposits in other banks -- 9,540 -- -- -- 9,5401,092 792 - - - 1,884 Loans 205,006 14,232 39,623 84,529 22,304 365,694241,935 9,781 49,483 99,085 40,504 440,788 Federal funds sold and cash equivalents 11,049 -- -- -- -- 11,049 --------- --------- --------- --------- --------- ---------41,685 - - - - 41,685 ---------------------------------------------------------------------------- Total repriceable assets $ 217,105 $ 44,294 $ 69,730 $ 94,525 $ 30,109 $ 455,763 ========= ========= ========= ========= ========= =========$285,762 $20,478 $77,553 $112,915 $53,098 $549,806 ============================================================================ LIABILITIES: NOW accounts $ -- $ 25,801 $ 5,160 $ 20,641 $ -- $ 51,602- $26,306 $5,261 $21,046 - $52,613 Savings and Money Market accounts 45,420 37,045 22,710 11,354 -- 116,52953,190 43,248 26,595 13,297 - 136,330 Certificates of deposit 31,987 75,323 21,091 759 -- 129,16019,414 105,946 21,136 1,095 - 147,591 Customer repurchase agreements and Federalfederal funds purchased 13,111 8,148 2,037 4,074 -- 27,37011,849 15,798 3,950 7,901 - 39,498 Other borrowing-short and long term 1,000 2,333 8,000 -- -- 11,333 --------- --------- --------- --------- --------- ---------4,333 - - - 5,333 ---------------------------------------------------------------------------- Total repriceable liabilities $ 91,518 $ 148,650 $ 58,998 $ 36,828 $ -- $ 335,994 ========= ========= ========= ========= ========= =========$85,453 $195,631 $56,942 $43,339 - $381,365 ============================================================================ GAP $ 125,587 $(104,356) $ 10,732 $ 57,697 $ 30,109 $ 119,769$200,309 $(175,153) $20,611 $69,576 $53,098 $168,441 Cumulative GAP 125,587 21,231 31,963 89,660 119,769$200,309 $25,156 $45,767 $115,343 $168,441 Interval gap/earnings assets 27.56% (22.90)36.43% (31.85)% 2.36% 12.66% 6.61%3.75% 12.65% 9.66% Cumulative gap/earning assets 27.56% 4.66 % 7.02% 19.68% 26.29%36.43% 4.58% 8.33% 20.98% 30.64%
Although NOW and MMA accounts are subject to immediate repricing, the Bank's GAP model has incorporated a repricing schedule to account for the historicala lag in effecting rate changes andbased on our experience, as measured by the amount of those deposit rate changes relative to the amount of rate change in assets. CAPITAL RESOURCES AND ADEQUACY The assessment of capital adequacy depends on a number of factors such as asset quality, liquidity, earnings performance, changing competitive conditions and economic forces, and the overall level of growth. The adequacy of the Company's current and future capital needs is monitored by management on an ongoing basis. Management seeks to maintain a capital structure that will assure an adequate level of capital to support anticipated asset growth and to absorb potential losses. The capital position of both the Company's wholly-owned subsidiary,Company and the Bank continues to meetexceed regulatory requirements.requirements to be considered well-capitalized. The primary indicators relied onused by bank regulators in measuring the capital position are the Tiertier 1 risk-based capital ratio, the total risk-based capital ratio, and the tier 1 leverage ratios.ratio. Tier 1 capital consists of common and qualifying preferred stockholders' equity less goodwill.intangibles. Total risk-based capital consists of Tier 1 capital, qualifying subordinated debt, and a portion of the allowance for credit losses. Risk-based capital ratios are calculated with reference to risk-weighted assets. The tier 1 leverage ratio compares Tier1measures the ratio of tier 1 capital to total average assets. At September 30, 2004,assets for the Company's and Bank's capital ratios were in excess of the mandated minimum requirements.most recent three month period. The ability of the Company to continue to grow is dependent on its earnings and the ability to obtain additional funds for contribution to the Bank's capital, through additional borrowing, the sale of additional common stock, the sale of preferred stock, or through the issuance of additional qualifying equity equivalents, such as subordinated debt or trust preferred securities. On August 1, 2003 the Company completed its offering with the sale of 2,448,979 shares of common stock for gross proceeds of approximately $30 million. 2220 CAPITALCapital The actual capital amounts and ratios for the Company and Bank as of September 30,March 31, 2005 and March 31, 2004 and 2003 are presented in the table below:
To Be Well Capitalized For Capital CapitalizedRatio Under Company Company Bank Bank Adequacy Prompt Corrective Actual Actual Actual Actual Purposes Action Provisions** InDollars in thousands Amount Ratio Amount Ratio Ratio Ratio ------ ----- ------ ----- ----- ----- As of September 30,March 31, 2005 Total capital to risk-weighted assets $64,692 13.0% $51,660 10.7% 8.00% 10.00% Tier 1 capital to risk-weighted assets $60,029 12.1% $47,012 9.7% 4.00% 6.00% Tier 1 capital to average assets (leverage) $60,029 10.7% $47,012 8.7% 3.00% 5.00% As of March 31, 2004 Total capital (toto risk-weighted Assets) $60,565 14.5% $43,431 10.7% 8.0% 10.0%assets $58,431 16.4% $39,003 10.9% 8.00% 10.00% Tier 1 to risk-weighted assets $54,656 15.3% $35,243 9.9% 4.00% 6.00% Tier 1 capital (to risk-weighted assets) $56,389 13.5% 39,300 9.7% 4.0% 6.0% Tier 1 capital (toto average Assets) $56,389 12.0% 39,300 8.4% 3.0% 5.0% As of September 30, 2003 Total capital (to risk-weighted assets) $55,137 17.1% $33,662 11.9% 8.0% 10.0% Tier 1 capital (to risk weighted assets) $51,900 16.1% 30,436 10.0% 4.0% 6.0% Tier 1 capital (to average assets) $51,900 14.3% 30,436 8.3% 3.0% 5.0%
assets (leverage) $54,656 14.0% $35,243 8.5% 3.00% 5.00% ** Applies to Bank only
Bank and holding company regulations, as well as Maryland law, impose certain restrictions on dividend payments by the Bank, as well as restricting extension of credit and transfers of assets between the Bank and the Company. At September 30, 2004,March 31, 2005, the Bank could pay dividends to the parent to the extent of its earnings so long as it maintained required capital ratios. ITEMItem 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISKQuantitative and Qualitative Disclosures About Market Risk Please refer to Item 2 of this report, "Management's Discussion and Analysis of Financial Condition and Results of Operations", under the caption "Asset/Liability Management and Quantitative and Qualitative Disclosure About Market Risk". ITEMItem 4. CONTROLS AND PROCEDURESControls and Procedures The Company's management, under the supervision and with the participation of the Company's Chief Executive Officer and Chief Financial Officer, evaluated as of the last day of the period covered by this report the effectiveness of the operation of the Company's disclosure controls and procedures, as defined in Rule 13a-14 under the Securities and Exchange Act of 1934. Based on that evaluation, the Chief Executive Officer and Chief Financial Officer concluded that the Company's disclosure controls and procedures were adequate. There were no changesDuring the first quarter of 2005, the Company established a Disclosure Controls Committee consisting of Board and Senior Management members. The Committee has adopted a charter and meets prior to the finalizing of financial press releases and the Company's reports on Form 10-K and 10-Q in the Company'sorder to discuss and review material financial information and related information contained in those releases for accuracy and completeness. This new internal control over financial reporting (as defined in Rule 13a-15 under the Securities Act of 1934) during the quarter ended September 30, 2004 that has materially affected,was not adopted as a corrective action or is reasonably likely to materially affect, the Company'sas a result of any identified material weaknesses or deficiency in internal control over financial reporting. 23reporting, but as an enhancement and supplement to existing internal control procedures. The Company expects that this committee will provide additional opportunity for assurance as to the financial reporting process and is judged by the Company to be a best practice. 21 PARTPart II OTHER INFORMATION ITEM 1 LEGAL PROCEEDINGSOther Information Item 1. Legal Proceedings From time to time the Company may become involved in legal proceedings. At the present time there are no proceedings which the Company believes will have an adverse impact on the financial condition or earnings of the Company. ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDSItem 2 Unregistered Sales of Equity Securities and Use of Proceeds (a) Sales of Unregistered Securities. None (b) Use of Proceeds. Not Applicable. (c) Issuer Purchases of Securities. None ITEMItem 3 DEFAULTS UPON SENIOR SECURITIES None. ITEMDefaults Upon Senior Securities None Item 4 SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERSSubmission of Matters to a Vote of Security Holders None ITEM 5. OTHER INFORMATIONItem 5 Other Information None. (a) Required 8-K Disclosures.Disclosures None (b) Changes in Procedures for Director Nominations by Security Holders. None ITEM 6. EXHIBITSItem 6 Exhibits
Exhibit No. Description of Exhibit - ----------- ---------------------- 3(a) Certificate of Incorporation of the Company, as amended (1) 3(b) Bylaws of the Company (2) 10.1 1998 Stock Option Plan (3) 10.2 Employment Agreement between Michael Flynn and the Company (4) 10.3 Employment Agreement between Thomas D. Murphy and the Bank (4) 10.4 Employment Agreement between Ronald D. Paul and the Company (4) 10.5 Director Fee Agreement between Leonard L. Abel and the Company (4) 10.6 Employment Agreement between Susan G. Riel and the Bank (4) 10.7 Employment Agreement between Martha F. Tonat and the Bank (4) 10.8 Employment Agreement between Wilmer L. Tinley and the Bank (4) 10.9 Employee Stock Purchase Plan (3) 10.2 Employment Agreement between Michael Flynn and the Company (4) 10.3 Employment Agreement between Thomas D. Murphy and the Bank (4) 10.4 Employment Agreement between Ronald D. Paul and the Company (4) 10.5 Director Fee Agreement between Leonard L. Abel and the Company (4) 10.6 Employment Agreement between Susan G. Riel and the Bank (4) 10.7 Employment Agreement between Martha F. Tonat and the Bank (4) 10.8 Employment Agreement between Wilmer L. Tinley and the Bank (4) 10.9 Employee Agreement for James H. Langmead (5) 10.10 Employee Stock Purchase Plan (6) 11 Statement Regarding Computation of Per Share Income 21 Subsidiaries of the Registrant 31.1 Rule 13a-14(a) Certification of Ronald D. Paul 31.2 Rule 13a-14(a) Certification of Wilmer L. Tinley 31.3 Rule 13a-14(a) Certification of Michael T. Flynn 32.1 Section 1350 Certification of Ronald D. Paul 32.2 Section 1350 Certification of Wilmer L. Tinley 32.3 Section 1350 Certification of Michael T. Flynn
22 - ------------------------------------------------------------------------------------------------------------- (1) Incorporated by reference to the exhibit of the same number to the Company's Quarterly Report on Form 10-QSB for the period ended September 30, 2002. (2) Incorporated by reference to Exhibit 3(b) to the Company's Registration Statement on Form SB-2, dated December 12, 1997. (3) Incorporated by reference to Exhibit 10.1 to the Company's Annual Report on Form 10-KSB for the year ended December 31, 1998. (4) Incorporated by reference to exhibits of the same number to the Company's Annual Report on Form 10-K for the year ended December 31, 2003. (5) Incorporated by reference to exhibits of the same number to the Company's Annual Report on Form 10-K for the year ended December 31, 2004 (6) Incorporated by reference to Exhibit 4 to the Company's Registration Statement on Form S-8 (No. 333-116352) 2423 SIGNATURES Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized. EAGLE BANCORP, INC. Date: November 8, 2004May 6, 2005 By: /s/ Ronald D. Paul ---------------------------------------------------------------------------- Ronald D. Paul, President and CEO Date: November 8, 2004May 6, 2005 By: /s/ Wilmer L. Tinley ------------------------------------------------------------------------------------------- Wilmer L. Tinley, Senior Vice President and CFO 25Chief Financial Officer 24