WASHINGTON, D.C. 20549
Old Line Bancshares, Inc.
Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.
Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or 15(d) of the Act.
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act).
The aggregate market value of the common equity held by non-affiliates was $46.3 million as of June 30, 2011 based on a sales price of $8.38 per share of Common Stock, which is the sales price at which the Common Stock was last traded on June 30, 2011 as reported by the NASDAQ Stock Market LLC.
The number of shares outstanding of the issuer’s Common Stock was 6,817,694 as of March 1, 2012.
Portions of the Proxy Statement for the 2012 Annual Meeting of Stockholders of Old Line Bancshares, Inc., to be filed with the Securities and Exchange Commission no later than 120 days after the close of the fiscal year, are incorporated by reference in Part III of this Annual Report on Form 10-K.
OLD LINE BANCSHARES, INC.
PART I
Business of Old Line Bancshares, Inc.
Old Line Bancshares, Inc. was incorporated under the laws of the State of Maryland on April 11, 2003 to serve as the holding company of Old Line Bank. The primary business of Old Line Bancshares, Inc. is to own all of the capital stock of Old Line Bank.
On May 22, 2003, the stockholders of Old Line Bank approved the reorganization of Old Line Bank into a holding company structure. The reorganization became effective on September 15, 2003. In connection with the reorganization, (i) Old Line Bank became our wholly-owned subsidiary and (ii) each outstanding share (or fraction thereof) of Old Line Bank common stock was converted into one share (or fraction thereof) of Old Line Bancshares, Inc. common stock, and the former holders of Old Line Bank common stock became the holders of all our outstanding shares.
Our primary business is to own all of the capital stock of Old Line Bank. We also have an approximately $761,000 investment in a real estate investment limited liability company named Pointer Ridge Office Investment, LLC (“Pointer Ridge”). We own 62.50% of Pointer Ridge.
Business of Old Line Bank
General
Old Line Bank is a trust company chartered under Subtitle 2 of Title 3 of the Financial Institutions Article of the Annotated Code of Maryland. Old Line Bank was originally chartered in 1989 as a national bank under the title “Old Line National Bank.” In June 2002, Old Line Bank converted to a Maryland chartered trust company exercising the powers of a commercial bank, and received a Certificate of Authority to do business from the Maryland Commissioner of Financial Regulation.
Old Line Bank converted from a national bank to a Maryland chartered trust company to reduce certain federal, supervisory and application fees that were then applicable to Old Line National Bank and to have a local primary regulator. Prior to the conversion, Old Line Bank’s primary regulator was the Office of the Comptroller of the Currency. Currently, Old Line Bank’s primary regulator is the Maryland Commissioner of Financial Regulation.
Old Line Bank does not exercise trust powers and its regulatory structure is the same as a Maryland chartered commercial bank. Old Line Bank is a member of the Federal Reserve System and the Federal Deposit Insurance Corporation insures our deposits.
We are headquartered in Bowie, Maryland, approximately 10 miles east of Andrews Air Force Base and 20 miles east of Washington, D.C. We engage in a general commercial banking business, making various types of loans and accepting deposits. We market our financial services to small to medium sized businesses, entrepreneurs, professionals, consumers and high net worth clients. Our current primary market area is the suburban Maryland (Washington, D.C. suburbs) counties of Anne Arundel, Calvert, Charles, Prince George’s and St. Mary’s. We also target customers throughout the greater Washington, D.C. metropolitan area. Our branch offices generally operate six days per week from 8:00 a.m. until 7:00 p.m. on weekdays and from 8:00 a.m. until noon on Saturday. None of our branch offices are open on Sunday.
Our principal source of revenue is interest income and fees generated by lending and investing funds on deposit. We typically balance the loan and investment portfolio towards loans. Generally speaking, loans earn more attractive returns than investments and are a key source of product cross sales and customer referrals. Our loan and investment strategies balance the need to maintain adequate liquidity via excess cash or federal funds sold with opportunities to leverage our capital appropriately.
We have based our strategic plan on the premise of enhancing stockholder value and growth through branching and operating profits. Our short term goals include maintaining credit quality, creating an attractive branch network, expanding fee income, generating extensions of core banking services and using technology to maximize stockholder value.
Recent Business Developments
Merger with Maryland Bankcorp, Inc.
On April 1, 2011, Old Line Bancshares acquired Maryland Bankcorp, Inc. (Maryland Bankcorp), the parent company of Maryland Bank & Trust Company, N.A. (MB&T). We converted each share of common stock of Maryland Bankcorp into the right to receive, at the holder’s election, $29.11 in cash or 3.4826 shares of Old Line Bancshares’ common stock. We paid cash for any fractional shares of Old Line Bancshares’ common stock and an aggregate cash consideration of $1.0 million. The total merger consideration was $18.8 million.
In connection with the acquisition, MB&T was merged with and into Old Line Bank, with Old Line Bank the surviving bank.
The acquisition increased Old Line Bancshares, Inc.’s total assets by more than $349 million for total assets immediately after closing of approximately $750 million. As a result of this acquisition Old Line Bank is the sixth largest independent commercial bank based in Maryland, with assets of more than $750 million and 19 full service branches serving five counties.
Branch Expansion Developments
The acquisition of MB&T added ten full service branches to Old Line Bank’s existing ten branch network, enhanced our presence in Charles County and established a branch network in St. Mary’s and Charles Counties. We subsequently closed one of the branches in Charles County.
In 2009, we substantially completed our organic branch expansion efforts with the opening of two new branch locations. On July 1, 2009, we opened a branch at 1641 State Route 3 North, Crofton, Maryland in Anne Arundel County.
In October 2009, we opened an additional branch in the Fairwood Office Park located at 12100 Annapolis Road, Suite 1, Glen Dale, Maryland. We hired the staff for this location during the third quarter of 2009.
In the fourth quarter of 2009, we moved our Greenbelt (Prince George’s County) Maryland branch that was opened in June 2007 on the 1st floor of an office building to a free standing building at the southwest corner of the intersection of Kenilworth Avenue and Ivy Lane, Greenbelt, Maryland. In April 2007, we hired the Branch Manager for this location and hired the remainder of the staff in May and September of 2007.
On January 2, 2011, we executed an agreement to lease 3,682 square feet of space on the 1st floor of an office building, plus the area comprising the drive-thru banking facilities, located at 2530 Riva Road in Annapolis, Maryland. We moved our current Annapolis branch to this new location during the second quarter of 2011. We are currently evaluating alternative uses for the existing branch.
Expansion of Commercial, Construction and Commercial Real Estate Lending
In December 2009, we added a team of four experienced, highly skilled loan officers to our staff. These officers have a combined 50 years of commercial banking experience and were employed by a large regional bank with offices in the suburban Maryland market prior to joining us. These individuals have worked in our market area for many years, have worked together as a team for several years and have a history of successfully generating a high volume of commercial, construction and commercial real estate loans. This team operates from our Greenbelt, Maryland branch location.
The acquisition of MB&T also significantly expanded our lending operations. As a result of the acquisition, we added a lending production office in Lexington Park, St. Mary’s County, Maryland, a lending production office in Prince Frederick, Calvert, County, Maryland and consolidated MB&T’s Waldorf, Charles County, Maryland lending production office into our existing Waldorf lending production office. This consolidation expanded our presence in Charles County, Maryland.
As anticipated, the acquisition, the addition of new lenders and our new branches caused an increase in non-interest expenses in 2011. As a result of the addition of these individuals and branches, however, we also experienced an increased level of loan and deposit growth during 2011 that we expect will continue for the foreseeable future, which has provided and we expect will continue to provide increased interest income that exceeds their non-interest expenses.
Sale and Repurchase of Preferred Stock to the U.S. Treasury
On December 5, 2008, we issued $7 million of our Series A Preferred Stock and warrants to purchase 141,892 shares of our common stock at $7.40 per share to the U.S. Department of the Treasury (“U.S. Treasury”) pursuant to the Capital Purchase Program under the Troubled Asset Relief Program implemented pursuant to the Emergency Economic Stabilization Act of 2008. Please see “-Supervision and Regulation-The Emergency Economic Stabilization Act of 2008” for additional information.
On July 15, 2009, we paid the U.S. Treasury $7,058,333 to repurchase the preferred stock outlined above. The amount paid included the liquidation value of the preferred stock and $58,333 of accrued but unpaid dividends. We have also repurchased at a fair market value of $225,000 the warrant to purchase 141,892 shares of our common stock that was issued to the U.S. Treasury in conjunction with the issuance of the preferred stock.
Location and Market Area
We consider our current primary market area to consist of the suburban Maryland (Washington, D.C. suburbs) counties of Anne Arundel, Calvert, Charles, Prince George’s and St. Mary’s. The economy in our current primary market area has focused on real estate development, high technology, retail and the government sector.
Our headquarters and a branch are located at 1525 Pointer Ridge Place, Bowie, Prince George’s County, Maryland. A critical component of our strategic plan and future growth is Prince George’s County. Prince George’s County wraps around the eastern boundary of Washington, D.C. and offers urban, suburban and rural settings for employers and residents. There are several national and international airports less than an hour away, as is Baltimore. We currently have seven branch locations and three loan production offices in Prince George’s County.
Five of our branch offices and a loan production office are located in Charles County, Maryland. Just 15 miles south of the Washington Capital Beltway, Charles County is the gateway to Southern Maryland. The northern part of Charles County is the “development district” where the commercial, residential and business growth is focused. Waldorf, White Plains and the planned community of St. Charles are located here.
Two of our branch offices are located in Anne Arundel County, Maryland. We have one in Annapolis that we opened in September 2008 that we relocated and expanded to include a loan production office in 2011. We have another branch that we opened in Crofton in July 2009. Anne Arundel County borders the Chesapeake Bay and is situated in the high tech corridor between Baltimore and Washington, D.C. With over 534 miles of shoreline, it provides waterfront living to many residential communities. Annapolis, the State Capital and home to the United States Naval Academy, and Baltimore/Washington International Thurgood Marshal Airport (BWI) are located in Anne Arundel County. Anne Arundel County has one of the strongest economies in the State of Maryland and its unemployment rate is consistently below the national average.
As a result of the acquisition of MB&T, in April 2011, we expanded our branch network to encompass the southern Maryland counties of Calvert and St. Mary’s. The unemployment rates in Calvert and St. Mary’s counties are among the lowest in the state of Maryland and also consistently rank below the national average.
Calvert County is located approximately 25 miles southeast of Washington, D.C. Calvert County is one of several Maryland counties that comprise the Washington Metropolitan Area and is adjacent to Anne Arundel, Prince George’s, St. Mary’s and Charles Counties. Major employers in Calvert County include municipal and government agencies and Constellation Energy. We have two branches and a loan production office in Calvert County.
In St. Mary’s County, we have three branches and a loan production office. St. Mary’s County is located approximately 35 miles southeast of Washington, D.C. It is adjacent to Charles, Calvert and St. Mary’s counties and is home to the Patuxent River Naval Air Station, a major naval air testing facility on the east coast of the United States.
Lending Activities
General. Our primary market focus is on making loans to small and medium size businesses, entrepreneurs, professionals, consumers and high net worth clients in our primary market area. Our lending activities consist generally of short to medium term commercial business loans, commercial real estate loans, real estate construction loans, home equity loans and consumer installment loans, both secured and unsecured. As a niche lending product, prior to 2008, we provided luxury boat financing to individuals, who generally tended to be high net worth individuals. These boats are generally Coast Guard documented and have a homeport of record in the Chesapeake Bay or its tributaries.
Credit Policies and Administration. We have adopted a comprehensive lending policy, which includes stringent underwriting standards for all types of loans. Our lending staff follows pricing guidelines established periodically by our management team. In an effort to manage risk, prior to funding, the loan committee consisting of our executive officers and eight members of the Board of Directors must approve by a majority vote all credit decisions in excess of a lending officer’s lending authority. Management believes that we employ experienced lending officers, secure appropriate collateral and carefully monitor the financial condition of our borrowers and the concentrations of loans in the portfolio.
In addition to the normal repayment risks, all loans in the portfolio are subject to the state of the economy and the related effects on the borrower and/or the real estate market. With the exception of loans provided to finance luxury boats, generally longer term loans have periodic interest rate adjustments and/or call provisions. Senior management monitors the loan portfolio closely to ensure that we minimize past due loans and that we swiftly deal with potential problem loans.
Old Line Bank also retains an outside, independent firm to review the loan portfolio. This firm performs a detailed annual review and an interim update at least once a year. We use the results of the firm’s report to validate our internal loan ratings and we review their commentary on specific loans and on our loan administration activities in order to improve our operations.
Commercial Business Lending. Our commercial business lending consists of lines of credit, revolving credit facilities, accounts receivable financing, term loans, equipment loans, SBA loans, standby letters of credit and unsecured loans. We originate commercial loans for any business purpose including the financing of leasehold improvements and equipment, the carrying of accounts receivable, general working capital and acquisition activities. We have a diverse client base and we do not have a concentration of these types of loans in any specific industry segment. We generally secure commercial business loans with accounts receivable, equipment, deeds of trust and other collateral such as marketable securities, cash value of life insurance, and time deposits at Old Line Bank.
Commercial business loans have a higher degree of risk than residential mortgage loans because the availability of funds for repayment generally depends on the success of the business. They may also involve higher average balances, increased difficulty monitoring and a higher risk of default since their repayment generally depends on the successful operation of the borrower’s business. To help manage this risk, we typically limit these loans to proven businesses and we generally obtain appropriate collateral and personal guarantees from the borrower’s principal owners and monitor the financial condition of the business. For loans in excess of $250,000, monitoring usually includes a review of the borrower’s annual tax returns and updated financial statements.
Commercial Real Estate Lending. We finance commercial real estate for our clients, usually for owner occupied properties. We generally will finance owner occupied commercial real estate at a maximum loan to value of 85%. Our underwriting policies and processes focus on the clients’ ability to repay the loan as well as an assessment of the underlying real estate. We originate commercial real estate loans on a fixed rate or adjustable rate basis. Usually, these rates adjust during a three, five or seven year time period based on the then current treasury or prime rate index. Repayment terms include amortization schedules from three years to a maximum of 25 years with principal and interest payments due monthly and with all remaining principal due at maturity.
Commercial real estate lending entails significant additional risks as compared with residential mortgage lending. Risks inherent in managing a commercial real estate portfolio relate to sudden or gradual drops in property values as well as changes in the economic climate that may detrimentally impact the borrower’s ability to repay. We attempt to mitigate these risks by carefully underwriting these loans. Our underwriting generally includes an analysis of the borrower’s capacity to repay, the current collateral value, a cash flow analysis and review of the character of the borrower and current and prospective conditions in the market. We generally limit loans in this category to 75%-80% of the value of the property and require personal and/or corporate guarantees. For loans of this type in excess of $250,000, we monitor the financial condition and operating performance of the borrower through a review of annual tax returns and updated financial statements. In addition, we will meet with the borrower and/or perform site visits as required.
Real Estate Construction Lending. This segment of our loan portfolio consists of funds advanced for construction of single family residences, multifamily housing and commercial buildings. These loans have short durations, meaning maturities typically of nine months or less. Residential houses, multifamily dwellings and commercial buildings under construction and the underlying land for which the loan was obtained secure the construction loans. All of these loans are concentrated in our primary market area.
Construction lending entails significant risks compared with residential mortgage lending. These risks involve larger loan balances concentrated with single borrowers with funds advanced upon the security of the land or the project under construction. The value of the project is estimated prior to the completion of construction. Thus, it is more difficult to evaluate accurately the total loan funds required to complete a project and related loan to value ratios. To mitigate these risks, we generally limit loan amounts to 80% of appraised values and obtain first lien positions on the property. We generally only offer real estate construction financing to experienced builders and commercial entities or individuals who have demonstrated the ability to obtain a permanent loan “take out”. We also perform a complete analysis of the borrower and the project under construction. This analysis includes a review of the cost to construct, the borrower’s ability to obtain a permanent “take out”, the cash flow available to support the debt payments and construction costs in excess of loan proceeds, and the value of the collateral. During construction, we advance funds on these loans on a percentage of completion bases. We inspect each project as needed prior to advancing funds during the term of the construction loan.
Residential Real Estate Lending. We offer a variety of consumer oriented residential real estate loans. The bulk of our portfolio is made up of home equity loans to individuals with a loan to value not exceeding 85%. We also offer fixed rate home improvement loans. Our home equity and home improvement loan portfolio gives us a diverse client base. Although most of these loans are in our primary market area, the diversity of the individual loans in the portfolio reduces our potential risk. Usually, we secure our home equity loans and lines of credit with a security interest in the borrower’s primary or secondary residence. Our initial underwriting includes an analysis of the borrower’s debt/income ratio which generally may not exceed 40%, collateral value, length of employment and prior credit history. We do not have any subprime residential real estate loans.
Consumer Installment Lending
Luxury Boat Loans. We offer various types of secured and unsecured consumer loans. Prior to 2008, a primary aspect of our consumer lending was financing for luxury boat purchases. Although we continue to maintain a portfolio totaling approximately $8.9 million of these loans and would consider making such loans in the future if borrowers were to apply for them, we have not originated any substantive new marine loans since the third quarter of 2007. These loans entail greater risks than residential mortgage lending because the boats that secure these loans are depreciable assets. Further, payment on these loans depends on the borrower’s continuing financial stability. Job loss, divorce, illness or personal bankruptcy may adversely impact the borrower’s ability to pay. To mitigate these risks, we have more stringent underwriting standards for these loans than for other installment loans. As a general guideline, the individual’s debt service should not exceed 36% of his or her gross income, the individual must own a home, have stability of employment and residency, verifiable liquidity, satisfactory prior credit repayment history and the loan to value ratio may not exceed 85%. To ascertain value, we generally receive a survey of the boat from a qualified surveyor and/or a current purchase agreement and compare the determined value to published industry values. The majority of these boats are United States Coast Guard documented vessels and we obtain a lien on the vessel with a first preferred ship mortgage, where applicable, or a security interest on the title.
Personal and Household Loans. We also make consumer loans for personal, family or household purposes as a convenience to our customer base. As a general guideline, a consumer’s total debt service should not exceed 40% of his or her gross income. The underwriting standards for consumer loans include a determination of the applicant’s payment history on other debts and an assessment of his or her ability to meet existing obligations and payments on the proposed loan.
Consumer loans may present greater credit risk than residential mortgage loans because many consumer loans are unsecured or rapidly depreciating assets secure these loans. Repossessed collateral for a defaulted consumer loan may not provide an adequate source of repayment of the outstanding loan balance because of the greater likelihood of damage, loss or depreciation. Consumer loan collections depend on the borrower’s continuing financial stability. If a borrower suffers personal financial difficulties, the loan may not be repaid. Also, various federal and state laws, including bankruptcy and insolvency laws, may limit the amount we can recover on such loans. However, in our opinion, many of these risks do not apply to the luxury boat loan portfolio due to the credit quality and liquidity of the borrowers.
Many of the loans that we acquired from MB&T do not adhere to the stringent underwriting standards that we maintain. Accordingly, during our due diligence process, we evaluated these loans using our underwriting standards and discounted the book value of these loans. This discounted book value was subsequently incorporated into our initial purchase price.
Lending Limit. As of December 31, 2011, our legal lending limit for loans to one borrower was approximately $9.5 million. As part of our risk management strategy, we may attempt to participate a portion of larger loans to other financial institutions. This strategy allows Old Line Bank to maintain customer relationships yet reduce credit exposure. However, this strategy may not always be available.
Investments and Funding
We balance our liquidity needs based on loan and deposit growth via the investment portfolio, purchased funds, and short term borrowings. It is our goal to provide adequate liquidity to support our loan growth. In the event we have excess liquidity, we use investments to generate positive earnings. In the event deposit growth does not fully support our loan growth, we can use a combination of investment sales, federal funds, other purchased funds and short term borrowings to augment our funding position.
We actively monitor our investment portfolio and we classify the majority of the portfolio as “available for sale.” In general, under such a classification, we may sell investment instruments as management deems appropriate. On a monthly basis, we “mark to market” the investment portfolio through an adjustment to stockholders’ equity net of taxes. Additionally, we use the investment portfolio to balance our asset and liability position. We invest in fixed rate or floating rate instruments as necessary to reduce our interest rate risk exposure.
Other Banking Products
We offer our customers safe deposit boxes, wire transfer services, debit cards, automated teller machines at all of our branch locations and credit cards through a third party processor. Additionally, we provide Internet banking capabilities to our customers. With our Internet banking service, our customers may view their accounts on line and electronically remit bill payments. Our commercial account services include direct deposit of payroll for our commercial clients’ employees, an overnight sweep service and remote deposit capture service.
Deposit Activities
Deposits are the major source of our funding. We offer a broad array of deposit products that include demand, NOW, money market and savings accounts as well as certificates of deposit. We believe that we pay competitive rates on our interest bearing deposits. As a relationship oriented organization, we generally seek to obtain deposit relationships with our loan clients.
As our overall balance sheet position dictates, we may become more or less competitive in our interest rate structure. We do use brokered deposits as a funding mechanism. Our primary source of brokered deposits is the Promontory Interfinancial Network (Promontory). Through this deposit matching network and its certificate of deposit account and money market registry services, we obtained the ability to offer our customers access to FDIC insured deposit products in aggregate amounts exceeding current insurance limits. When we place funds through Promontory on behalf of a customer, we receive matching deposits through the network. During 2009 and 2010, we also purchased brokered certificates of deposit from other sources. We did not purchase brokered deposits from any other source in 2011.
Competition
The banking business is highly competitive. We compete with other commercial banks, savings associations, credit unions, mortgage banking firms, consumer finance companies, securities brokerage firms, insurance companies, money market mutual funds and other financial institutions operating in our primary market area and elsewhere.
We believe that we have effectively leveraged our talents, contacts and location to achieve a strong financial position. However, our primary market area is highly competitive and heavily branched. Competition in our primary market area for loans to small and medium sized businesses, entrepreneurs, professionals and high net worth clients is intense, and pricing is important. Most of our competitors have substantially greater resources and lending limits than we do and offer extensive and established branch networks and other services that we do not offer. Moreover, larger institutions operating in our primary market area have access to borrowed funds at a lower rate than is available to us. Deposit competition also is strong among institutions in our primary market area. As a result, it is possible that to remain competitive we may need to pay above market rates for deposits.
Employees
As of March 1, 2012, Old Line Bank had 158 full time and 19 part time employees. No collective bargaining unit represents any of our employees and we believe that relations with our employees are good. Old Line Bancshares, Inc. has no employees.
Supervision and Regulation
Old Line Bancshares, Inc. and Old Line Bank are subject to extensive regulation under state and federal banking laws and regulations. These laws impose specific requirements and restrictions on virtually all aspects of operations and generally are intended to protect depositors, not stockholders. The following summary sets forth certain material elements of the regulatory framework applicable to Old Line Bancshares, Inc. and Old Line Bank. It does not describe all of the provisions of the statutes, regulations and policies that are identified. To the extent that the following information describes statutory and regulatory provisions, it is qualified in its entirety by express reference to each of the particular statutory and regulatory provisions. A change in applicable statutes, regulations or regulatory policy may have a material effect on our business.
Old Line Bancshares, Inc.
Old Line Bancshares, Inc. is a Maryland corporation registered as a bank holding company under the Bank Holding Company Act of 1956, as amended. We are subject to regulation and examination by the Federal Reserve Board, and are required to file periodic reports and any additional information that the Federal Reserve Board may require. The Bank Holding Company Act generally prohibits a bank holding company from engaging in activities other than banking, managing or controlling banks or other permissible subsidiaries and acquiring or retaining direct or indirect control of any company engaged in any activities closely related to banking or managing or controlling banks.
In accordance with the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010 (the “Dodd-Frank Act”) and Federal Reserve Board policy, a bank holding company is expected to serve as a source of financial and managerial strength to its subsidiary banks and may not conduct its operations in an unsafe or unsound manner. In addition, in serving as a source of strength to its subsidiary banks, a bank holding company should stand ready to use available resources to provide adequate capital funds to its subsidiary banks during periods of financial stress or adversity and should maintain the financial flexibility and capital raising capacity to obtain additional resources for assisting its subsidiary banks. A bank holding company’s failure to meet its obligations to serve as a source of strength to its subsidiary banks will generally be considered by the Federal Reserve Board to be an unsafe and unsound banking practice or a violation of the Federal Reserve Board regulations or both. This doctrine is commonly known as the “source of strength” doctrine. The Federal Reserve Board may require a bank holding company to terminate any activity or relinquish control of a non-bank subsidiary (other than a non-bank subsidiary of a bank) upon the Federal Reserve Board’s determination that such activity or control constitutes a serious risk to the financial soundness or stability of any subsidiary depository institution of the bank holding company. Further, federal bank regulatory authorities have additional discretion to require a bank holding company to divest itself of any bank or non-bank subsidiary if the agency determines that divestiture may aid the depository institution’s financial condition.
The status of Old Line Bancshares, Inc. as a registered bank holding company under the Bank Holding Company Act of 1856, as amended, does not exempt it from certain federal and state laws and regulations applicable to Maryland corporations generally, including, without limitation, certain provisions of the federal securities laws.
Old Line Bank
Old Line Bank is a Maryland chartered trust company (with all of the powers of a commercial bank), is a member of the Federal Reserve System, and the Deposit Insurance Fund of the Federal Deposit Insurance Corporation (“FDIC”) insures its deposit accounts up to the maximum legal limits. It is subject to regulation, supervision and regular examination by the Maryland Office of the Commissioner of Financial Regulation (“Commissioner”) and the Federal Reserve Board. The regulations of these various agencies govern most aspects of Old Line Bank’s business, including required reserves against deposits, loans, investments, mergers and acquisitions, borrowing, dividends and location and number of branch offices. The Dodd-Frank Act transferred responsibility for the implementation of financial consumer protection laws to a new independent agency in the Federal Reserve Board. The new agency, the Consumer Financial Protection Bureau, will issue rules and regulations governing consumer financial protection. However, depository institutions of less than $10 billion in assets, such as Old Line Bank, will continue to be examined for compliance with consumer protection laws by the Commissioner and Federal Reserve Board, which will also have enforcement authority.
Capital Adequacy Guidelines
The Federal Reserve Board has adopted risk based capital adequacy guidelines pursuant to which it assesses the adequacy of capital in examining and supervising banks and in analyzing bank regulatory applications. Risk based capital requirements determine the adequacy of capital based on the risk inherent in various classes of assets and off balance sheet items.
Old Line Bank is expected to meet a minimum ratio of total qualifying capital (the sum of core capital (Tier I) and supplementary capital (Tier II)) to risk weighted assets of 8%. At least half of this amount (4%) must be in the form of Tier I Capital. In general, this requirement is similar to the capital that a bank must have in order to be considered “adequately capitalized” under the prompt corrective action regulations. See “– Prompt Corrective Action.” Old Line Bank currently complies with this minimum requirement.
Tier I Capital generally consists of the sum of common stockholders’ equity, noncumulative perpetual preferred stock including any related surplus (subject in the case of the latter to limitations on the kind and amount of such stock which may be included as Tier I Capital), and minority interest in the equity accounts of consolidated subsidiaries, less goodwill and other intangible assets subject to certain exceptions.” Tier II Capital consists of the following: hybrid capital instruments; perpetual preferred stock which is not otherwise eligible to be included as Tier I Capital; term subordinated debt and intermediate term preferred stock including related surplus, subject to certain limitations; and, subject to limitations, general allowances for loan losses. Assets are adjusted under the risk based guidelines to take into account different risk characteristics, with the categories ranging from 0% (requiring no risk based capital) for assets such as cash, to 100% for the bulk of assets which are typically held by a commercial bank, including certain multi-family residential and commercial real estate loans, commercial business loans and consumer loans, and 200% for assets with relatively high credit risk, such as asset backed securities one category below investment grade.
Residential first mortgage loans on one to four family residential real estate and certain seasoned multi-family residential real estate loans, which are not 90 days or more past due or non-performing and which have been made in accordance with prudent underwriting standards are assigned a 50% level in the risk weighing system, as are certain privately-issued mortgage backed securities representing indirect ownership of such loans. Off balance sheet items also are adjusted to take into account certain risk characteristics.
In addition to the risk based capital requirements, the Federal Reserve Board has established a minimum 3.0% Leverage Capital Ratio (Tier I Capital to total adjusted assets) requirement for the most highly rated banks, with an additional cushion of at least 100 to 200 basis points for all other banks, which effectively increases the minimum Leverage Capital Ratio for such other banks to 4.0% - 5.0% or more. The highest rated banks are those that are not anticipating or experiencing significant growth and have well diversified risk, including no undue interest rate risk exposure, excellent asset quality, high liquidity, good earnings and, in general, those which are considered a strong banking organization.
Prompt Corrective Action
Under Section 38 of the FDIA, each federal banking agency is required to implement a system of prompt corrective action for institutions that it regulates. The federal banking agencies have promulgated substantially similar regulations to implement the system of prompt corrective action established by Section 38 of the FDIA. Under the regulations, a bank will be deemed to be: (i) “well capitalized” if it has a Total Risk Based Capital Ratio of 10.0% or more, a Tier 1 Risk Based Capital Ratio of 6.0% or more, a Leverage Capital Ratio of 5.0% or more and is not subject to any written capital order or directive; (ii) “adequately capitalized” if it has a Total Risk Based Capital Ratio of 8.0% or more, a Tier 1 Risk Based Capital Ratio of 4.0% or more and a Tier 1 Leverage Capital Ratio of 4.0% or more (3.0% under certain circumstances) and does not meet the definition of “well capitalized;” (iii) “undercapitalized” if it has a Total Risk Based Capital Ratio that is less than 8.0%, a Tier 1 Risk Based Capital Ratio that is less than 4.0% or a Leverage Capital Ratio that is less than 4.0% (3.0% under certain circumstances); (iv) “significantly undercapitalized” if it has a Total Risk Based Capital Ratio that is less than 6.0%, a Tier 1 Risk Based Capital Ratio that is less than 3.0% or a Leverage Capital Ratio that is less than 3.0%; and (v) “critically undercapitalized” if it has a ratio of tangible equity to total assets that is equal to or less than 2.0%.
An institution generally must file a written capital restoration plan which meets specified requirements with an appropriate federal banking agency within 45 days of the date the institution receives notice or is deemed to have notice that it is undercapitalized, significantly undercapitalized or critically undercapitalized. A federal banking agency must provide the institution with written notice of approval or disapproval within 60 days after receiving a capital restoration plan, subject to extensions by the applicable agency.
An institution that is required to submit a capital restoration plan must concurrently submit a performance guaranty by each company that controls the institution. Such guaranty will be limited to the lesser of (i) an amount equal to 5.0% of the institution’s total assets at the time the institution was notified or deemed to have notice that it was undercapitalized or (ii) the amount necessary at such time to restore the relevant capital measures of the institution to the levels required for the institution to be classified as adequately capitalized. Such a guaranty will expire after the federal banking agency notifies the institution that it has remained adequately capitalized for each of four consecutive calendar quarters. An institution that fails to submit a written capital restoration plan within the requisite period, including any required performance guaranty, or fails in any material respect to implement a capital restoration plan, will be subject to the restrictions in Section 38 of the FDIA which are applicable to significantly undercapitalized institutions.
Immediately upon becoming undercapitalized, an institution becomes subject to the provisions of Section 38 of the FDIA, which (i) restrict payment of capital distributions and management fees; (ii) require that the appropriate federal banking agency monitor the condition of the institution and its efforts to restore its capital; (iii) require submission of a capital restoration plan; (iv) restrict the growth of the institution’s assets; and (v) require prior approval of certain expansion proposals. The appropriate federal banking agency for an undercapitalized institution also may take any number of discretionary supervisory actions if the agency determines that any of these actions is necessary to resolve the problems of the institution at the least possible long term cost to the deposit insurance fund, subject in certain cases to specified procedures. These discretionary supervisory actions include: requiring the institution to raise additional capital, restricting transactions with affiliates, requiring divestiture of the institution or sale of the institution to a willing purchaser, and any other supervisory action that the agency deems appropriate. These and additional mandatory and permissive supervisory actions may be taken with respect to significantly undercapitalized and critically undercapitalized institutions.
A “critically undercapitalized institution” will be placed in conservatorship or receivership within 90 days unless the FDIC formally determines that forbearance from such action would better protect the deposit insurance fund. Unless the FDIC or other appropriate federal banking regulatory agency makes specific further findings and certifies that the institution is viable and is not expected to fail, an institution that remains critically undercapitalized on average during the fourth calendar quarter after the date it becomes critically undercapitalized must be placed in receivership. The general rule is that the FDIC will be appointed as receiver within 90 days after a bank becomes critically undercapitalized unless extremely good cause is shown and the federal regulators agree to an extension. In general, good cause is defined as capital that has been raised and is immediately available for infusion into the bank except for certain technical requirements that may delay the infusion for a period of time beyond the 90 day time period.
Additionally, under Section 11(c)(5) of the FDIA, a conservator or receiver may be appointed for an institution where: (i) an institution’s obligations exceed its assets; (ii) there is substantial dissipation of the institution’s assets or earnings as a result of any violation of law or any unsafe or unsound practice; (iii) the institution is in an unsafe or unsound condition; (iv) there is a willful violation of a cease and desist order; (v) the institution is unable to pay its obligations in the ordinary course of business; (vi) losses or threatened losses deplete all or substantially all of an institution’s capital, and there is no reasonable prospect of becoming “adequately capitalized” without assistance; (vii) there is any violation of law or unsafe or unsound practice or condition that is likely to cause insolvency or substantial dissipation of assets or earnings, weaken the institution’s condition, or otherwise seriously prejudice the interests of depositors or the insurance fund; (viii) an institution ceases to be insured; (ix) the institution is undercapitalized and has no reasonable prospect that it will become adequately capitalized, fails to become adequately capitalized when required to do so, or fails to submit or materially implement a capital restoration plan; or (x) the institution is critically undercapitalized or otherwise has substantially insufficient capital.
Currently, Old Line Bank is well capitalized.
Basel III
In December 2010, the Basel Committee released its final framework for strengthening international capital and liquidity regulation, now officially identified by the Basel Committee as “Basel III”. Basel III, when implemented by the U.S. banking agencies and fully phased in, will require bank holding companies and their bank subsidiaries to maintain substantially more capital, with a greater emphasis on common equity. Basel III increases the minimum Tier 1 common equity ratio to 4.5%, net of regulatory deductions, and introduces a capital conservation buffer of an additional 2.5% of common equity to risk weighted assets, raising the target minimum common equity ratio to 7%. This capital conservation buffer also increases the minimum Tier 1 capital ratio from 6% to 8.5% and the minimum total capital ratio from 8% to 10.5%. In addition, Basel III introduces a countercyclical capital buffer of up to 2.5% of common equity or other fully loss absorbing capital for periods of excess credit growth. Basel III also introduces a non-risk adjusted Tier 1 leverage ratio of 3%, based on a measure of total exposure rather than total assets, and new liquidity standards. The requirements to maintain higher levels of capital or to maintain higher levels of liquid assets could adversely impact our financial results.
Deposit Insurance
The deposits of Old Line Bank are insured up to applicable limits per insured depositor by the FDIC. The Dodd-Frank Act permanently increased the FDIC deposit insurance coverage per separately insured depositor for all account types to $250,000. In November 2010, as required by the Dodd-Frank Act, the FDIC issued a Final Rule that provides for unlimited insurance coverage of non-interest bearing demand transaction accounts, regardless of the balance of the account, until January 1, 2013. On January 18, 2011, the FDIC issued a Final Rule to include Interest on Lawyer Trust Accounts (“IOLTAs”) in the temporary unlimited insurance coverage for non-interest bearing demand transaction accounts. This temporary unlimited insurance coverage replaces the Transaction Account Guarantee Program (TAGP), which expired on December 31, 2010. Unlike the TAGP, there is no special assessment associated with the temporary unlimited insurance coverage, nor may institutions opt out of the unlimited coverage.
Under the FDIA, the FDIC may terminate insurance of deposits upon a finding that the institution has engaged in unsafe or unsound practices, is in an unsafe or unsound condition to continue operations or has violated any applicable law, regulation, rule, order or condition imposed by the FDIC.
Deposit Insurance Assessments
Under current FDIC regulations, each depository institution is assigned to a risk category based on capital and supervisory measures. In 2009, the FDIC revised the method for calculating the assessment rate for depository institutions by introducing several adjustments to an institution’s initial base assessment rate. A depository institution is assessed premiums by the FDIC based on its risk category and the amount of deposits held. On February 7, 2011, the FDIC approved a final rule on Assessments, Dividends, Assessment Base and Large Bank Pricing (“Rule”). The Rule, mandated by the Dodd-Frank Act, changes the deposit insurance assessment system from one that is based on domestic deposits to one that is based on average consolidated total assets minus average tangible equity. In addition, the Rule adopts a “scorecard” assessment scheme for larger banks and suspends dividend payments if the Depository Insurance Fund (“DIF”) reserve ratio exceeds 1.5%, but provides for decreasing assessment rates when the DIF reserve ratio reaches certain thresholds. Under the Rule, larger insured depository institutions will likely be forced to pay higher assessments to the DIF than under the old system, which should offset the cost of the assessment increases for institutions with consolidated assets of less than $10 billion, such as Old Line Bank.
The Emergency Economic Stabilization Act of 2008
In the third quarter of 2008, the Federal Reserve, the U.S. Treasury and the FDIC initiated measures to stabilize the financial markets and to provide liquidity for financial institutions. The Emergency Economic Stabilization Act of 2008 (“EESA”) was signed into law on October 3, 2008 and authorized the U.S. Treasury to provide funds to restore liquidity and stability to the U.S. financial system. Under the authority of EESA, the U.S. Treasury instituted a voluntary capital purchase program to encourage U.S. financial institutions to build capital to increase the flow of financing to U.S. businesses and consumers to support the U.S. economy. Under the program, the U.S. Treasury purchased senior preferred shares of financial institutions that pay cumulative dividends at a rate of 5% per year for five years and thereafter at a rate of 9% per year. On December 5, 2008, Old Line Bancshares issued to the U.S. Treasury $7 million of Series A Preferred Stock and warrants to purchase 141,892 shares of our common stock at $7.40 per share. We elected to participate in the capital purchase program at an amount equal to approximately 3% of our risk weighted assets at the time.
On July 15, 2009, we repurchased from the U.S. Treasury the 7,000 shares of preferred stock that we issued to them in December 2008. We also repurchased the warrant to purchase 141,892 shares of our common stock that was issued to the U.S. Treasury in conjunction with the issuance of preferred stock.
Maryland Regulatory Assessment
The Maryland Commissioner of Financial Regulation in the Department of Labor, Licensing and Regulation assesses state chartered banks to cover the expense of regulating banking institutions. The Commissioner assesses each banking institution the sum of $1,000, plus $0.08 for each $1,000 of assets of the institution over $1,000,000, as disclosed on the banking institution’s most recent financial report. In 2011, we paid $42,529 to the Maryland Commissioner of Financial Regulation.
Regulatory Enforcement Authority
The Financial Institutions Reform, Recovery, and Enforcement Act of 1989 (“FIRREA”) included substantial enhancement to the enforcement powers available to federal banking regulators, including the Federal Reserve Board. This enforcement authority includes, among other things, the ability to assess civil money penalties, to issue cease and desist or removal orders and to initiate injunctive actions against banking organizations and institution affiliated parties. In general, these enforcement actions may be initiated for violations of laws and regulations and unsafe or unsound practices. Other actions or inactions may provide the basis for enforcement action, including misleading or untimely reports filed with regulatory authorities. FIRREA significantly increased the amount of and grounds for civil money penalties and requires, except under certain circumstances, public disclosure of final enforcement actions by the federal banking agencies.
Restrictions on Transactions with Affiliates and Insiders
Maryland law imposes restrictions on certain transactions with affiliates of Maryland commercial banks. Generally, under Maryland law, a director, officer or employee of a commercial bank may not borrow, directly or indirectly, any money from the bank, unless the loan has been approved by a resolution adopted by and recorded in the minutes of the board of directors of the bank, or the executive committee of the bank, if that committee is authorized to make loans. If the executive committee approves such a loan, the loan approval must be reported to the board of directors at its next meeting. Certain commercial loans made to directors of a bank and certain consumer loans made to non-officer employees of the bank are exempt from the law’s coverage.
In addition, Old Line Bank is subject to the provisions of Sections 23A and 23B of the Federal Reserve Act and Regulation W of the Federal Reserve Board (collectively, “Regulation W”), which limit the amount of loans or extensions of credit to, investments in, or certain other transactions with, affiliates, and limits the amount of advances to third parties collateralized by the securities or obligations of affiliates. Regulation W limits the aggregate amount of transactions with any individual affiliate to 10% of the capital and surplus of Old Line Bank and also limits the aggregate amount of transactions with all affiliates to 20% of capital and surplus. Loans and certain other extensions of credit to affiliates are required to be secured by collateral in an amount and of a type described in Regulation W, and the purchase of low quality assets from affiliates is generally prohibited.
Regulation W, among other things, prohibits an institution from engaging in certain transactions with certain affiliates (as defined in the Federal Reserve Act) unless the transactions are on terms substantially the same, or at least as favorable to such institution and/or its subsidiaries, as those prevailing at the time for comparable transactions with non-affiliated entities. In the absence of comparable transactions, such transactions may only occur under terms and circumstances, including credit standards that in good faith would be offered to or would apply to non-affiliated companies.
In addition, under Regulation W:
| · | a bank and its subsidiaries may not purchase a low quality asset from an affiliate; |
| · | covered transactions and other specified transactions between a bank or its subsidiaries and an affiliate must be on terms and conditions that are consistent with safe and sound banking practices; and |
| · | with some exceptions, each loan or extension of credit by a bank to an affiliate must be secured by collateral with a market value ranging from 100% to 130%, depending on the type of collateral, of the amount of the loan or extension of credit. |
Regulation W generally excludes non-bank and non-savings association subsidiaries of banks from treatment as affiliates, except to the extent that the Federal Reserve Board decides to treat these subsidiaries as affiliates.
Old Line Bank also is subject to the restrictions contained in Sections 22(g) and 22(h) of the Federal Reserve Act and the Federal Reserve Board’s Regulation O thereunder (collectively, “Regulation O”), which govern loans and extensions of credit to executive officers, directors and principal stockholders. Under Regulation O, loans to a director, an executive officer or a greater than 10% stockholder of a bank as well as certain affiliated interests of any of the foregoing may not exceed, together with all other outstanding loans to such person and affiliated interests, the loans to one borrower limit applicable to national banks (generally 15% of the institution’s unimpaired capital and surplus), and all loans to all such persons in the aggregate may not exceed the institution’s unimpaired capital and unimpaired surplus. Regulation O also prohibits the making of loans in an amount greater than $25,000 or 5% of capital and surplus but in any event not over $500,000, to directors, executive officers and greater than 10% stockholders of a bank, and their respective affiliates, unless such loans are approved in advance by a majority of the Board of Directors of the bank with any interested director not participating in the voting. Further, Regulation O requires that loans to directors, executive officers and principal stockholders be made on terms substantially the same as those that are offered in comparable transactions to unrelated third parties unless the loans are made pursuant to a benefit or compensation program that is widely available to all employees of the bank and does not give preference to insiders over other employees. Regulation O also prohibits a depository institution from paying overdrafts over $1,000 of any of its executive officers or directors unless they are paid pursuant to written preauthorized extension of credit or transfer of funds plans. Regulation O also has special rules for loans to executive officers, and generally prohibits the making of such loans in an amount greater than $25,000 or 2.5% of capital and surplus but in any event not over $100,000 unless such loan meets certain collateralization requirements or is made to finance the education of the executive officer's children, or to finance or refinance the executive officer’s residence.
All of Old Line Bank’s loans to its and Old Line Bancshares, Inc.’s executive officers, directors and greater than 10% stockholders, and affiliated interests of such persons, comply with the requirements of Regulation W and Regulation O.
We have entered into banking transactions with our directors and executive officers and the business and professional organizations in which they are associated in the ordinary course of business. We make any loans and loan commitments in accordance with all applicable laws.
Loans to One Borrower
Old Line Bank is subject to the statutory and regulatory limits on the extension of credit to one borrower. Generally, the maximum amount of total outstanding loans that a Maryland chartered trust company may have to any one borrower at any one time is 15% of Old Line Bank’s unimpaired capital and unimpaired surplus. An additional amount may be lent, equal to 10% of unimpaired capital and surplus, if such loan is secured by readily marketable collateral, which is defined to include certain securities and bullion, but generally does not include real estate.
Liquidity
Old Line Bank is subject to the reserve requirements imposed by the State of Maryland. A Maryland commercial bank is required to have at all times a reserve equal to at least 15% of its demand deposits. Old Line Bank is also subject to the reserve requirements of Federal Reserve Board Regulation D, which applies to all depository institutions. Specifically, as of December 31, 2011, amounts in transaction accounts above $10.7 million and up to $58.8 million must have reserves held against them in the ratio of three percent of the amount. Amounts above $58.8 million require reserves of $1,443,000 plus 10% of the amount in excess of $58.8 million. For 2012, amounts in transaction accounts above $11.5 million and up to $71.0 million must have reserves held against them in the ratio of three percent of the amount. Amounts above $71.0 million require reserves of $1,785,000 plus 10 percent of the amount in excess of $71.0 million. The Maryland reserve requirements may be used to satisfy the requirements of Federal Reserve Regulation D. Old Line Bank is in compliance with its reserve requirements.
Dividends
Old Line Bancshares, Inc. is a legal entity separate and distinct from Old Line Bank. Virtually all of Old Line Bancshares, Inc.’s revenue available for the payment of dividends on its common stock results from dividends paid to Old Line Bancshares, Inc. by Old Line Bank. Under Maryland law, Old Line Bank may declare a cash dividend, after providing for due or accrued expenses, losses, interest, and taxes, from its undivided profits or, with the prior approval of the Maryland Commissioner of Financial Regulation, from its surplus in excess of 100% of its required capital stock. Also, if Old Line Bank’s surplus is less than 100% of its required capital stock, cash dividends may not be paid in excess of 90% of net earnings. In addition to these specific restrictions, the bank regulatory agencies have the ability to prohibit or limit proposed dividends if such regulatory agencies determine the payment of such dividends would result in Old Line Bank being in an unsafe and unsound condition.
Community Reinvestment Act
Old Line Bank is required to comply with the Community Reinvestment Act (“CRA”) regardless of its capital condition. The CRA requires that, in connection with its examinations of Old Line Bank, the Federal Reserve Board evaluates the record of Old Line Bank in meeting the credit needs of its local community, including low and moderate income neighborhoods, consistent with the safe and sound operation of the institution. The CRA does not establish specific lending requirements or programs for financial institutions nor does it limit an institution’s discretion to develop the types of products and services that it believes are best suited to its particular community, consistent with the CRA. These factors are considered in, among other things, evaluating mergers, acquisitions and applications to open a branch or facility. The CRA also requires all institutions to make public disclosure of their CRA ratings. Old Line Bank received a “Satisfactory” rating in its latest CRA examination.
USA PATRIOT Act
The USA PATRIOT Act of 2001 (the “USA PATRIOT Act”) substantially broadened the scope of U.S. anti-money laundering laws and regulations by imposing significant new compliance and due diligence obligations, creating new crimes and penalties and expanding the extraterritorial jurisdiction of the United States. The PATRIOT Act requires financial institutions, including banks, to establish anti-money laundering programs, including employee training and independent audit requirements, meet minimum standards specified by the Act, follow minimum standards for customer identification and maintenance of customer identification records, and regularly compare customer lists against lists of suspected terrorists, terrorist organizations and money launderers. The U.S. Treasury has issued a number of implementing regulations that apply to various requirements of the USA PATRIOT Act to financial institutions such as Old Line Bank. Those regulations impose obligations on financial institutions to maintain appropriate policies, procedures and controls to detect, prevent and report money laundering and terrorist financing.
Failure of a financial institution to comply with the USA PATRIOT Act’s requirements could have serious legal and reputational consequences for the institution. Old Line Bank has adopted appropriate policies, procedures and controls to address compliance with the requirements of the USA PATRIOT Act under the existing regulations and will continue to revise and update its policies, procedures and controls to reflect changes required by the USA PATRIOT Act and Treasury’s regulations.
The costs or other effects of the compliance burdens imposed by the PATRIOT Act or future anti-terrorist, homeland security or anti-money laundering legislation or regulations cannot be predicted with certainty.
Consumer Protection Laws
Old Line Bank is subject to a number of federal and state laws designed to protect borrowers and promote lending to various sectors of the economy. These laws include the Equal Credit Opportunity Act, the Fair Credit Reporting Act, the Fair and Accurate Credit Transactions Act, the Truth in Lending Act, the Home Mortgage Disclosure Act, and the Real Estate Settlement Procedures Act, and various state law counterparts.
In addition, federal law currently contains extensive customer privacy protection provisions. Under these provisions, a financial institution must provide to its customers, at the inception of the customer relationship and annually thereafter, the institution’s policies and procedures regarding the handling of customers’ nonpublic personal financial information. These provisions also provide that, except for certain limited exceptions, a financial institution may not provide such personal information to unaffiliated third parties unless the institution discloses to the customer that such information may be so provided and the customer is given the opportunity to opt out of such disclosure. Further, under the “Interagency Guidelines Establishing Information Security Standards,” banks must implement a comprehensive information security program that includes administrative, technical, and physical safeguards to ensure the security and confidentiality of customer information. Federal law makes it a criminal offense, except in limited circumstances, to obtain or attempt to obtain customer information of a financial nature by fraudulent or deceptive means.
Dodd-Frank Wall Street Reform and Consumer Protection Act
On July 21, 2010, the previously mentioned Dodd-Frank Act was signed into law. The Dodd-Frank Act contains a wide variety of provisions affecting the regulation of depository institutions in addition to those already mentioned. Those include restrictions related to mortgage loan originations, risk retention requirements as to securitized loans and the noted newly created consumer protection agency. The Dodd-Frank Act requires the Federal Reserve Board to set minimum capital levels for bank holding companies that are as stringent as those required for the insured depository subsidiaries, and the components of Tier 1 capital must be restricted to capital instruments that are currently considered to be Tier 1 capital for insured depository institutions. The Dodd-Frank Act also addresses many investor protections, corporate governance and executive compensation matters that will affect most U.S. publicly traded companies, including Old Line Bancshares, Inc. The Dodd-Frank Act (1) grants stockholders of U.S. publicly traded companies an advisory vote on executive compensation; (2) enhances independence requirements for compensation committee members; (3) requires companies listed on national securities exchanges to adopt incentive based compensation clawback policies for executive officers; and (4) provides the SEC with authority to adopt proxy access rules that would allow stockholders of publicly traded companies to nominate candidates for election as a director and have those nominees included in a company’s proxy materials.
Many of the requirements of the Dodd-Frank Act will be implemented over time and most will be subject to regulations implemented over the course of several years. Given the uncertainty associated with the manner in which the provisions of the Dodd-Frank Act will be implemented by the various regulatory agencies and through regulations, the full extent of the impact such requirements will have on our operations is unclear. The changes resulting from the Dodd-Frank Act may impact the profitability of our business activities, require changes to certain of our business practices, impose upon us more stringent capital, liquidity and leverage requirements or otherwise adversely affect our business. These changes may also require us to invest significant management attention and resources to evaluate and make any changes necessary to comply with new statutory and regulatory requirements. Failure to comply with the new requirements may negatively impact our results of operations and financial condition. While we cannot predict what effect any presently contemplated or future changes in the laws or regulations or their interpretations would have on us, these changes could be materially adverse to our investors.
Other Legislative Initiatives
In addition to the Dodd-Frank Act and the regulations that will be promulgated thereunder, new proposals may be introduced in the United States Congress and in the Maryland Legislature and before various bank regulatory authorities which would alter the powers of, and restrictions on, different types of banking organizations and which would restructure part or all of the existing regulatory framework for banks, bank holding companies and other providers of financial services. Moreover, other bills may be introduced in Congress which would further regulate, deregulate or restructure the financial services industry, including proposals to substantially reform the regulatory framework. We cannot predict whether or in what form any proposed regulation or statute will be adopted or the extent to which any new regulation or statute may affect our business.
Bank Holding Company Regulation
As a bank holding company, Old Line Bancshares, Inc. is subject to regulation and examination by the Maryland Office of the Commissioner of Financial Regulation and the Federal Reserve Board. Old Line Bancshares, Inc. is required to file with the Federal Reserve Board an annual report and such additional information as the Federal Reserve Board may require pursuant to the Bank Holding Company Act of 1956, as amended (the “BHC Act”). Among other things, the BHC Act requires regulatory filings by a stockholder or other party that seeks to acquire direct or indirect “control” of an FDIC-insured depository institution. The determination whether an investor “controls” a depository institution is based on all of the facts and circumstances surrounding the investment. As a general matter, a party is deemed to control a depository institution or other company if the party owns or controls 25% or more of any class of voting stock. Subject to rebuttal, a party may be presumed to control a depository institution or other company if the investor owns or controls 10% or more of any class of voting stock. Ownership by affiliated parties, or parties acting in concert, is typically aggregated for these purposes. If a party’s ownership of Old Line Bancshares, Inc. were to exceed certain thresholds, the investor could be deemed to “control” Old Line Bancshares, Inc. for regulatory purposes. This could subject the investor to regulatory filings or other regulatory consequences.
Pursuant to provisions of the BHC Act and regulations promulgated by the Federal Reserve Board thereunder, Old Line Bancshares, Inc. may only engage in or own companies that engage in activities deemed by the Federal Reserve Board to be so closely related to the business of banking or managing or controlling banks as to be a proper incident thereto, and the holding company must obtain permission from the Federal Reserve Board prior to engaging in most new business activities. In addition, bank holding companies like Old Line Bancshares, Inc. must be well capitalized and well managed in order to engage in the expanded financial activities permissible only for a financial holding company.
Federal banking regulators have adopted risk-based capital guidelines for bank holding companies. Currently, the required minimum ratio of total capital to risk-weighted assets (including off-balance sheet activities, such as standby letters of credit) is 8%. At least half of the total capital is required to be Tier 1 capital, consisting principally of common stockholders’ equity, non-cumulative perpetual preferred stock, a limited amount of cumulative perpetual preferred stock and minority interests in the equity accounts of consolidated subsidiaries, less goodwill. The remainder (Tier 2 capital) may consist of a limited amount of subordinated debt and intermediate-term preferred stock, certain hybrid capital instruments and other debt securities, perpetual preferred stock and a limited amount of the general loan loss allowance. In addition to the risk-based capital guidelines, the federal banking regulators established minimum leverage ratio (Tier 1 capital to total assets) guidelines for bank holding companies. These guidelines provide for a minimum leverage ratio of 3% for those bank holding companies which have the highest regulatory examination ratings and are not contemplating or experiencing significant growth or expansion. All other bank holding companies are required to maintain a leverage ratio of at least 4%.
The Federal Reserve Board has issued a policy statement regarding the payment of dividends by bank holding companies. In general, the Federal Reserve’s policies provide that dividends should be paid only out of current earnings and only if the prospective rate of earnings retention by the bank holding company appears consistent.
Effect of Governmental Monetary Policies
Domestic economic conditions and the monetary and fiscal policies of the United States government and its agencies affect our earnings. The Federal Reserve Board’s monetary policies have had, and are likely to continue to have, an important impact on the operating results of financial institutions through its power to implement national monetary policy in order, among other things, to curb inflation or combat a recession. The monetary policies of the Federal Reserve Board affect the levels of bank loans, investments and deposits through its control over the issuance of United States government securities, its regulation of the discount rate applicable to member banks and its influence over reserve requirements to which member banks are subject. We cannot predict the nature or impact of future changes in monetary and fiscal policies.
Forward Looking Statements
Some of the matters discussed in this annual report including under the captions “Business of Old Line Bancshares, Inc.,” “Business of Old Line Bank,” “Risk Factors”, and “Management’s Discussion And Analysis Of Financial Condition And Results Of Operations” and elsewhere in this annual report. These forward-looking statements include statements regarding the impact of our merger with Maryland Bankcorp going forward, changes in and future revenues, income, expenses and non-interest income, improved earnings and stockholder value, retention of existing branches, our growth and expansion strategy, liquidity, loan, deposit, asset and customer growth, maintaining the net interest margin during 2012 and beyond, borrowers continuing to stay current on their loans, continued use of brokered deposits, losses on non-accrual loans, our expectation with respect to earnings on our bank owned life insurance policies partially offsetting certain expenses and obligations, our expectation with respect to ratification of the sale of a foreclosed property with respect to a non-accrual loan and our plan to foreclose on the property securing another non-accrual loan, that we plan to continue efforts to sell acquired and legacy real estate owned, potential regulatory changes, the impact of new accounting guidance, the allowance for loan losses, interest rate sensitivity, market risk, the status of the unrealized losses in our investment portfolio and business, financial and other goals. Forward-looking statements often use words such as “believe,” “expect,” “plan,” “may,” “will,” “should,” “project,” “contemplate,” “anticipate,” “forecast,” “intend” or other words of similar meaning. You can also identify them by the fact that they do not relate strictly to historical or current facts. When you read a forward-looking statement, you should keep in mind the risk factors described below and any other information contained in this annual report, which identifies a risk or uncertainty. Our actual results and the actual outcome of our expectations and strategies could be different from that described in this annual report because of these risks and uncertainties and you should not put undue reliance on any forward-looking statements. All forward-looking statements speak only as of the date of this filing, and we undertake no obligation to make any revisions to the forward-looking statements to reflect events or circumstances after the date of this filing or to reflect the occurrence of unanticipated events.
You should consider carefully the following risks, along with other information contained in this Form 10-K. The risks and uncertainties described below are not the only ones that may affect us. Additional risks and uncertainties also may adversely affect our business and operations including those discussed in Item 7-Management’s Discussion and Analysis of Financial Condition and Results of Operations. Any of the following events, should they actually occur, could materially and adversely affect our business and financial results.
Risk Factors Related to the Merger with Maryland Bankcorp
We may fail to realize all of the anticipated benefits of the merger. As discussed above in “Item 1-Business”, in April 2011 we acquired Maryland Bankcorp. The ultimate success of the merger will depend, in part, on our ability to realize the anticipated benefits and cost savings from combining our businesses with Maryland Bankcorp’s. To realize these anticipated benefits and cost savings, however, we must successfully complete the combination of these businesses. If we are unable to achieve these objectives, we may not fully realize the anticipated benefits and cost savings of the merger or they may take longer to realize than expected.
It is possible that the continuing integration process could result in the loss of key employees, the loss of key depositors or other bank customers, the disruption of our ongoing businesses or inconsistencies in standards, controls, procedures and policies that adversely affect our ability to maintain our relationships with our clients, customers, depositors and employees or to achieve the anticipated benefits of the merger. Integration efforts between the two companies may, to some extent, continue to divert management attention and resources. These integration matters could have an adverse effect on us during the remaining transition period.
We may not have adequately assessed the fair value of the acquired assets and liabilities. Current accounting guidance requires that we record assets and liabilities at their estimated fair values on the purchase date. In accordance with accounting for business combinations, we included the credit losses evident in the fair value of loans at the date of our acquisition of MB&T and eliminated the allowance for loan losses maintained by MB&T at the acquisition date. The determination of fair value requires that we consider a number of factors including the remaining life of the acquired loans and deposits, estimated prepayments or withdrawals, estimated loss ratios, estimated value of the underlying collateral, and the net present value of expected cash flows. Actual deviations from these predicted cash flows, maturities or repayments or the underlying value of the collateral may mean that our present value determination is inaccurate. This may cause fluctuations in interest income, non-interest income, provision expense, interest expense and non-interest expense and negatively impact our results of operations.
Risk Factors Relating to Old Line Bancshares’ Business
If economic conditions deteriorate further, our borrowers’ ability to repay loans declines and the value of the collateral securing our loans decreases. These conditions could adversely affect our results of operations and financial condition. Changes in prevailing economic conditions, including declining real estate values, changes in interest rates which may cause a decrease in interest rate spreads, adverse employment conditions, the monetary and fiscal policies of the federal government and other significant external events may adversely affect our financial results. While the recession has officially ended and there continues to be evidence of improvement in the economy, it remains unclear when conditions will improve to the extent that they will positively impact borrowers’ ability to repay their loans in general and demand for loans overall. Although signs of stability have emerged, we expect that the business environment in the State of Maryland and the entire United States will continue to present challenges for the foreseeable future. Although we have seen limited and sporadic pockets of price stability or even appreciation in our market area, there remains potential for future decline in real estate values. Because real estate related loans comprise a significant portion of our loans, continued decreases in real estate values could adversely affect the value of property used as collateral for loans in our portfolio. Although the adverse economic climate during the past four years has not severely impacted us due to our strict underwriting standards, further adverse changes in the economy, including increased unemployment or the economy moving back into a recession, could have a negative effect on the ability of our borrowers to make timely repayments of their loans, which would have an adverse impact on our earnings.
If U.S. markets and economic conditions do not significantly improve or further deteriorate, it could adversely affect our liquidity. Old Line Bank must maintain sufficient liquidity to ensure cash flow is available to satisfy current and future financial obligations including demand for loans and deposit withdrawals, funding of operating costs and other corporate purposes. We obtain funding through deposits and various short term and long term wholesale borrowings, including federal funds purchased, unsecured borrowings, brokered certificates of deposits and borrowings from the Federal Home Loan Bank of Atlanta and others. Economic uncertainty and disruptions in the financial system may adversely affect our liquidity. Dramatic declines in the housing market during the past four years, falling real estate prices and increased foreclosures and unemployment, have resulted in significant asset value write downs by financial institutions, including government sponsored entities and investment banks. These investment write downs have caused financial institutions to seek additional capital. Should we experience a substantial deterioration in our financial condition or should disruptions in the financial markets restrict our funding, it would negatively impact our liquidity. To mitigate this risk, we closely monitor our liquidity and maintain a line of credit with the Federal Home Loan Bank and have received approval to borrow from the Federal Reserve Bank of Richmond.
Our need to comply with extensive and complex governmental regulation could have an adverse effect on our business and our growth strategy. The banking industry is subject to extensive regulation by state and federal banking authorities. Many of these regulations are intended to protect depositors, the public or the FDIC insurance funds, not stockholders. Regulatory requirements affect our lending practices, capital structure, investment practices, dividend policy, ability to attract and retain personnel and many other aspects of our business. These requirements may constrain our rate of growth and changes in regulations could adversely affect us. The cost of compliance with regulatory requirements could adversely affect our ability to operate profitably.
In addition, because federal regulation of financial institutions changes regularly and is the subject of constant legislative debate, we cannot forecast how federal regulation of financial institutions may change in the future and impact our operations. In light of the performance of and government intervention in the financial sector, we fully expect there will be significant changes to the banking and financial institutions’ regulatory agencies in the near future. We further anticipate that regulatory authorities may enact additional laws and regulations in response to the ongoing financial crisis that could have an impact on our operations. Changes in regulation and oversight, including in the form of changes to statutes, regulations or regulatory policies or changes in interpretation or implementation of statutes, regulations or policies, could affect the service and products we offer, increase our operating expenses, increase compliance challenges and otherwise adversely impact our financial performance and condition. In addition, the burden imposed by these federal and state regulations may place banks in general, and Old Line Bank specifically, at a competitive disadvantage compared to less regulated competitors.
The recently enacted Dodd-Frank Act may adversely impact our results of operations, liquidity or financial condition. In July 2010, President Obama signed into law the Dodd-Frank Act. The Dodd-Frank Act represents a comprehensive overhaul of the U.S. financial services industry. Among other things, the Dodd-Frank Act establishes the new federal Bureau of Consumer Financial Protection (the “BCFP”), includes provisions affecting corporate governance and executive compensation disclosure at all Securities and Exchange Commission (“SEC”) reporting companies, allows financial institutions to pay interest on business checking accounts, broadens the base for FDIC insurance assessments, and includes new restrictions on how mortgage brokers and loan originators may be compensated. The Dodd-Frank Act requires the BCFP and other federal agencies to implement many new and significant rules and regulations to implement its various provisions. We will not know the full impact of the Dodd-Frank Act on our business for years until regulations implementing the statute are adopted and implemented. As a result, we cannot at this time predict the extent to which the Dodd-Frank Act will impact our business, operations or financial condition. However, compliance with these new laws and regulations may require us to make changes to our business and operations and will likely result in additional costs and a diversion of management’s time from other business activities, any of which may adversely impact our results of operations, liquidity or financial condition. Further, if the industry responds to provisions allowing financial institutions to pay interest on business checking accounts by competing for those deposits with interest bearing accounts, this may put some degree of downward pressure on our net interest margin during 2012 and beyond.
Because we serve a limited market area in Maryland, an economic downturn in our market area could more adversely affect us than it affects our larger competitors that are more geographically diverse. Our current primary market area consists of the suburban Maryland (Washington, D.C. suburbs) counties of Anne Arundel, Calvert, Charles, Prince George’s and St. Mary’s. We have expanded in the counties in which we have historically operated and into Calvert and St. Mary’s Counties, Maryland and may expand in contiguous northern and western counties, such as Montgomery County and Howard County, Maryland. However, broad geographic diversification is not currently part of our community bank focus. Overall, during the last four years, the business environment negatively impacted many businesses and households in the United States and worldwide. Although the economic decline has not impacted the suburban Maryland and Washington D.C. suburbs as adversely as other areas of the United States, it has caused an increase in unemployment and business failures and a decline in property values. As a result, if our market area continues to suffer an economic downturn, it may more severely affect our business and financial condition than it affects larger bank competitors. Our larger competitors serve more geographically diverse market areas, parts of which may not be affected by the same economic conditions that may exist in our market area. Further, unexpected changes in the national and local economy may adversely affect our ability to attract deposits and to make loans. Such risks are beyond our control and may have a material adverse effect on our financial condition and results of operations and, in turn, the value of our securities.
We depend on the services of key personnel. The loss of any of these personnel could disrupt our operations and our business could suffer. Our success depends substantially on the skills and abilities of our executive management team, including James W. Cornelsen, our President and Chief Executive Officer, Joseph E. Burnett, our Executive Vice President and Chief Lending Officer, Christine M. Rush, our Executive Vice President and Chief Financial Officer and Sandi F. Burnett, our Executive Vice President and Chief Credit Officer. They provide valuable services to us and would be difficult to replace. Although we have entered into employment agreements with these executives, the existence of such agreements does not assure that we will retain their services.
Also, our growth and success and our anticipated future growth and success, in a large part, is due and we anticipate will be due to the relationships maintained by our banking executives with our customers. The loss of services of one or more of these executives or other key employees could have a material adverse effect on our operations and our business could suffer. The experienced commercial lenders that we have hired are not a party to any employment agreement with us and they could terminate their employment with us at any time and for any reason.
Our growth and expansion strategy may not be successful. Our ability to grow depends upon our ability to attract new deposits, identify loan and investment opportunities and maintain adequate capital levels. We may also grow through acquisitions of existing financial institutions or branches thereof. There are no guarantees that our expansion strategies will be successful. Also, in order to effectively manage our anticipated and/or actual loan growth we have and may continue to make additional investments in equipment and personnel, which also will increase our non-interest expense. If we grow too quickly and are not able to control costs and maintain asset quality, growth could materially and adversely affect our financial performance.
Our concentrations of loans in various categories may also increase the risk of credit losses. We currently invest more than 25% of our capital in various loan types and industry segments, including commercial real estate loans and loans to the hospitality industry (hotels/motels). While recent declines in the local commercial real estate market have not caused the collateral securing our loans to exceed acceptable loan to value ratios, a further deterioration in the commercial real estate market could cause deterioration in the collateral securing these loans and/or a decline in our customers’ earning capacity. This could negatively impact us. Although we have made a large portion of our hospitality loans to long term, well established operators in strategic locations, a continued decline in the occupancy rate in these facilities could negatively impact their earnings. This could adversely impact their ability to repay their loan which would adversely impact our net income.
If our allowance for loan losses is not sufficient to cover actual loan losses, our earnings will decrease. We maintain an allowance for loan losses that we believe is adequate for absorbing any potential losses in our loan portfolio. Management, through a periodic review and consideration of the loan portfolio, determines the amount of the allowance for loan losses. Although we believe the allowance for loan losses is adequate to absorb probable losses in our loan portfolio, even under normal economic conditions, we cannot predict such losses with certainty. The unprecedented volatility experienced in the financial and capital markets during the last four years makes this determination even more difficult as processes we use to estimate the allowance for loan losses may no longer be dependable because they rely on complex judgments, including forecasts of economic conditions that may not be accurate. As a result, we cannot be sure that our allowance is or will be adequate in the future. If management’s assumptions and judgments prove to be incorrect and the allowance for loan losses is inadequate to absorb future losses, our earnings will suffer.
As of December 31, 2011, commercial and industrial, construction, and commercial real estate mortgage loans comprise approximately 79.64% of our loan portfolio. These types of loans are generally viewed as having more risk of default than residential real estate or consumer loans and typically have larger balances than residential real estate loans and consumer loans. A deterioration of one or a few of these loans could cause a significant increase in non-performing loans. Such an increase could result in a net loss of earnings from these loans, an increase in the provision for loan losses and an increase in loan charge-offs, all of which could have a material adverse effect on our financial condition and results of operations.
Our profitability depends on interest rates and changes in monetary policy may impact us. Our results of operations depend to a large extent on our “net interest income,” which is the difference between the interest expense incurred in connection with our interest bearing liabilities, such as interest on deposit accounts, and the interest income received from our interest earning assets, such as loans and investment securities. Interest rates, because they are influenced by, among other things, expectations about future events, including the level of economic activity, federal monetary and fiscal policy, and geopolitical stability, are not predictable or controllable. Additionally, competitive factors heavily influence the interest rates we can earn on our loan and investment portfolios and the interest rates we pay on our deposits. Community banks are often at a competitive disadvantage in managing their cost of funds compared to the large regional, super regional or national banks that have access to the national and international capital markets. These factors influence our ability to maintain a stable net interest margin.
We seek to maintain a neutral position in terms of the volume of assets and liabilities that mature or reprice during any period so that we may reasonably predict our net interest margin. However, interest rate fluctuations, loan prepayments, loan production and deposit flows are constantly changing and influence our ability to maintain this neutral position. Generally speaking, our earnings are more sensitive to fluctuations in interest rates the greater the variance in the volume of assets and liabilities that mature and reprice in any period. The extent and duration of the sensitivity will depend on the cumulative variance over time, the velocity and direction of interest rates, and whether we are more asset than liability sensitive. Accordingly, we may not be successful in maintaining this neutral position and, as a result, our net interest margin may suffer.
The market value of our investments could negatively impact stockholders’ equity. We have designated all of our investment securities portfolio (and 19.95% of total assets) at December 31, 2011 as available for sale. We “mark to market” temporary unrealized gains and losses in the estimated value of the available for sale portfolio and reflect this adjustment as a separate item in stockholders’ equity, net of taxes. As of December 31, 2011, we had temporary unrealized gains in our available for sale portfolio of $2.4 million (net of taxes). As a result of the recent economic recession and the continued economic slowdown, several municipalities continue to report budget deficits and companies continue to report lower earnings. These budget deficits and lower earnings could cause temporary and other than temporary impairment charges in our investment securities portfolio and cause us to report lower net income and a decline in stockholders’ equity.
Any future issuances of common stock in connection with acquisitions or otherwise could dilute your ownership of Old Line Bancshares. We may use our common stock to acquire other companies or to make investments in banks and other complementary businesses in the future. We may also issue common stock, or securities convertible into common stock, through public or private offerings, in order to raise additional capital in connection with future acquisitions, to satisfy regulatory capital requirements or for general corporate purposes. Any such stock issuances would dilute your ownership interest in Old Line Bancshares and may dilute the per share value of the common stock.
Our future acquisitions, if any, may cause us to become more susceptible to adverse economic events. While we currently have no plans to acquire additional financial institutions, we may do so in the future if an attractive acquisition opportunity arises that is consistent with our business plan. Any future business acquisitions could be material to us, and the degree of success achieved in acquiring and integrating these businesses into Old Line Bancshares could have a material effect on the value of our common stock. In addition, any acquisition could require us to use substantial cash or other liquid assets or to incur debt. In those events, we could become more susceptible to future economic downturns and competitive pressures.
We face limits on our ability to lend. The amount of our capital limits the amount that we can loan to a single borrower. Generally, under current law, we may lend up to 15% of our unimpaired capital and surplus to any one borrower. As of December 31, 2011, we were able to lend approximately $9.5 million to any one borrower. This amount is significantly less than that of many of our competitors and may discourage potential borrowers who have credit needs in excess of our legal lending limit from doing business with us. We generally try to accommodate larger loans by selling participations in those loans to other financial institutions, but this strategy is not always available. We may not be able to attract or maintain customers seeking larger loans and we may not be able to sell participations in such loans on terms we consider favorable.
Additional capital may not be available when needed or required by regulatory authorities. Federal and state regulatory authorities require us to maintain adequate levels of capital to support our operations. In addition, we may elect to raise additional capital to support our business or to finance future acquisitions, if any, or we may otherwise elect or our regulators may require that we raise additional capital. Our ability to raise additional capital, if needed, will depend on conditions in the capital markets, economic conditions and a number of other factors, many of which are outside our control. Current conditions in the capital markets are such that traditional sources of capital may not be available to us on reasonable terms if we needed to raise additional capital. Accordingly, we may not be able to raise additional capital if needed or on terms that are favorable or otherwise not dilutive to existing stockholders. If we cannot raise additional capital when needed, it may have a material adverse effect on our financial condition, results of operations and prospects.
We face substantial competition which could adversely affect our growth and operating results. We operate in a competitive market for financial services and face intense competition from other financial institutions both in making loans and in attracting deposits. Many of these financial institutions have been in business for many years, are significantly larger, have established customer bases, have greater financial resources and lending limits than we do, and are able to offer certain services that we are not able to offer. If we cannot attract deposits and make loans at a sufficient level, our operating results will suffer, as will our opportunities for growth.
System failure or cybersecurity breaches of our network security could subject us to increased operating costs as well as litigation and other potential losses. We rely heavily on communications and information systems to conduct our business. The computer systems and network infrastructure we use could be vulnerable to unforeseen hardware and cybersecurity issues. Our operations are dependent upon our ability to protect our computer equipment against damage from fire, power loss, telecommunications failure or a similar catastrophic event. Any damage or failure that causes an interruption in our operations could have an adverse effect on our financial condition and results of operations. In addition, our operations are dependent upon our ability to protect the computer systems and network infrastructure we use, including our Internet banking activities, against damage from physical break-ins, cybersecurity breaches and other disruptive problems caused by the Internet or other users. Such computer break-ins and other disruptions would jeopardize the security of information stored in and transmitted through our computer systems and network infrastructure, which may result in significant liability to us, subject us to additional regulatory scrutiny, damage our reputation, result in a loss of customers, and inhibit current and potential customers from our Internet banking services, any of all of which could have a material adverse effect on our results of operations and financial condition. Each year, we add additional security measures to our computer systems and network infrastructure to mitigate the possibility of cybersecurity breaches including firewalls and penetration testing, but there can be no assurance that such security measures will be effective in preventing such breaches, damage or failures. We continue to investigate cost effective measures as well as insurance protection; there is no guarantee, however, that such insurance, if obtained, would cover all costs associated with any breach, damage or failure of our computer systems and network infrastructure.
Consumers may decide not to use banks to complete their financial transactions. Technology and other changes are allowing consumers to complete financial transactions through alternative methods that historically have involved banks. For example, consumers can now maintain funds that would have historically been held as bank deposits in brokerage accounts, mutual funds or general-purpose reloadable prepaid cards. Consumers can also complete transactions such as paying bills and transferring funds directly without the assistance of banks. The process of eliminating banks as intermediaries could result in the loss of fee income, as well as the loss of customer deposits and the related income generated from those deposits. The loss of these revenue streams and the lower cost of deposits as a source of funds could have a material adverse effect on our financial condition and results of operations.
Item 1B. Unresolved Staff Comments
Not applicable as we are not an accelerated filer or large accelerated filer.
As of December 31, 2011, we operate a total of 19 branch locations and seven loan production offices. Our headquarters is located at 1525 Pointer Ridge Place, Bowie, Maryland in Prince George’s County. Pointer Ridge Office Investment, LLC, an entity in which we have an approximately $761,000 investment and a 62.50% ownership interest owns this property. Frank Lucente, a director of Old Line Bancshares, Inc. and Old Line Bank controls 12.50% of Pointer Ridge and controls the manager of Pointer Ridge.
| Legacy Branches |
| Location | Address | Opened Date | Square Feet | Monthly Lease Amount | | Term | Renewal Option |
Bowie Suite 100 | 1525 Pointer Ridge Place Bowie, Maryland | 6/2006 | 2,557 | $7,166 | | 13 years | (2) 5years |
| | | | | | | | |
Bowie Suite 300 | 1525 Pointer Ridge Place Bowie, Maryland | 6/2006 | 5,449 | $13,373 | | 13 years | (2) 5years |
| | | | | | | | |
Bowie Suite 400 | 1525 Pointer Ridge Place Bowie, Maryland | 6/2006 | 11,053 | $26,695 | | 13 years | (2) 5years |
| | | | | | | | |
| Old Line Centre | 12080 Old Line Centre Waldorf, Maryland | 11/1989 | 2,048 | $5,142 | | 10 years | (2) 5years |
| | | | | | | | |
| Accokeek | 15808 Livingston Road Accokeek, Maryland | 12/1995 | 1,218 | Owned | | | |
| | | | | | | | |
| Crain Highway | 2995 Crain Highway Waldorf, Maryland | 6/1999 | 8,044 | Owned | | | |
| | | | | | | | |
| Clinton | 7801 Old Branch Avenue Clinton, Maryland | 9/2002 | 2,550 | $2,807 | | 10 years | (3) 5years |
| | | | | | | | |
College Park 4th Floor | 9658 Baltimore Avenue College Park, Maryland | 7/2005 | 1,268 | $3,215 | | 10 years | (2) 5 years |
| | | | | | | | |
College Park 1st Floor | 9658 Baltimore Avenue College Park, Maryland | 3/2008 | 1,916 | $5,464 | | 10 years | (2) 5 years |
| | | | | | | | |
| Greenbelt | 6421 Ivy Lane Greenbelt, Maryland | 9/2009 | 33,000 | $8,825 | | 30 years | (2) 10 years |
| | | | | | | | |
| Annapolis | 2530 Riva Road Annapolis, Maryland | 9/2011 | 3,899 | $9,748 | | 10yrs 7mo | (2) 5 years |
| | | | | | | | |
| Annapolis | 167-U Jennifer Road Annapolis, Maryland | 9/2008 | 1,620 | $5,606 | | 5 years | (1) 5 years |
| | | | | | | | |
| Crofton | 1641 Maryland Route 3 North Crofton, Maryland | 7/2009 | 2,420 | $7,161 | | 10 years | (3) 5 years |
The following table outlines the properties we acquired on April 1, 2011
| Properties Acquired April 1, 2011 |
| Location | Address | Opened Date | Square Feet | Monthly Lease Amount | | Term | | Renewal Option |
| | | | | | | | | |
| Bryans Road | 7175 Indian Head Highway Bryans Road, Maryland | 5/1964 | 3,711 | $ 7,939 | | 20 years | | N/A |
| | | | | | | | | |
| California | 22741 Three Notch Road California, Maryland | 4/1985 | 3,366 | $ 6,249 | | 20 years | | none |
| | | | | | | | | |
| Callaway | 20990 Point Lookout Road Callaway, Maryland | 8/2005 | 1,795 | Owned | | | | |
| | | | | | | | | |
| Fort Washington | 12740 Old Fort Road Fort Washington, Maryland | 2/1973 | 2,800 | $ 6,331 | | 5 years | | N/A |
| | | | | | | | | |
| La Plata | 101 Charles Street La Plata, Maryland | 4/1974 | 2,910 | $ 8,405 | | 15 years | | (3) 10 years |
| | | | | | | | | |
| Leonardtown Road | 3135 Leonardtown Road Waldorf, Maryland | 6/1963 | 7,076 | Owned | | | | |
| Lexington Park | 46930 South Shangri La Drive Lexington Park, Maryland | 6/1959 | 7,763 | $ 10,767 | | 20 years | | N/A |
| | | | | | | | | |
| Prince Frederick | 691 Prince Frederick Beulvald Prince Frederick, Maryland | 8/1999 | 3,400 | $ 9,124 | | 20 years | | N/A |
| | | | | | | | | |
| Solomons | 80 HolidayDrive Solomons, Maryland | 2/1998 | 2,194 | $ 4,294 | | 20 years | | N/A |
| | | | | | | | | |
| Waldorf Operations | 3220 Old Washington Road Waldorf, Maryland | 12/1988 | 21,064 | Owned | | | | |
From time to time, Old Line Bancshares, Inc. or Old Line Bank may be involved in litigation relating to claims arising out of its normal course of business. We do not have any material pending legal matters or litigation for Old Line Bank or Old Line Bancshares, Inc.
PART II
| Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities |
Common Stock Prices
The table below shows the high and low sales information as reported on the Nasdaq Capital Market. The quotations reflect interdealer prices, without retail mark up, mark down, or commission, and may not represent actual transactions.
| | | Sale Price Range | |
| | | | | | | |
| | | High | | | Low | |
| 2011 | | | | | | |
| First Quarter | | $ | 10.45 | | | $ | 7.45 | |
| Second Quarter | | | 9.49 | | | | 8.22 | |
| Third Quarter | | | 8.43 | | | | 6.64 | |
| Fourth Quarter | | | 8.25 | | | | 6.83 | |
| | | | | | | | | |
| 2010 | | | | | | | | |
| First Quarter | | $ | 7.65 | | | $ | 6.20 | |
| Second Quarter | | | 8.09 | | | | 7.44 | |
| Third Quarter | | | 8.99 | | | | 7.02 | |
| Fourth Quarter | | | 8.99 | | | | 7.26 | |
As of December 31, 2011, there were 6,817,694 shares of common stock issued and outstanding held by approximately 465 stockholders of record. There were 325,331 shares of common stock issuable on the exercise of outstanding stock options, 312,145 of which were exercisable. The remaining are exercisable as follows:
| Date Exercisable | | # of Shares | |
| May 7, 2012 | | | 2,000 | |
| January 27, 2012 | | | 5,593 | |
| January 27, 2013 | | | 5,593 | |
| Total | | | 13,186 | |
Dividends
We have paid the following dividends on our common stock during the years indicated:
| | | 2011 | | | 2010 | |
| March | | $ | 0.03 | | | $ | 0.03 | |
| June | | | 0.03 | | | | 0.03 | |
| September | | | 0.03 | | | | 0.03 | |
| December | | | 0.04 | | | | 0.03 | |
| Total | | $ | 0.13 | | | $ | 0.12 | |
Our ability to pay dividends in the future will depend on the ability of Old Line Bank to pay dividends to us. Old Line Bank’s ability to continue paying dividends will depend on Old Line Bank’s compliance with certain dividend regulations imposed upon us by bank regulatory authorities.
In addition, we will consider a number of other factors, including our income and financial condition, tax considerations, and general business conditions before deciding to pay additional dividends in the future. We can provide no assurance that we will continue to pay dividends to our stockholders.
Issuer Purchases of Equity Securities
We did not repurchase any of our securities during the quarter ended December 31, 2011.
The following table summarizes Old Line Bancshares, Inc.’s selected financial information and other financial data. The selected balance sheet and statement of income data are derived from our audited financial statements. You should read this information together with “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and our financial statements and the related notes included elsewhere in this report. Results for past periods are not necessarily indicative of results that may be expected for any future period.
| December 31, | | 2011 | | | 2010 | | | 2009 | |
| | | (Dollars in thousands except per share data) | |
| Earnings and dividends: | | | | | | | | | |
| Interest revenue | | $ | 32,321 | | | $ | 18,509 | | | $ | 17,096 | |
| Interest expense | | | 5,219 | | | | 4,943 | | | | 5,580 | |
| Net interest income | | | 27,101 | | | | 13,566 | | | | 11,516 | |
| Provision for loan losses | | | 1,800 | | | | 1,082 | | | | 900 | |
| Non-interest revenue | | | 2,741 | | | | 1,352 | | | | 1,820 | |
| Non-interest expense | | | 20.884 | | | | 11,409 | | | | 9,257 | |
| Income taxes | | | 1,927 | | | | 997 | | | | 1,056 | |
| Net income | | | 5.232 | | | | 1,430 | | | | 2,123 | |
| Less: Net income (loss) attributable to the non-controlling interest | | | (148 | ) | | | (73 | ) | | | 87 | |
| Net income attributable to Old Line Bancshares, Inc. | | | 5,380 | | | | 1,503 | | | | 2,036 | |
| Net income available to common stockholders | | | 5,380 | | | | 1,503 | | | | 1,550 | |
| | | | | | | | | | | | | |
| Per common share data | | | | | | | | | | | | |
| Basic earnings | | $ | 0.86 | | | $ | 0.39 | | | $ | 0.40 | |
| Diluted earnings | | | 0.86 | | | | 0.38 | | | | 0.40 | |
| Dividends paid | | | 0.13 | | | | 0.12 | | | | 0.12 | |
| Common stockholders book value, period end | | | 9.98 | | | | 9.52 | | | | 9.31 | |
| Common stockholders tangible book value, period end | | | 9.28 | | | | 9.52 | | | | 9.31 | |
| Average common shares outstanding | | | | | | | | | | | | |
| Basic | | | 6,223,057 | | | | 3,880,060 | | | | 3,862,364 | |
| Diluted | | | 6,253,898 | | | | 3,903,577 | | | | 3,869,466 | |
| Common shares outstanding, period end | | | 6,817,694 | | | | 3,891,705 | | | | 3,862,364 | |
| | | | | | | | | | | | | |
| Balance Sheet Data: | | | | | | | | | | | | |
| Total assets | | $ | 811,042 | | | $ | 401,910 | | | $ | 357,219 | |
| Total loans, less allowance for loan losses | | | 539,298 | | | | 299,606 | | | | 265,009 | |
| Total investment securities | | | 161,785 | | | | 54,786 | | | | 33,819 | |
| Total deposits | | | 690,768 | | | | 340,527 | | | | 286,348 | |
| Stockholders’ equity | | | 68,040 | | | | 37,054 | | | | 35,941 | |
| | | | | | | | | | | | | |
| Performance Ratios: | | | | | | | | | | | | |
| Return on average assets | | | 0.79 | % | | | 0.38 | % | | | 0.60 | % |
| Return on average stockholders’ equity | | | 9.37 | % | | | 4.14 | % | | | 5.22 | % |
| Total ending equity to total ending assets | | | 8.39 | % | | | 9.22 | % | | | 10.06 | % |
Net interest margin (1) | | | 4.61 | % | | | 3.86 | % | | | 3.77 | % |
| Dividend payout ratio for period | | | 15.3 | % | | | 31.0 | % | | | 22.7 | % |
| | | | | | | | | | | | | |
| Asset Quality Ratios: | | | | | | | | | | | | |
| Allowance to period-end loans | | | 0.69 | % | | | 0.82 | % | | | 0.93 | % |
| Non-performing assets to total assets | | | 1.22 | % | | | 0.96 | % | | | 0.44 | % |
| Non-performing loans to allowance for loan losses | | | 155.84 | % | | | 109.81 | % | | | 63.93 | % |
| | | | | | | | | | | | | |
| Capital Ratios: | | | | | | | | | | | | |
| Tier I risk-based capital | | | 10.6 | % | | | 11.6 | % | | | 12.8 | % |
| Total risk-based capital | | | 11.3 | % | | | 12.4 | % | | | 13.7 | % |
| Leverage capital ratio | | | 7.8 | % | | | 9.2 | % | | | 10.0 | % |
(1) See “Management’s Discussion and Analysis of Financial Condition and Results of Operating-Reconciliation of Non-GAAP Measures.”
| Management’s Discussion and Analysis of Financial Condition and Results of Operations |
Introduction
Some of the matters discussed below include forward-looking statements. Forward-looking statements often use words such as “believe,” “expect,” “plan,” “may,” “will,” “should,” “project,” “contemplate,” “anticipate,” “forecast,” “intend” or other words of similar meaning. You can also identify them by the fact that they do not relate strictly to historical or current facts. Our actual results and the actual outcome of our expectations and strategies could be different from those anticipated or estimated for the reasons discussed below and under the heading “Information Regarding Forward Looking Statements.”
Overview
Old Line Bancshares was incorporated under the laws of the State of Maryland on April 11, 2003 to serve as the holding company of Old Line Bank.
Our primary business is to own all of the capital stock of Old Line Bank. We also have an approximately $761,000 investment in a real estate investment limited liability company named Pointer Ridge Office Investment, LLC (Pointer Ridge). We own 62.50% of Pointer Ridge. Frank Lucente, one of our directors and a director of Old Line Bank, controls 12.50% of Pointer Ridge and controls the manager of Pointer Ridge. The purpose of Pointer Ridge is to acquire, own, hold for profit, sell, assign, transfer, operate, lease, develop, mortgage, refinance, pledge and otherwise deal with real property located at the intersection of Pointer Ridge Road and Route 301 in Bowie, Maryland. Pointer Ridge owns a commercial office building containing approximately 40,000 square feet and leases this space to tenants. We lease approximately 50% of this building for our main office and operate a branch of Old Line Bank from this address.
Summary of Recent Performance and Other Activities
In an economic climate that continues to present challenges for our industry, we are pleased to report significant strategic accomplishments during the year and that we produced results that demonstrate the quality and potential of our franchise. Net income available to common stockholders, after inclusion of $574,321 in merger and integration expenses, was $5.4 million or $0.86 per basic and diluted common share for the year ending December 31, 2011 which represented a 258.03% increase over the prior year’s net income available to common stockholders of $1.5 million.
On April 1, 2011, we acquired Maryland Bankcorp, the parent company of MB&T. This acquisition created the sixth largest independent commercial bank based in Maryland, with assets of more than $750 million and with 19 full service branches serving five counties. Teams from both institutions have worked diligently to successfully join the two organizations.
The following highlights certain financial data and events that have occurred during 2011:
| · | Our acquisition of Maryland Bankcorp became effective April 1, 2011. |
| · | Average total loans grew approximately $174.1 million or 60.98% for the twelve months ended December 31, 2011 compared to the twelve months ended December 31, 2010, primarily as a result of our acquisition of Maryland Bankcorp. |
| · | Average non-interest bearing deposits grew $78.0 million (143.54%) for the twelve months ended December 31, 2011 relative to the same period in 2010, primarily as a result of our acquisition of Maryland Bankcorp. |
| · | At December 31, 2011, we had two legacy loans (i.e. loans in our portfolio prior to the acquisition of Maryland Bankcorp) on non-accrual status in the amount of $1.2 million. |
| · | At December 31, 2011, we had 17 acquired loans (loans acquired from MB&T pursuant to the merger) on non-accrual status totaling $4.6 million |
| · | At year end 2011, we had four accruing legacy loans past due between 30 and 89 days in the amount of $744,610 and one accruing legacy loan past due 90 or more days in the amount of $34,370. |
| · | At December 31, 2011, we had 22 accruing acquired loans totaling $839,274 past due between 30 and 89 days. |
| · | At December 31, 2011, our book value was $9.98 per common share and a tangible book value was $9.28 per common share. |
| · | We maintained liquidity and by all regulatory measures remained “well capitalized”. |
| · | We increased the provision for loan losses by $718,000 during the year ended December 31, 2011 as compared to December 31, 2010. |
| · | As a result of the provision discussed above, and net charge offs for the twelve month period of $527,205, the allowance for loan losses increased to $3.7 million at December 31, 2011 from $2.5 million at December 31, 2010. |
On April 1, 2011, all MB&T branches were rebranded as Old Line Bank branches and all data processing and accounting systems were consolidated. As discussed below, during the second quarter of 2011, we also substantially completed the assessment and recordation on our financial statements of MB&T’s assets and liabilities at fair value as required by current accounting guidance. With the exception of the closing of one MB&T branch, which MB&T had previously designated for closure, we have also retained, and expect to continue to retain, all of MB&T’s branches, and the branch personnel with severance of employees occurring only at MB&T’s operations, accounting and executive offices. We are pleased to have the remaining MB&T personnel as part of the Old Line Bank team and anticipate that they will contribute significantly to our success.
Pursuant to the merger agreement, the stockholders of Maryland Bankcorp received approximately 2.1 million shares of Old Line Bancshares common stock and the aggregate cash consideration paid to holders of Maryland Bankcorp stockholders was $1.0 million. The total merger consideration was $18.8 million. Included in Note 2 to the consolidated financial statements is additional discussion about the MB&T acquisition.
In accordance with accounting for business combinations, we have recorded the acquired assets and liabilities at their estimated fair value on April 1, 2011, the acquisition date. The determination of the fair value of the loans caused a significant write down in the value of certain loans, which we assigned to an accretable or non-accretable balance. We will recognize the accretable balance as interest income over the remaining term of the loan. We will recognize the non-accretable balance as the borrower repays the loan. The accretion of the loan marks, along with other fair value adjustments to loans and to deposits, favorably impacted our net interest income by $2.2 million for the twelve months ended December 31, 2011. We based the determination of fair value on cash flow expectations and/or collateral values. These cash flow evaluations are inherently subjective as they require material estimates, all of which may be susceptible to significant change. Change in our cash flow expectations could impact net interest income after provision for loan losses. We will recognize any decline in expected cash flows as impairment and record a provision for loan losses during the period. We will recognize any improvement in expected cash flows, as an adjustment to interest income.
In conjunction with the merger, we also recorded the deposits acquired at their fair value and recorded a core deposit intangible of $5.0 million. The amortization of this intangible asset decreased net income by $584,024 for the twelve months ended December 31, 2011, respectively.
The following summarizes the highlights of our financial performance for the twelve month period ended December 31, 2011 compared to the twelve month period ended December 31, 2010 (000’s):
| Years Ended December 31, | | 2011 | | | 2010 | | | $ Change | | | % Change | |
| | | | | | | | | | | | | |
| Net income available to common stockholders | | $ | 5,380 | | | $ | 1,503 | | | $ | 3,877 | | | | 257.95 | % |
| Interest revenue | | | 32,321 | | | | 18,509 | | | | 13,812 | | | | 74.62 | |
| Interest expense | | | 5,219 | | | | 4,943 | | | | 276 | | | | 5.58 | |
| Net interest income after provision for loan losses | | | 25,301 | | | | 12,484 | | | | 12,817 | | | | 102.67 | |
| Non-interest revenue | | | 2,741 | | | | 1,352 | | | | 1,389 | | | | 102.74 | |
| Non-interest expense | | | 20,884 | | | | 11,409 | | | | 9,475 | | | | 83.05 | |
| Average total loans | | | 459,530 | | | | 285,465 | | | | 174,065 | | | | 60.98 | |
| Average interest earning assets | | | 599,397 | | | | 355,590 | | | | 243,807 | | | | 68.56 | |
| Average total interest bearing deposits | | | 435,796 | | | | 263,007 | | | | 172,789 | | | | 65.70 | |
| Average non-interest bearing deposits | | | 132,326 | | | | 54,335 | | | | 77,991 | | | | 143.54 | |
Net interest margin (1) | | | 4.61 | % | | | 3.86 | % | | | | | | | | |
| Return on average equity | | | 9.37 | % | | | 4.14 | % | | | | | | | | |
| Basic earnings per common share | | $ | 0.86 | | | $ | 0.39 | | | $ | 0.47 | | | | 120.51 | % |
| Diluted earnings per common share | | | 0.86 | | | | 0.38 | | | | 0.48 | | | | 126.32 | % |
______________________________
(1) See “Reconciliation of Non-GAAP Measures”
Growth Strategy
We have based our strategic plan on the premise of enhancing stockholder value and growth through branching and operating profits. Our short term goals include collecting payment on non-accrual and past due loans, profitably disposing of other real estate owned, enhancing and maintaining credit quality, maintaining an attractive branch network, expanding fee income, generating extensions of core banking services, and using technology to maximize stockholder value. During the past two years, we have expanded in Prince George’s County and Anne Arundel County, Maryland and the April 2011 acquisition of Maryland Bankcorp has expanded our operations in Charles County and into St. Mary’s and Calvert Counties, Maryland.
In December 2009, we added a team of four experienced, highly skilled loan officers to our staff. These officers have a combined 50 years of commercial banking experience and were employed by a large regional bank with offices in the suburban Maryland market prior to joining us. These individuals have worked in our market area for many years, have worked together as a team for several years and have a history of successfully generating a high volume of commercial, construction and commercial real estate loans.
On July 1, 2009, we opened a branch at 1641 State Route 3 North, Crofton, Maryland in Anne Arundel County. During July and August of 2009, we hired the staff for this location. In October 2009, we opened our branch in the Fairwood Office Park located at 12100 Annapolis Road, Suite 1, Glen Dale, Maryland. We hired the staff for this location during the third quarter of 2009.
Other Opportunities
We use the Internet and technology to augment our growth plans. Currently, we offer our customers image technology, Internet banking with on-line account access and bill payer service. We provide selected commercial customers the ability to remotely capture their deposits and electronically transmit them to us. In order to support our growth, provide improved management information capabilities and enhance the products and services we deliver to our customers, during the first quarter of 2009, we began enhancing our core data processing systems. We completed this process in April 2009. We will continue to evaluate cost effective ways that technology can enhance our management, products and services.
We may take advantage of strategic opportunities presented to us via mergers occurring in our marketplace. For example, we may purchase branches that other banks close or lease branch space from other banks or hire additional loan officers. We also continually evaluate and consider opportunities with financial service companies or institutions with which we may become a strategic partner, merge, or acquire.
Repayment of Troubled Asset Relief Program (TARP) Investment
On July 15, 2009, we repurchased from the U.S. Treasury 7,000 shares of preferred stock that we issued to them in December 2008 under the U.S. Treasury’s Capital Purchase Program through the Troubled Asset Relief Program. We paid the U.S. Treasury $7,058,333 to repurchase the preferred stock which reflects the liquidation value of the preferred stock and $58,333 of accrued but unpaid dividends. We have also repurchased at a fair market value of $225,000 the warrant to purchase 141,892 shares of our common stock.
Although the current economic climate continues to present significant challenges for our industry, we have worked diligently towards our goal of becoming the premier community bank east of Washington D.C. While we remain uncertain whether the economy will continue to experience anemic growth or if the high unemployment rate and soaring national debt will continue to dampen the economic climate, we remain cautiously optimistic that we have identified any problem assets and our remaining borrowers will continue to stay current on their loans. Now that we have substantially completed our planned branch expansion, enhanced our data processing capabilities and expanded our commercial lending team, we believe that we are well positioned to capitalize on the opportunities that may become available in a healthy economy as we have with the Maryland Bankcorp acquisition.
As a result of this acquisition, we anticipate that salaries and benefits expenses and other operating expenses will continue to be higher than they were in 2011. We have identified several areas within the former MB&T non-interest expense structure that we expect will provide expense reductions from those incurred since the acquisition date of April 1, 2011. We began to realize some of these reductions during the fourth quarter of 2011 and anticipate that we will realize additional expense reductions during the first half of 2012. We anticipate that, over time, income generated from the branches acquired in the merger, our new loan officers, and our expanded market area will offset any corresponding increases in expenses. We believe with our 19 branches, including the April 2011 addition of Maryland Bankcorp’s nine branches and staff, our lending staff, our corporate infrastructure and our solid balance sheet and strong capital position, we can continue to focus our efforts on improving earnings per share and enhancing stockholder value.
Results of Operations
Net Interest Income
Net interest income is the difference between income on interest earning assets and the cost of funds supporting those assets. Earning assets are comprised primarily of loans, investments, and federal funds sold. Cost of funds consists of interest bearing deposits and other borrowings. Non-interest bearing deposits and capital are also funding sources. Changes in the volume and mix of earning assets and funding sources along with changes in associated interest rates determine changes in net interest income.
2011 compared to 2010
Net interest income after provision for loan losses for the twelve months ended December 31, 2011 increased $12.8 million or 102.67% to $25.3 million from $12.5 million for the same period in 2010. As discussed below and outlined in detail in the Rate/Volume Analysis, these changes were the result of average interest earning assets growing at a faster rate than average interest bearing liabilities, an improvement in interest rates earned on interest earning assets, and a decline in interest paid on interest bearing liabilities. The accretion of the fair value adjustments positively impacted net interest income after provision for loan losses while the $718,000 increase in the provision for loan losses negatively impacted it. The acquisition of MB&T was the most significant factor that caused these changes and the improvement in net interest margin as discussed below.
Although a competitive rate environment and a low prime rate have caused lower market yields that have negatively impacted net interest income in 2011, the relatively stable rate environment has allowed us to adjust the mix and volume of interest earning assets and liabilities on the balance sheet. This also contributed to the improvement in the net interest margin.
We offset the effect on net income caused by the low rate environment primarily by growing total average interest earning assets $243.8 million or 68.56% to $599.4 million for the twelve months ended December 31, 2011 from $355.6 million for the twelve months ended December 31, 2010. The growth in average interest earning assets derived from a $174.0 million increase in average total loans and a $76.3 million increase in average investment securities. The growth in net interest income that derived from the increase in total average interest earning assets was partially offset by growth in average interest bearing liabilities. The growth in average interest bearing liabilities resulted primarily from the $172.8 million increase in average interest bearing deposits which increased to $435.8 million for the twelve months ended December 31, 2011 from $263.0 million for the twelve months ended December 31, 2010.
Our net interest margin was 4.61% for the twelve months ended December 31, 2011 as compared to 3.86% for the twelve months ended December 31, 2010. The yield on average interest earning assets increased 23 basis points during the period from 5.25% for the year ended December 31, 2010 to 5.48% for the year ended December 31, 2011. This increase was primarily because we received a higher average rate on the loan portfolio and paid a 56 basis point lower rate on interest bearing liabilities.
During 2011, we successfully collected payments or payment in full on acquired loans that we had recorded at fair value according to ASC 310-20 and ASC 310-30. These payments occurred subsequent to the acquisition of MB&T on April 1, 2011 and were a direct result of our efforts to negotiate payments, sell notes or foreclose on and sell collateral after the acquisition date. The accretion of the fair value adjustments positively impacted the yield on loans and increased the net interest margin as follows:
| | | Twelve Months Ended December 31, 2011 | | | | |
| | | Fair Value Accretion Dollars | | | % Impact on Net Interest Margin | |
| Commercial loans | | $ | 150,497 | | | | 0.03 | % |
| Mortgage loans | | | 1,725,898 | | | | 0.29 | % |
| Consumer loans | | | 3,624 | | | | 0.00 | % |
| Interest bearing deposits | | | 324,991 | | | | 0.05 | % |
| Total Fair Value Accretion | | $ | 2,205,010 | | | | 0.37 | % |
Non-interest bearing deposits are a primary source of funding for our investment and loan portfolios. These deposits allow us to fund growth in interest earning assets at minimal cost. As a result of the MB&T acquisition and growth generated from our legacy branch network, our average non-interest bearing deposits increased $78.0 million to $132.3 million during the twelve months ended December 31, 2011 compared to the twelve months ended December 31, 2010. This was also a significant contributor to the improvement in the net interest margin as it allowed us to increase our level of interest earning assets which allowed us to increase interest income without a corresponding increase in interest bearing liabilities and interest expense.
With the branches acquired in the MB&T acquisition and increased recognition in St. Mary’s, Calvert, Charles, Prince George’s and Anne Arundel counties, the high level of non-interest bearing deposits and continued growth in these and interest bearing deposits, we anticipate that we will continue to grow earning assets during 2012. If the Federal Reserve maintains the federal funds rate at current levels and the economy remains stable, we believe that we can continue to grow total loans and deposits during 2012 and beyond. We also believe that we will continue to maintain the net interest margin in the range of 4.50% during 2012, although we will not be able to so maintain the net interest margin if we fail to collect on a significant portion of impaired acquired loans. As a result of this growth and maintenance of the net interest margin, we expect that net interest income will continue to increase during 2012, although there can be no guarantee that this will be the case.
One of our primary sources of funding loans, investments and interest bearing deposits is non-interest bearing demand deposits. As of July 21, 2011, the Dodd-Frank Act permits depository institutions to pay interest on business transaction and other accounts. Although, we have not yet experienced any impact from this legislation on our operations, it is possible that interest costs associated with deposits could increase.
2010 compared to 2009
Net interest income after provision for loan losses for the year ended December 31, 2010 amounted to $12.5 million, which was $1.9 million or 17.92% greater than the 2009 level of $10.6 million. As discussed below and outlined in detail in the Rate/Volume Analysis, these changes were the result of interest earning assets growing at a faster rate than interest-bearing liabilities. A decline in interest rates on these interest earning assets partially offset this growth. The interest rate on interest bearing deposits also declined at a faster rate than the rate on interest earning assets.
Changes in the federal funds rate and the prime rate affect the interest rates on interest earning assets, net interest income and net interest margin. The prime interest rate, which is the rate offered on loans to borrowers with strong credit, began 2008 at 7.25% and decreased 400 basis points during the year. During 2009 and 2010, the prime interest rate remained unchanged at 3.25% for the entire period. The intended federal funds rate has also moved in a similar manner to the prime interest rate. It began 2008 at 4.25% and decreased 400 basis points during the year. During 2009 and 2010, the intended federal funds rate remained relatively constant at zero to 0.25% for the entire period. These declines have caused the short and long term interest yield to decline dramatically during the past two years from prior periods. As a result, when investments and loans matured during 2009 and 2010, they were invested in lower yielding securities and loans.
We offset the effect on net interest income caused by these declines in interest rates primarily by growing total average interest earning assets $47.2 million to $355.6 million for the year ended December 31, 2010 from $308.4 million for the year ended December 31, 2009. The growth in average interest earning assets derived primarily from a $30.9 million increase in average total loans, an $11.2 million growth in average investment securities and a $2.8 million increase in average interest bearing deposits in other banks. The growth in net interest income that derived from the increase in total average interest earning assets was partially offset by growth in average interest bearing deposits which grew $41.3 million to $263.0 million from $221.7 million.
One of our primary sources of funding loans, investments and interest bearing deposits is non-interest bearing demand deposits. The growth of this lower cost funding base positively impacts our net interest margin. Average non-interest bearing deposits grew $14.9 million or 37.82% to $54.3 million for the year ended December 31, 2010 from $39.4 million for the year ended December 31, 2009.
Our net interest margin was 3.86% for the year ended December 31, 2010, as compared to 3.77% for the year ended December 31, 2009. The increase in the net interest margin occurred because the cost of interest bearing deposits decreased 56 basis points from 2.05% for the twelve months ended December 31, 2009 to 1.49% for the twelve months ended December 31, 2010. A 4 basis point decline in the interest yield on borrowed funds also contributed to the improvement in the net interest margin. The decrease in these interest yields during the comparable periods was primarily the result of decreases in interest rates offered on certain deposit products due to decreases in average market interest rates and decreases in renewal interest rates on maturing certificates of deposit.
The following table illustrates average balances of total interest earning assets and total interest bearing liabilities for the periods indicated, showing the average distribution of assets, liabilities, stockholders’ equity and related income, expense and corresponding weighted average yields and rates. The average balances used in this table and other statistical data were calculated using average daily balances.
| | | Average Balances, Interest and Yields | |
| Twelve Months Ended December 31, | | 2011 | | | 2010 | | | 2009 | |
| | | Average | | | | | | | | | Average | | | | | | | | | Average | | | | | | | |
| | | balance | | | Interest | | | Yield | | | balance | | | Interest | | | Yield | | | balance | | | Interest | | | Yield | |
| Assets: | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| Federal funds sold(1) | | $ | 4,511,838 | | | $ | 6,088 | | | | 0.13 | % | | $ | 2,720,879 | | | $ | 7,258 | | | | 0.27 | % | | $ | 458,457 | | | $ | 1,149 | | | | 0.25 | % |
| Interest bearing deposits | | | 11,617,100 | | | | 35,954 | | | | 0.31 | | | | 19,837,453 | | | | 188,361 | | | | 0.95 | | | | 17,004,299 | | | | 270,290 | | | | 1.59 | |
| Investment securities(1)(2) | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| U.S. Treasury | | | 951,656 | | | | 7,665 | | | | 0.81 | | | | - | | | | - | | | | - | | | | 187,658 | | | | 7,647 | | | | 4.07 | |
| U.S. government agency | | | 17,015,717 | | | | 351,399 | | | | 2.07 | | | | 5,778,185 | | | | 173,228 | | | | 3.00 | | | | 8,411,754 | | | | 313,654 | | | | 3.73 | |
| Mortgage backed securities | | | 85,595,192 | | | | 2,635,172 | | | | 3.08 | | | | 39,179,963 | | | | 1,399,979 | | | | 3.57 | | | | 24,642,044 | | | | 1,059,386 | | | | 4.30 | |
| Municipal securities | | | 19,232,924 | | | | 1,100,704 | | | | 5.72 | | | | 2,351,798 | | | | 117,062 | | | | 4.98 | | | | 2,540,562 | | | | 126,752 | | | | 4.99 | |
| Other | | | 3,443,591 | | | | 128,679 | | | | 3.74 | | | | 2,621,530 | | | | 70,976 | | | | 2.71 | | | | 2,886,213 | | | | 72,150 | | | | 2.50 | |
| Total investment securities | | | 126,239,080 | | | | 4,223,619 | | | | 3.35 | | | | 49,931,476 | | | | 1,761,245 | | | | 3.53 | | | | 38,668,231 | | | | 1,579,589 | | | | 4.08 | |
| Loans:(1) | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| Commercial | | | 96,395,235 | | | | 5,208,608 | | | | 5.40 | | | | 78,586,868 | | | | 4,298,503 | | | | 5.47 | | | | 70,966,468 | | | | 4,168,203 | | | | 5.87 | |
| Mortgage | | | 348,392,803 | | | | 21,994,769 | | | | 6.31 | | | | 192,748,540 | | | | 11,638,569 | | | | 6.04 | | | | 168,196,382 | | | | 10,346,433 | | | | 6.15 | |
| Consumer | | | 14,741,474 | | | | 1,400,154 | | | | 9.50 | | | | 14,129,643 | | | | 775,337 | | | | 5.49 | | | | 15,399,539 | | | | 856,562 | | | | 5.56 | |
| Total loans | | | 459,529,512 | | | | 28,603,531 | | | | 6.22 | | | | 285,465,051 | | | | 16,712,409 | | | | 5.85 | | | | 254,562,389 | | | | 15,371,198 | | | | 6.04 | |
| Allowance for loan losses | | | 2,500,720 | | | | - | | | | | | | | 2,364,613 | | | | - | | | | | | | | 2,277,747 | | | | - | | | | | |
| Total loans, net of allowance | | | 457,028,792 | | | | 28,603,531 | | | | 6.26 | | | | 283,100,438 | | | | 16,712,409 | | | | 5.90 | | | | 252,284,642 | | | | 15,371,198 | | | | 6.09 | |
| Total interest earning assets(1) | | | 599,396,810 | | | | 32,869,192 | | | | 5.48 | | | | 355,590,246 | | | | 18,669,273 | | | | 5.25 | | | | 308,415,629 | | | | 17,222,226 | | | | 5.58 | |
| Non-interest bearing cash | | | 24,604,437 | | | | | | | | | | | | 8,811,003 | | | | | | | | | | | | 7,104,387 | | | | | | | | | |
| Premises and equipment | | | 20,989,733 | | | | | | | | | | | | 17,151,436 | | | | | | | | | | | | 14,548,001 | | | | | | | | | |
| Other assets | | | 32,537,952 | | | | | | | | | | | | 12,470,229 | | | | | | | | | | | | 11,904,806 | | | | | | | | | |
| Total assets(1) | | $ | 677,528,932 | | | | | | | | | | | $ | 394,022,914 | | | | | | | | | | | $ | 341,972,823 | | | | | | | | | |
| Liabilities and Stockholders' Equity: | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| Interest bearing deposits | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| Savings | | $ | 48,051,608 | | | | 154,573 | | | | 0.32 | | | $ | 8,692,555 | | | | 27,487 | | | | 0.32 | | | $ | 6,853,343 | | | | 25,602 | | | | 0.37 | |
| Money market and NOW | | | 106,201,797 | | | | 615,337 | | | | 0.58 | | | | 54,820,016 | | | | 480,613 | | | | 0.88 | | | | 33,931,390 | | | | 171,476 | | | | 0.51 | |
| Other time deposits | | | 281,542,957 | | | | 3,619,784 | | | | 1.29 | | | | 199,494,261 | | | | 3,412,238 | | | | 1.71 | | | | 180,866,687 | | | | 4,356,021 | | | | 2.41 | |
| Total interest bearing deposits | | | 435,796,362 | | | | 4,389,694 | | | | 1.01 | | | | 263,006,832 | | | | 3,920,338 | | | | 1.49 | | | | 221,651,420 | | | | 4,553,099 | | | | 2.05 | |
| Borrowed funds | | | 46,130,710 | | | | 829,477 | | | | 1.80 | | | | 38,079,368 | | | | 1,022,425 | | | | 2.68 | | | | 37,817,464 | | | | 1,026,755 | | | | 2.72 | |
| Total interest bearing liabilities | | | 481,927,072 | | | | 5,219,171 | | | | 1.08 | | | | 301,086,200 | | | | 4,942,763 | | | | 1.64 | | | | 259,468,884 | | | | 5,579,854 | | | | 2.15 | |
| Non-interest bearing deposits | | | 132,326,211 | | | | | | | | | | | | 54,335,130 | | | | | | | | | | | | 39,410,471 | | | | | | | | | |
| | | | 614,253,283 | | | | 5,219,171 | | | | 0.85 | | | | 355,421,330 | | | | 4,942,763 | | | | 1.39 | | | | 298,879,355 | | | | 5,579,854 | | | | 1.87 | |
| Other liabilities | | | 5,315,810 | | | | | | | | | | | | 1,632,031 | | | | | | | | | | | | 3,390,944 | | | | | | | | | |
| Non-controlling interest | | | 517,639 | | | | | | | | | | | | 640,378 | | | | | | | | | | | | 692,144 | | | | | | | | | |
| Stockholders' equity | | | 57,442,200 | | | | | | | | | | | | 36,329,175 | | | | | | | | | | | | 39,010,380 | | | | | | | | | |
| Total liabilities and stockholders' equity | | $ | 677,528,932 | | | | | | | | | | | $ | 394,022,914 | | | | | | | | | | | $ | 341,972,823 | | | | | | | | | |
| Net interest spread(1) | | | | | | | | | | | 4.40 | | | | | | | | | | | | 3.61 | | | | | | | | | | | | 3.43 | |
| Net interest income(1) | | | | | | $ | 27,650,021 | | | | 4.61 | % | | | | | | $ | 13,726,510 | | | | 3.86 | % | | | | | | $ | 11,642,372 | | | | 3.77 | % |
| 1) | Interest revenue is presented on a fully taxable equivalent (FTE) basis. The FTE basis adjusts for the tax favored status of these types of assets. Management believes providing this information on a FTE basis provides investors with a more accurate picture of our net interest spread and net interest income and we believe it to be the preferred industry measurement of these calculations. See “Reconciliation of Non-GAAP Measures.” |
| 2) | Available for sale investment securities are presented at amortized cost. |
The following table describes the impact on our interest income and expense resulting from changes in average balances and average rates for the periods indicated. The change in interest income due to both volume and rate is reported with the rate variance.
Rate/Volume Variance Analysis
| | | Twelve Months Ended December 31, | | | Twelve Months Ended December 31, | |
| | | 2011 compared to 2010 | | | 2010 compared to 2009 | |
| | | Variance due to: | | | Variance due to: | |
| | | | | | | | | | | | | | | | | | | |
| | | Total | | | Rate | | | Volume | | | Total | | | Rate | | | Volume | |
| | | | | | | | | | | | | | | | | | | |
| Interest earning assets: | | | | | | | | | | | | | | | | | | |
Federal funds sold(1) | | $ | (1,170 | ) | | $ | (4,599 | ) | | $ | 3,429 | | | $ | 6,109 | | | $ | 79 | | | $ | 6,030 | |
| Interest bearing deposits | | | (152,407 | ) | | | (94,383 | ) | | | (58,024 | ) | | | (81,929 | ) | | | (121,656 | ) | | | 39,727 | |
Investment Securities(1) | | | | | | | | | | | | | | | | | | | | | | | | |
| U.S. Treasury | | | 7,665 | | | | - | | | | 7,665 | | | | (7,647 | ) | | | - | | | | (7,647 | ) |
| U.S. government agency | | | 178,171 | | | | (68,358 | ) | | | 246,529 | | | | (140,426 | ) | | | (54,063 | ) | | | (86,363 | ) |
| Mortgage backed securities | | | 1,235,193 | | | | (217,780 | ) | | | 1,452,973 | | | | 340,593 | | | | (202,358 | ) | | | 542,951 | |
| Municipal securities | | | 983,642 | | | | 20,104 | | | | 963,538 | | | | (9,690 | ) | | | (293 | ) | | | (9,397 | ) |
| Other | | | 57,703 | | | | 31,622 | | | | 26,081 | | | | (1,174 | ) | | | 5,731 | | | | (6,905 | ) |
| Loans: | | | | | | | | | | | | | | | | | | | | | | | | |
| Commercial | | | 910,105 | | | | (52,751 | ) | | | 962,856 | | | | 130,300 | | | | (298,525 | ) | | | 428,825 | |
| Mortgage | | | 10,356,200 | | | | 552,902 | | | | 9,803,298 | | | | 1,292,136 | | | | (193,487 | ) | | | 1,485,623 | |
| Consumer | | | 624,817 | | | | 589,871 | | | | 34,946 | | | | (81,225 | ) | | | (11,408 | ) | | | (69,817 | ) |
Total interest revenue (1) | | | 14,199,919 | | | | 756,628 | | | | 13,443,291 | | | | 1,447,047 | | | | (875,980 | ) | | | 2,323,027 | |
| | | | | | | | | | | | | | | | | | | | | | | | | |
| Interest bearing liabilities: | | | | | | | | | | | | | | | | | | | | | | | | |
| Savings | | | 127,086 | | | | 484 | | | | 126,602 | | | | 1,885 | | | | (4,315 | ) | | | 6,200 | |
| Money market and NOW | | | 134,724 | | | | (203,570 | ) | | | 338,294 | | | | 309,137 | | | | 168,213 | | | | 140,924 | |
| Other time deposits | | | 207,546 | | | | (978,552 | ) | | | 1,186,098 | | | | (943,783 | ) | | | (1,358,323 | ) | | | 414,540 | |
| Borrowed funds | | | (192,948 | ) | | | (381,257 | ) | | | 188,309 | | | | (4,330 | ) | | | (11,410 | ) | | | 7,080 | |
| Total interest expense | | | 276,408 | | | | (1,562,895 | ) | | | 1,839,303 | | | | (637,091 | ) | | | (1,205,835 | ) | | | 568,744 | |
| | | | | | | | | | | | | | | | | | | | | | | | | |
Net interest income(1) | | $ | 13,923,511 | | | $ | 2,319,523 | | | $ | 11,603,988 | | | $ | 2,084,138 | | | $ | 329,855 | | | $ | 1,754,283 | |
| 1) | Interest revenue is presented on a fully taxable equivalent (FTE) basis. Management believes providing this information on a FTE basis provides investors with a more accurate picture of our net interest spread and net interest income and we believe it to be the preferred industry measurement of these calculations. See “Reconciliation of Non-GAAP Measures.” |
Provision for Loan Losses
Originating loans involves a degree of risk that credit losses will occur in varying amounts according to, among other factors, the type of loans being made, the credit worthiness of the borrowers over the term of the loans, the quality of the collateral for the loan, if any, as well as general economic conditions. We charge the provision for loan losses to earnings to maintain the total allowance for loan losses at a level considered by management to represent its best estimate of the losses known and inherent in the portfolio that are both probable and reasonable to estimate, based on, among other factors, prior loss experience, volume and type of lending conducted, estimated value of any underlying collateral, economic conditions (particularly as such conditions relate to Old Line Bank’s market area), regulatory guidance, peer statistics, management’s judgment, past due loans in the loan portfolio, loan charge off experience and concentrations of risk (if any). We charge losses on loans against the allowance when we believe that collection of loan principal is unlikely. We add back recoveries on loans previously charged to the allowance.
The provision for loan losses was $1.8 million for the twelve months ended December 31, 2011, as compared to $1.1 million for the twelve months ended December 31, 2010, an increase of $718,000 or 66.36%. After completing the analysis outlined below, during the twelve month period ended December 31, 2011, we increased the provision for loan losses primarily because although our asset quality remained stable, we experienced approximately $50.0 million in organic growth in the legacy portfolio during the twelve months ended December 31, 2011 and the economy remained weak. We have allocated a specific reserve for those loans where we consider it probable that we will incur a loss. Although there are no indicators that our legacy asset quality has deteriorated or changed in any manner, the addition of several new lenders from the acquisition, the increased size and complexity of the acquired portfolio and the anemic growth in the economy all contribute to increased uncertainty regarding the future performance of our borrowers. As a result, our historical asset quality may not be an accurate indicator of our future performance. Therefore, we determined that it was prudent to increase the allowance for loan losses. Our legacy non-performing assets remain statistically low at 0.16% of total assets and we had only $744,610 of legacy loans past due between 30-89 days and $34,370 past due 90 days or more at year end.
The provision for loan losses was $1.1 million for the year ended December 31, 2010. This represented a $182,000 or 20.22% increase as compared to $900,000 for the year ended December 31, 2009. After completing the analysis outlined below, we increased the provision for loan losses primarily because we had seen a modest increase in our historical losses over prior periods and some of our borrowers continued to report weaker profitability. At year end 2010, we had three loans totaling $2.7 million past due and classified as non-accrual. We had no other loans past due between 30-89 days.
We review the adequacy of the allowance for loan losses at least quarterly. Our review includes evaluation of impaired loans as required by ASC Topic 310-Receivables, and ASC Topic 450-Contingencies. Also incorporated in determining the adequacy of the allowance is guidance contained in the SEC’s SAB No. 102, Loan Loss Allowance Methodology and Documentation; the Federal Financial Institutions Examination Council’s Policy Statement on Allowance for Loan and Lease Losses Methodologies and Documentation for Banks and Savings Institutions and the Interagency Policy Statement on the Allowance for Loan and Lease Losses provided by the Office of the Comptroller of the Currency, Board of Governors of the Federal Reserve System, Federal Deposit Insurance Corporation, National Credit Union Administration and Office of Thrift Supervision.
We base the evaluation of the adequacy of the allowance for loan losses upon loan categories. We categorize loans as installment and other consumer loans (other than boat loans), boat loans, mortgage loans (commercial real estate, residential real estate and real estate construction) and commercial loans. We apply loss ratios to each category of loan. We further divide commercial and commercial real estate loans by risk rating and apply loss ratios by risk rating, to determine estimated loss amounts. We evaluate delinquent loans and loans for which management has knowledge about possible credit problems of the borrower or knowledge of problems with loan collateral separately and assign loss amounts based upon the evaluation.
We determine loss ratios for installment and other consumer loans (other than boat loans), boat loans and mortgage loans (commercial real estate, residential real estate and real estate construction) based upon a review of prior 18 months delinquency trends for the category, the three year loss ratio for the category, peer group loss ratios and industry standards.
With respect to commercial loans, management assigns a risk rating of one through eight to each loan at inception, with a risk rating of one having the least amount of risk and a risk rating of eight having the greatest amount of risk. For commercial loans of less than $250,000, we may review the risk rating annually based on, among other things, the borrower’s financial condition, cash flow and ongoing financial viability; the collateral securing the loan; the borrower’s industry and payment history. We review the risk rating for all commercial loans in excess of $250,000 at least annually. We evaluate loans with a risk rating of five or greater separately and assign loss amounts based upon the evaluation. For loans with risk ratings between one and four, we determine loss ratios based upon a review of prior 18 months delinquency trends, the three year loss ratio, peer group loss ratios and industry standards.
We also identify and make any necessary allocation adjustments for any specific concentrations of credit in a loan category that in management’s estimation increase the risk inherent in the category. If necessary, we will also make an adjustment within one or more loan categories for economic considerations in our market area that may impact the quality of the loans in the category. For all periods presented, there were no specific adjustments made for concentrations of credit. As discussed above, for all periods presented we have adjusted our provision for loan losses in all segments of our portfolio as a result of economic considerations. We consider qualitative or environmental factors that are likely to cause estimated credit losses associated with our existing portfolio to differ from historical loss experience. These factors include, but are not limited to, changes in lending policies and procedures, changes in the nature and volume of the loan portfolio, changes in the experience, ability and depth of lending management and the effect of other external factors such as competition and legal and regulatory requirements on the level of estimated credit losses in our existing portfolio.
In the event that our review of the adequacy of the allowance results in any unallocated amounts, we reallocate such amounts to our loan categories based on the percentage that each category represents to total gross loans. We have risk management practices designed to ensure timely identification of changes in loan risk profiles. However, undetected losses inherently exist within the portfolio. We believe that the allocation of the unallocated portion of the reserve in the manner described above is appropriate. Although we may allocate specific portions of the allowance for specific credits or other factors, the entire allowance is available for any credit that we should charge off. We will not create a separate valuation allowance unless we consider a loan impaired.
During the year ended December 31, 2011, we charged approximately $446,000 related to a legacy real estate loan and a legacy consumer loan in the amount of $47,261 to the allowance for loan losses. The borrower and guarantor on the real estate loan have filed bankruptcy. During the first quarter of 2011, we charged $446,000 to the allowance for loan losses and reduced the balance on this loan from $1,616,317 to $1,169,337, which represented the fair value of the underlying collateral. We have an additional $65,000 of the allowance for loan losses specifically allocated to this loan. As outlined below, we anticipate ratification of the foreclosure will occur during the second quarter of 2012 and that we will receive approximately $966,000 from the sales proceeds and charge approximately $203,000 to the allowance for loan losses. During the first quarter of 2011, we also repossessed a boat. At the time of the repossession, in order to carry the boat at its fair value, we charged $47,261 to the allowance for loan losses. We subsequently sold the boat and recorded an additional loss of approximately $120,000 in non-interest expense. The remaining charges to the allowance for loan losses were primarily related to various immaterial acquired loans. The recoveries recorded to the allowance for loan losses were all substantially recovered from acquired loans that were charged to the allowance for loan losses at MB&T prior to the acquisition date of April 1, 2011.
During the year ended December 31, 2010, we charged $1.1 million to the allowance for loan losses. This amount derived primarily from two loans. The first loan was an unsecured facility in the amount of $137,151. The borrower experienced health related problems that detrimentally impacted his business. The second loan is a residential land acquisition and development loan. During the third quarter of 2010, we received a deed in lieu of foreclosure on this property and an appraisal of the property indicated that the value was insufficient to repay the full principal balance and cost associated with the property. Therefore, we recognized this impairment and charged $946,739 to the allowance for losses during the third quarter of 2010. The remaining amount charged to the allowance for loan losses during 2010 consisted of small deficiencies related to various loans.
Our policies require a review of assets on a regular basis, and we believe that we appropriately classify loans as well as other assets if warranted. We believe that we use the best information available to make a determination with respect to the allowance for loan losses, recognizing that the determination is inherently subjective and that future adjustments may be necessary depending upon, among other factors, a change in economic conditions of specific borrowers or generally in the economy, and new information that becomes available to us. However, there are no assurances that the allowance for loan losses is sufficient to absorb losses on non-performing assets, or that the allowance will be sufficient to cover losses on non-performing assets in the future.
The allowance for loan losses represents 0.69% of total loans at December 31, 2011, 0.82% of total loans at December 31, 2010 and 0.93% at December 31, 2009. We have no exposure to foreign countries or foreign borrowers. Based on our analysis and the satisfactory historical performance of the loan portfolio, we believe this allowance appropriately reflects the inherent risk of loss in our portfolio.
The following table represents an analysis of the allowance for loan losses for the periods indicated:
| Allowance for Loan Losses | |
| | | 2011 | | | 2010 | | | 2009 | |
| Years Ended December 31, | | Acquired | | | Legacy | | | Total | | | Legacy | | | Legacy | |
| Balance, beginning of period | | $ | - | | | $ | 2,468,476 | | | $ | 2,468,476 | | | $ | 2,481,716 | | | $ | 1,983,751 | |
| Provision for loan losses | | | - | | | | 1,800,000 | | | | 1,800,000 | | | | 1,082,000 | | | | 900,000 | |
| | | | | | | | | | | | | | | | | | | | | |
| Chargeoffs: | | | | | | | | | | | | | | | | | | | | |
| Commercial | | | (34,053 | ) | | | - | | | | (34,053 | ) | | | (137,151 | ) | | | - | |
| Mortgage | | | (158,811 | ) | | | (446,980 | ) | | | (605,791 | ) | | | (958,472 | ) | | | (344,825 | ) |
| Consumer | | | (75,158 | ) | | | (47,261 | ) | | | (122,419 | ) | | | (4,194 | ) | | | (57,210 | ) |
| Total chargeoffs | | | (268,022 | ) | | | (494,241 | ) | | | (762,263 | ) | | | (1,099,817 | ) | | | (402,035 | ) |
| Recoveries: | | | | | | | | | | | - | | | | | | | | | |
| Mortgage | | | 13,701 | | | | - | | | | 13,701 | | | | 3,650 | | | | - | |
| Commercial | | | 154,523 | | | | - | | | | 154,523 | | | | - | | | | - | |
| Consumer | | | 66,630 | | | | 204 | | | | 66,834 | | | | 927 | | | | - | |
| Total recoveries | | | 234,854 | | | | 204 | | | | 235,058 | | | | 4,577 | | | | - | |
| Net (chargeoffs) recoveries | | | (33,168 | ) | | | (494,037 | ) | | | (527,205 | ) | | | (1,095,240 | ) | | | (402,035 | ) |
| | | | | | | | | | | | | | | | | | | | | |
| Balance, end of period | | | | | | | | | | $ | 3,741,271 | | | $ | 2,468,476 | | | $ | 2,481,716 | |
| | | | | | | | | | | | | | | | | | | | | |
| Ratio of allowance for loan losses to: | | | | | | | | | | | | | | | | | | | | |
| Total gross loans | | | | | | | | | | | 0.69 | % | | | 0.82 | % | | | 0.93 | % |
| Non-accrual loans | | | | | | | | | | | 64.17 | % | | | 91.07 | % | | | 156.43 | % |
| Ratio of net-chargeoffs during period to | | | | | | | | | | | | | | | | | | | | |
| average loans outstanding during period: | | | | | | | | | | | 0.115 | % | | | 0.384 | % | | | 0.158 | % |
The following table provides a breakdown of the allowance for loan losses:
| Allocation of Allowance for Loan Losses | |
| | |
| December 31, | | 2011 | | | 2010 | | | 2009 | |
| | | Amount | | | % of Loans in Each Category | | | Amount | | | % of Loans in Each Category | | | Amount | | | % of Loans in Each Category | |
| | | | | | | | | | | | | | | | | | | |
| | | | | | | | | | | | | | | | | | | |
| Consumer | | $ | 130,653 | | | | 0.89 | % | | $ | 8,433 | | | | 0.48 | % | | $ | 10,319 | | | | 0.57 | % |
| Boat | | | 565,240 | | | | 1.63 | | | | 294,723 | | | | 3.86 | | | | 81,417 | | | | 4.91 | |
| Mortgage | | | 2,123,068 | | | | 77.73 | | | | 1,748,122 | | | | 67.97 | | | | 1,845,126 | | | | 66.74 | |
| Commercial | | | 922,310 | | | | 19.75 | | | | 417,198 | | | | 27.69 | | | | 544,854 | | | | 27.78 | |
| | | | | | | | | | | | | | | | | | | | | | | | | |
| Total | | $ | 3,741,271 | | | | 100.00 | % | | $ | 2,468,476 | | | | 100.00 | % | | $ | 2,481,716 | | | | 100.00 | % |
| Allocation of Allowance for Loan Losses | |
| | |
| December 31, | | 2008 | | | 2007 | |
| | | Amount | | | % of Loans in Each Category | | | Amount | | | % of Loans in Each Category | |
| | | | | | | | | | | | | |
| | | | | | | | | | | | | |
| Consumer | | $ | 13,391 | | | | 0.50 | % | | $ | 10,236 | | | | 0.46 | % |
| Boat | | | 94,910 | | | | 6.22 | | | | 106,405 | | | | 8.66 | |
| Mortgage | | | 1,348,850 | | | | 63.21 | | | | 1,080,897 | | | | 63.56 | |
| Commercial | | | 526,600 | | | | 30.07 | | | | 389,199 | | | | 27.32 | |
| | | | | | | | | | | | | | | | | |
| Total | | $ | 1,983,751 | | | | 100.00 | % | | $ | 1,586,737 | | | | 100.00 | % |
Non-interest Revenue
2011 compared to 2010
Non-interest revenue totaled $2.7 million for the twelve months ended December 31, 2011, an increase of $1.4 million or 102.76% from the 2010 amount of $1.3 million. The increase in non-interest revenue during the period was primarily attributable to increases in service charges on deposit accounts and to a lesser extent, gains on sales or call of investment securities, and earnings on bank owned life insurance, partially offset by a $123,039 impairment on equity securities. The primary cause of the increase in service charges on deposit accounts and in other fees and commissions, which increased slightly during the period, was the acquisition of MB&T and the resulting growth in customer services and deposits. During the twelve month period, we sold securities and had securities called which provided the gain on sales of investment securities. We did not have any gains, sales or calls of securities during the twelve months ended December 31, 2010. Earnings on bank owned life insurance increased because of the addition of the MB&T bank owned life insurance policies and because during the period we recorded an approximately $213,000 non-recurring gain that occurred due to the loss of a colleague during the period. There was a $74,144 decrease in the rent and other revenue that we earn from Pointer Ridge resulting from the loss of tenants in the building that Pointer Ridge owns. A $122,500 impairment in an equity security owned by Old Line Bank prior to the acquisition and a $539 charge off of an acquired security also partially offset the increases in non-interest revenues. We charged the impairment against earnings because we believe that current market factors indicate these securities are permanently impaired. The loss on disposal of assets was a result of the assets disposed of in the closure of one of the acquired MB&T branches.
Because of the acquisition of Maryland Bankcorp, the business development efforts of our lenders, managers and the new branches, we expect that customer relationships will continue to grow during 2012. We anticipate this growth will cause an increase in service charges on deposit accounts. We do not expect any additional non-recurring earnings on bank owned life insurance in 2012. We plan to continue our efforts to sell acquired and legacy other real estate owned. We are unable to predict the timing of those sales or any gains or losses that we may incur with the sale of those properties.
The following table outlines the changes in non-interest revenue for the twelve month periods.
| Years Ended December 31, | | 2011 | | | 2010 | | | $ Change | | | % Change | |
| Service charges on deposit accounts | | $ | 1,208,466 | | | $ | 306,548 | | | $ | 901,918 | | | | 294.22 | % |
| Gains on sales or calls of investment securities | | | 140,149 | | | | - | | | | 140,149 | | | | - | |
| Other than temporary impairment on investment securities | | | (123,039 | ) | | | - | | | | (123,039 | ) | | | - | |
| Earnings on bank owned life insurance | | | 701,509 | | | | 336,834 | | | | 364,675 | | | | 108.27 | |
| Pointer Ridge rent and other revenue | | | 206,486 | | | | 280,630 | | | | (74,144 | ) | | | (26.42 | ) |
| Gain on other real estate owned | | | 248,005 | | | | 192,724 | | | | 55,281 | | | | 28.68 | |
| Other fees and commissions | | | 359,701 | | | | 235,266 | | | | 124,435 | | | | 52.89 | |
| Total non-interest revenue | | $ | 2,741,277 | | | $ | 1,352,002 | | | $ | 1,389,275 | | | | 102.76 | % |
2010 compared to 2009
Non-interest revenue declined $467,765 to $1.4 million for the twelve months ended December 31, 2010 primarily because of a $286,653 decline in rent and other revenue from Pointer Ridge, a $158,551 decline in gain on sales of investment securities and a $175,490 decline in other fees and commissions. During the twelve months ended December 31, 2009, Pointer Ridge produced $567,283 in rent and other revenue that is included in other fees and commissions. Approximately $300,000 of that amount derived from a non-recurring lease termination fee. During the same period in 2010, we received $280,630 in rental and other income from Pointer Ridge. The absence of the lease termination fee in 2010 and the subsequent loss of additional tenants in the building owned by Pointer Ridge were the major causes of the decline in Pointer Ridge’s rent and other revenue. In an effort to minimize call and prepayment risk and manage future interest rate risk, we elected to sell available for sale securities during 2009. During 2010, we did not identify any compelling reasons to sell any investment securities. Earnings on bank owned life insurance declined $39,331 as a result of a decline in the interest yield earned on the life insurance policies. Other fees and commissions (excluding Pointer Ridge) declined $175,490 primarily because in 2010, we received $25,530 in rental income from the tenant who leased the second floor of our branch located at 301 Crain Highway, Waldorf, Maryland compared to $109,800 in 2009. The tenant terminated his lease in March 2010. As a result, rental income declined $84,270. These declines were offset by a $192,724 gain on the sale of other real estate owned. During the fourth quarter of 2010, we ratified the sale of property that we had acquired through foreclosure in March 2010. At the time of foreclosure, we valued the property at $223,169 and we subsequently sold the property for $425,000 less approximately $10,000 in costs.
The following table outlines the changes in non-interest revenue for the twelve month periods.
| Years Ended December 31, | | 2010 | | | 2009 | | | $ Change | | | % Change | |
| Service charges on deposit accounts | | $ | 306,548 | | | $ | 307,012 | | | $ | (464 | ) | | | (0.15 | ) % |
| Net gains on sales of investment securities | | | - | | | | 158,551 | | | | (158,551 | ) | | | - | |
| Earnings on bank owned life insurance | | | 336,834 | | | | 376,165 | | | | (39,331 | ) | | | (10.46 | ) |
| Pointer Ridge rent and other revenue | | | 280,630 | | | | 567,283 | | | | (286,653 | ) | | | (50.53 | ) |
| Gain on other real estate owned | | | 192,724 | | | | - | | | | 192,724 | | | | - | |
| Other fees and commissions | | | 235,266 | | | | 410,756 | | | | (175,490 | ) | | | (42.72 | ) |
| Total non-interest revenue | | $ | 1,352,002 | | | $ | 1,819,767 | | | $ | (467,765 | ) | | | (25.70 | ) % |
Non-interest Expense
2011 compared to 2010
Non-interest expense increased $9.5 million for the twelve months ended December 31, 2011. The following chart outlines the changes in non-interest expenses for the period.
| Years ended December 31, | | 2011 | | | 2010 | | | $ Change | | | % Change | |
| Salaries | | $ | 7,755,401 | | | $ | 4,681,679 | | | $ | 3,073,722 | | | | 65.65 | % |
| Employee benefits | | | 2,269,190 | | | | 1,284,993 | | | | 984,197 | | | | 76.59 | |
| Occupancy | | | 2,521,960 | | | | 1,296,088 | | | | 1,225,872 | | | | 94.58 | |
| Equipment | | | 609,597 | | | | 416,094 | | | | 193,503 | | | | 46.50 | |
| Data processing | | | 816,815 | | | | 452,675 | | | | 364,140 | | | | 80.44 | |
| Pointer Ridge other operating | | | 562,223 | | | | 413,484 | | | | 148,739 | | | | 35.97 | |
FDIC insurance and State of Maryland assessments | | | 613,881 | | | | 527,807 | | | | 86,074 | | | | 16.31 | |
| Merger and integration | | | 574,321 | | | | 574,369 | | | | (48 | ) | | | (0.01 | ) |
| Core deposit premium | | | 584,024 | | | | - | | | | 584,024 | | | | - | |
| Other operating | | | 4,576,931 | | | | 1,762,316 | | | | 2,814,615 | | | | 159.71 | |
| Total non-interest expenses | | $ | 20,884,343 | | | $ | 11,409,505 | | | $ | 9,474,838 | | | | 83.04 | % |
Salaries, employee benefits, occupancy, equipment, data processing and other operating expenses increased primarily because of increased operating expenses resulting from the acquisition of MB&T. As a result of the acquisition, we increased our number of employees by 86 and our branch network by nine. Employee benefits also increased approximately $183,000 as a result of a non-recurring expense payable to the estate of a colleague who passed away during the period. Pointer Ridge other operating expense increased because of a onetime increase in management fees, the charge off of rents due from a prior tenant and increased operating expenses associated with the building. Merger and integration costs include severance costs of approximately $203,630 and attorney, accounting, director compensation and other professional fees of approximately $218,410 associated with the acquisition of MB&T. The increase in FDIC insurance and State of Maryland assessments was a result of the additional assets acquired from MB&T. This increase was partially offset by the change in the FDIC assessment base and rate calculation as required by the Dodd-Frank Act. The increase in the core deposit premium was the result of the acquisition of MB&T and subsequent amortization of the core deposit intangible. Other operating expenses also increased because of a $221,297 increase in expenses associated with acquired and legacy other real estate owned.
2010 compared to 2009
Non-interest expense for the twelve months ended December 31, 2010 increased 23.25% or $2.2 million relative to the amount reported in 2009. Salaries, employee benefits, occupancy, equipment, data processing expenses, and other operating expenses increased primarily because of increased operating expenses from the two branches that we opened in 2009 and the new lending team that we hired in December 2009. Benefits also increased because of the increase in stock option and restricted stock awards granted in the first quarter of 2010. The transfer of the ownership of other real estate owned from the borrowers’ name to ours and maintenance of these properties caused a $72,000 increase in other operating expenses. A $104,376 increase in director fees was also a primary contributor to the increase in other operating expenses. Director fees increased because we increased the fees paid for participation in meetings and the retainer fee for directors in 2010. FDIC and State of Maryland assessments decreased $34,043 because there was no special assessment in 2010 while we paid a special assessment of approximately $149,000 in 2009. This savings was offset by increased rates and higher deposit levels. During the twelve month period, we incurred $574,369 in merger costs associated with the agreement to acquire Maryland Bankcorp for accounting, advisory, attorney, data processing and salaries.
The following chart outlines the changes in non-interest expenses for the period.
| Years Ended December 31, | | 2010 | | | 2009 | | | $ Change | | | % Change | |
| Salaries | | $ | 4,681,679 | | | $ | 4,037,027 | | | $ | 644,652 | | | | 15.97 | % |
| Employee benefits | | | 1,284,993 | | | | 1,012,014 | | | | 272,979 | | | | 26.97 | |
| Occupancy | | | 1,296,088 | | | | 1,085,768 | | | | 210,320 | | | | 19.37 | |
| Equipment | | | 416,094 | | | | 354,531 | | | | 61,563 | | | | 17.36 | |
| Data processing | | | 452,675 | | | | 340,870 | | | | 111,805 | | | | 32.80 | |
| FDIC Insurance and State of Maryland assessments | | | 527,807 | | | | 561,850 | | | | (34,043 | ) | | | (6.06 | ) |
| Pointer Ridge other operating | | | 413,484 | | | | 405,868 | | | | 7,616 | | | | 1.88 | |
| Merger Expense | | | 574,369 | | | | - | | | | 574,369 | | | | 100.00 | |
| Other operating | | | 1,762,316 | | | | 1,458,953 | | | | 303,363 | | | | 20.79 | |
| Total non-interest expenses | | $ | 11,409,505 | | | $ | 9,256,881 | | | $ | 2,152,624 | | | | 23.25 | % |
We anticipate 2012 non-interest expenses will exceed last year’s expenses. During the year, we will continue to incur increased salary, benefits, occupancy, equipment and data processing expenses related to increased operational expenses associated with the merger of MB&T. We have continued to focus our efforts on reducing the operating expenses and anticipate that we will continue to see reduction in these expenses from those reported since the acquisition date.
Income Taxes
2011 compared to 2010
Income tax expense was $1.9 million (26.91% of pre-tax income) for the twelve months ended December 31, 2011 as compared to $996,750 (41.08% of pre-tax income) for the same period in 2010. The decrease in the tax rate as a percentage of pre-tax income was primarily because our continued and improved profitability subsequent to the merger, allowed us to record a onetime recapture of a valuation allowance recorded at the merger date which reduced income tax expense during the fourth quarter of 2011. We also experienced an increase in tax exempt income and tax deductible expenses during the period which also decreased the tax expense.
2010 compared to 2009
Income tax expense was $996,750 (41.08% of pre-tax income) for the year ended December 31, 2010 compared to $1,055,522 (33.20% of pre-tax income) for the same period in 2009. The increase in the effective tax rate is primarily due to certain merger expenses that are not deductible for tax purposes.
Net Income Available to Common Stockholders
2011 compared to 2010
Net income available to common stockholders was $5.4 million or $0.86 per basic and diluted common share for the twelve month period ending December 31, 2011 compared to net income available to common stockholders of $1.5 million or $0.39 per basic and $0.38 per diluted common share for the same period in 2010. The increase in net income attributable to Old Line Bancshares for the 2011 period was primarily the result of a $12.8 million increase in net interest income and a $1.4 million increase in non-interest revenue. These increases were partially offset by a $9.5 million increase in non-interest expense, a $718,000 increase in the provision for loan losses and a $929,874 increase in taxes compared to the same period in 2010.
2010 compared to 2009
Net income attributable to Old Line Bancshares decreased $533,486 for the twelve months ended December 31, 2010 compared to the twelve months ended December 31, 2009. Net income available to common stockholders for the twelve month period ended December 31, 2010 of $1.5 million remained comparable to the $1.6 million reported for the twelve month period ended December 31, 2009. Earnings per basic and diluted common share were $0.39 and $0.38, respectively, for the twelve months ended December 31, 2010 and $0.40 for the same period in 2009. The decrease in net income attributable to Old Line Bancshares was the result of a $467,765 decrease in non-interest revenue and a $2.2 million increase in non-interest expense. This was partially offset by a $1.9 million increase in net interest income after provision for loan losses. As a result of our repurchase during 2009 from the U.S. Treasury the 7,000 shares of preferred stock that we issued to them as part of the Troubled Asset Relief Program, we eliminated the dividends associated with this stock and, as a result, net income available to common stockholders remained comparable for the twelve months ended December 31, 2010 and 2009.
Analysis of Financial Condition
Investment Securities
Our portfolio consists primarily of time deposits in other banks, investment grade securities including U.S. Treasury securities, U.S. government agency securities, U.S. government sponsored entity securities, securities issued by states, counties and municipalities, mortgage backed securities, and certain equity securities, including Federal Reserve Bank stock, Federal Home Loan Bank stock, Maryland Financial Bank stock and Atlantic Central Bankers Bank stock. With the acquisition of MB&T, we acquired approximately $262,000 of Student Loan Marketing Association (SLMA) stock. We have prudently managed our investment portfolio to maintain liquidity and safety. The portfolio provides a source of liquidity, collateral for borrowings as well as a means of diversifying our earning asset portfolio. While we generally intend to hold the investment securities until maturity, currently all of our investment securities are classified as available for sale because during the second quarter of 2011, we sold a held to maturity security and, as required by accounting guidance, we reclassified all securities classified as held to maturity to available for sale. We account for investment securities classified as available for sale at fair value and report the unrealized gains and losses as a separate component of stockholders’ equity, net of income tax effects. We account for investment securities when classified in the held to maturity category at amortized cost. Although we will occasionally sell a security, generally, we invest in securities for the yield they produce and not to profit from trading the securities. As a result of the acquisition of Maryland Bankcorp, we evaluated the investment portfolio to ensure that the securities acquired in the acquisition meet our investment criteria, provide adequate liquidity, and that there is adequate diversity of investments in the portfolio. This analysis precipitated the sale of the security mentioned above and may cause additional sales during 2012. There are no trading securities in the portfolio.
The investment securities at December 31, 2011 amounted to $161.8 million, an increase of $107.0 million, or 195.25%, from the December 31, 2010 amount of $54.7 million. As outlined above, at December 31, 2011, all securities were classified as available for sale.
The fair value of available for sale securities included net unrealized gains of $3.5 million at December 31, 2011 (reflected as unrealized gains of $2.4 million in stockholders’ equity after deferred taxes) as compared to net unrealized gains of $450,758 ($272,956 net of taxes) as of December 31, 2010. In general, the increase in fair value was a result of the acquisition of MB&T, changes in time to maturity and decreasing market rates. We have evaluated securities with unrealized losses for an extended period of time and determined that these losses are temporary because, at this point in time, we expect to hold them until maturity. We have no intent or plan to sell these securities, it is not likely that we will have to sell these securities and we have not identified any portion of the loss that is a result of credit deterioration in the issuer of the security. As the maturity date moves closer and/or interest rates decline, the unrealized losses in the portfolio will decline or dissipate.
The investment securities at December 31, 2010 amounted to $54.9 million, an increase of $21.1million, or 62.43%, from the December 31, 2009 amount of $33.8 million. Available for sale investment securities increased to $33.0 million at December 31, 2010 from $28.0 million at December 31, 2009. The increase in the available for sale investment securities occurred primarily because we moved funds from time deposits in other banks in order to increase the yield on these investments while maintaining liquidity. Held to maturity securities at December 31, 2010 increased to $21.7 million from the $5.8 million balance on December 31, 2009 because we had sufficient liquidity that when available for sale securities or time deposits matured we elected to categorize the newly purchased investments as held to maturity. The fair value of available for sale securities included net unrealized gains of $450,758 at December 31, 2010 (reflected as unrealized gains of $272,956 in stockholders’ equity after deferred taxes) as compared to net unrealized gains of $609,165 ($368,880 net of taxes) as of December 31, 2009. In general, the increase in fair value was the result of decreasing market rates.
The following table sets forth a summary of the investment securities portfolio as of the periods indicated. Available for sale securities are reported at estimated fair value; held to maturity securities are reported at amortized cost.
| Investment Securities | |
| (Dollars in thousands) | |
| | | | |
| December 31, | | 2011 | | | 2010 | | | 2009 | |
| | | | | | | | | | |
| Available For Sale Securities | | | | | | | | | |
| U.S. Treasury | | $ | 1,256 | | | $ | - | | | $ | - | |
| U.S. government agency | | | 26,091 | | | | 3,804 | | | | 7,291 | |
| Municipal securities | | | 35,142 | | | | 1,327 | | | | 2,275 | |
| Mortgage backed | | | 99,296 | | | | 27,919 | | | | 18,447 | |
| Total Available for Sale Securities | | $ | 161,785 | | | $ | 33,050 | | | $ | 28,013 | |
| | | | | | | | | | | | | |
| Held To Maturity Securities | | | | | | | | | | | | |
| U.S. Treasury | | $ | - | | | $ | - | | | $ | - | |
| Municipal securities | | | - | | | | 984 | | | | 301 | |
| Mortgage backed | | | - | | | | 20,752 | | | | 5,506 | |
| Total Held to Maturity Securities | | $ | - | | | $ | 21,736 | | | $ | 5,807 | |
| | | | | | | | | | | | | |
| Equity securities | | $ | 3,946 | | | $ | 2,563 | | | $ | 2,958 | |
The following table shows the maturities for the securities portfolio at December 31, 2011 and 2010:
| Fair Value, Amortized Cost and Weighted Average Yield | |
| | | | | | | | | | | | | | |
| | Available for Sale | | Held to Maturity | |
| December 31, 2011 | Amortized Cost | | Fair Value | | WeightedAverage Yield | | Amortized Cost | | Fair Value | | | WeightedAverage Yield | |
| Maturing | | | | | | | | | | | | | |
| Less than 3 months | | $ | 255,000 | | | $ | 255,872 | | | | 4.37 | % | | $ | - | | | $ | - | | | | | |
| Over 3 months through 1 year | | | 1,004,229 | | | | 1,025,000 | | | | 4.25 | % | | | - | | | | - | | | | | |
| Over one to five years | | | 19,052,724 | | | | 19,138,115 | | | | 1.37 | % | | | - | | | | - | | | | | |
| Over five to ten years | | | 28,684,389 | | | | 29,502,002 | | | | 2.77 | % | | | - | | | | - | | | | | |
| Over ten years | | | 108,806,473 | | | | 111,863,846 | | | | 3.03 | % | | | - | | | | - | | | | | |
| | | $ | 157,802,815 | | | $ | 161,784,835 | | | | | | | $ | - | | | $ | - | | | | | |
| | | | | | | | | | | | | | | | | | | | | | | | | |
| Pledged Securities | | $ | 34,530,023 | | | $ | 35,550,747 | | | | | | | $ | - | | | $ | - | | | | | |
| | | Available for Sale | | | Held to Maturity | |
| December 31, 2010 | | Amortized Cost | | | Fair Value | | | WeightedAverage Yield | | | Amortized Cost | | | Fair Value | | | WeightedAverage Yield | |
| Maturing | | | | | | | | | | | | | | | | | | |
| Less than 3 months | | $ | - | | | $ | - | | | | | | $ | - | | | $ | - | | | | |
| Over 3 months through 1 year | | | 1,009,341 | | | | 1,041,750 | | | | 3.68 | % | | | - | | | | - | | | | |
| Over one to five years | | | 1,992,780 | | | | 2,078,874 | | | | 3.81 | % | | | 302,084 | | | | 305,385 | | | | 3.40 | % |
| Over five to ten years | | | 12,034,769 | | | | 12,202,523 | | | | 2.90 | % | | | 6,784,476 | | | | 7,005,706 | | | | 3.76 | % |
| Over ten years | | | 17,562,147 | | | | 17,726,648 | | | | 3.65 | % | | | 14,649,909 | | | | 14,654,490 | | | | 3.15 | % |
| | | $ | 32,599,037 | | | $ | 33,049,795 | | | | | | | $ | 21,736,469 | | | $ | 21,965,581 | | | | | |
| | | | | | | | | | | | | | | | | | | | | | | | | |
| Pledged Securities | | $ | - | | | $ | - | | | | | | | $ | - | | | $ | - | | | | | |
We have pledged U.S. government and municipal securities to customers who require collateral for overnight repurchase agreements and deposits. Contractual maturities of mortgage backed securities are not reliable indicators of their expected life because mortgage borrowers have the right to prepay mortgages at any time. Additionally, the issuer may call the callable agency securities listed above prior to the contractual maturity.
Pointer Ridge Office Investment, LLC
On November 17, 2008, we purchased Chesapeake Custom Homes, L.L.C.’s 12.50% membership interest in Pointer Ridge, a real estate investment limited liability company. As a result of this purchase, our membership interest increased from 50.00% to 62.50%. Consequently, we consolidated Pointer Ridge’s results of operations from the date of acquisition. Prior to the date of acquisition, we accounted for our investment in Pointer Ridge using the equity method. The following table summarizes the condensed Balance Sheets and Statements of Income for Pointer Ridge.
| Pointer Ridge Office Investment, LLC | | | | | | | | | |
| December 31, | | 2011 | | | 2010 | | | 2009 | |
| Balance Sheets | | | | | | | | | |
| Current assets | | $ | 429,611 | | | $ | 758,257 | | | $ | 891,233 | |
| Non-current assets | | | 7,088,001 | | | | 7,252,413 | | | | 7,432,268 | |
| Liabilities | | | 6,299,819 | | | | 6,397,360 | | | | 6,480,230 | |
| Equity | | | 1,217,793 | | | | 1,613,310 | | | | 1,843,271 | |
| | | | | | | | | | | | | |
| Statements of Income | | | | | | | | | | | | |
| Revenue | | $ | 765,044 | | | $ | 822,920 | | | $ | 1,239,137 | |
| Expenses | | | 1,160,562 | | | | 1,017,184 | | | | 1,006,563 | |
| Net income (loss) | | $ | (395,518 | ) | | $ | (194,264 | ) | | $ | 232,574 | |
We purchased Chesapeake Custom Homes, L.L.C.’s 12.50% membership interest at the book value which was equivalent to the fair value. Accordingly, we did not record any goodwill with this purchase.
We lease space for our headquarters office and branch location in the building owned by Pointer Ridge at 1525 Pointer Ridge Place, Bowie, Maryland. We eliminate these lease payments in consolidation. Frank Lucente, a director of Old Line Bancshares, Inc. and Old Line Bank, controls 12.50% of Pointer Ridge and controls the manager of Pointer Ridge.
Loan Portfolio
Loans secured by real estate comprise the majority of the loan portfolio. Old Line Bank’s loan customers are generally located in the greater Washington, D.C. metropolitan area.
The loan portfolio, net of allowance, unearned fees and origination costs, increased $239.7 million or 80.01% to $539.3 million at December 31, 2011 from $299.6 million at December 31, 2010. Commercial business loans increased by $23.6 million (28.26%), commercial real estate loans increased by $119.6 million (77.92%), residential real estate loans increased by $69.6 million (256.83%), real estate construction loans (primarily commercial real estate construction and acquisition and development) increased by $27.3 million (111.89%) and consumer loans increased by $594 thousand (4.54%) from their respective balances at December 31, 2010. During the twelve months ended December 31, 2011, we received scheduled loan payoffs on construction loans that negatively impacted our loan growth for the period. The $190.8 million of acquired loans were the primary cause of growth during the period although we also experienced an approximately $50.0 million growth in loans as a result of business development efforts. We saw loan and deposit growth generated from our entire team of lenders, branch personnel and board of directors. We anticipate the entire team along with the team from MB&T will continue to focus their efforts on business development in the future and continue to grow the loan portfolio. However, the current economic climate and the continued challenges associated with integrating MB&T into our organization may cause slower loan growth.
The loan portfolio, net of allowance, unearned fees and origination costs, increased $34.6 million or 13.06% to $299.6 million at December 31, 2010 from $265.0 million at December 31, 2009. Commercial business loans increased by $9.3 million (12.53%), commercial real estate loans increased by $29.5 million (23.79%), residential real estate loans (generally home equity and fixed rate home improvement loans) increased by $3.7 million (15.81%), real estate construction loans (primarily commercial real estate construction) decreased by $6.5 million (21.04%) and consumer loans decreased by $1.5 million (10.27%) from their respective balances at December 31, 2009.
During 2010, we received scheduled loan payoffs on construction loans that negatively impacted our loan growth for the period. In spite of these payoffs, we experienced a 13.06% growth in the loan portfolio. We saw loan and deposit growth generated from our entire team of lenders, branch personnel and board of directors.
The following table summarizes the composition of the loan portfolio by dollar amount and percentages:
| Loan Portfolio | |
| (Dollars in thousands) | |
| December 31, | | 2011 | | | 2010 | | | 2009 | |
| | | | | | | | | | | | | | | | | | | |
| Real Estate | | | | | | | | | | | | | | | | | | |
| Commercial | | $ | 273,101 | | | | 50.36 | % | | $ | 153,527 | | | | 50.91 | % | | $ | 124,002 | | | | 46.44 | % |
| Construction | | | 51,662 | | | | 9.53 | | | | 24,378 | | | | 8.08 | | | | 30,872 | | | | 11.56 | |
| Residential | | | 96,724 | | | | 17.84 | | | | 27,081 | | | | 8.98 | | | | 23,350 | | | | 8.74 | |
| Commercial | | | 107,126 | | | | 19.75 | | | | 83,523 | | | | 27.69 | | | | 74,175 | | | | 27.78 | |
| Consumer | | | 13,674 | | | | 2.52 | | | | 13,080 | | | | 4.34 | | | | 14,622 | | | | 5.48 | |
| | | | 542,287 | | | | 100.00 | % | | | 301,589 | | | | 100.00 | % | | | 267,021 | | | | 100.00 | % |
| Allowance for loan losses | | | (3,741 | ) | | | | | | | (2,469 | ) | | | | | | | (2,481 | ) | | | | |
| Deferred loan costs, net | | | 752 | | | | | | | | 486 | | | | | | | | 469 | | | | | |
| | | $ | 539,298 | | | | | | | $ | 299,606 | | | | | | | $ | 265,009 | | | | | |
The following table presents the maturities or re-pricing periods of selected loans outstanding at
December 31, 2011:
| | | Loan Maturity Distribution at December 31, 2011 | |
| | | 1 year or less | | | 1-5 years | | | After 5 years | | | Total | |
| | | (Dollars in thousands) | |
| Real Estate | | | | | | | | | | | | |
| Commercial | | $ | 54,642 | | | $ | 203,819 | | | $ | 14,640 | | | $ | 273,101 | |
| Construction | | | 26,650 | | | | 20,288 | | | | 4,724 | | | | 51,662 | |
| Residential | | | 34,505 | | | | 25,494 | | | | 36,725 | | | | 96,724 | |
| Commercial | | | 64,338 | | | | 40,714 | | | | 2,074 | | | | 107,126 | |
| Consumer | | | 2,107 | | | | 2,192 | | | | 9,375 | | | | 13,674 | |
| Total Loans | | $ | 182,242 | | | $ | 292,507 | | | $ | 67,538 | | | $ | 542,287 | |
| | | | | | | | | | | | | | | | | |
| Fixed Rates | | $ | 35,275 | | | $ | 72,024 | | | $ | 61,941 | | | $ | 169,240 | |
| Variable Rates | | | 146,967 | | | | 220,483 | | | | 5,597 | | | | 373,047 | |
| Total Loans | | $ | 182,242 | | | $ | 292,507 | | | $ | 67,538 | | | $ | 542,287 | |
Asset Quality
Management performs reviews of all delinquent loans and directs relationship officers to work with customers to resolve potential credit issues in a timely manner.
As outlined below, we have only two construction loans that have an interest reserve included in the commitment amount and where advances on the loan currently pay the interest due.
| Loans With Interest Paid From Loan Advances | |
| (Dollars in thousands) | |
| Years Ended December 31, | | 2011 | | | 2010 | |
| | | # of Borrowers | | | | | | # of Borrowers | | | | |
| Hotels | | 1 | | | $ | 2,093 | | | 1 | | | $ | 979 | |
| Single family acquisition & development | | 1 | | | | 1,418 | | | 1 | | | | 2,336 | |
| | | 2 | | | $ | 3,511 | | | 2 | | | $ | 3,315 | |
At inception, the total loan and commitment amount were equivalent to an appraised 80% or less “as is” or “as developed” loan to value. We continually monitor these loans and where appropriate have received new appraisals on these properties, additional collateral, a payment on the principal, or have downgraded the risk rating on the loan and increased our loan loss provision accordingly. In certain cases, these loans have experienced a delay in the project either as a result of delays in receiving regulatory approvals or the borrower has elected to delay the project because the current economic climate has caused real estate values to decline. Although payments on these loans are current, management monitors their performance closely.
At year end, in addition to the two non-accrual legacy loans and 17 non-accrual acquired loans, there were four legacy loans totaling $744,610 and 22 acquired loans totaling $839,274 that were 30-89 days past due, and one legacy loan past due 90 days or more in the amount of $34,370. Management has identified an additional 12 potential problem loans totaling $8.6 million. Management has concerns either about the ability of these borrowers to continue to comply with repayment terms because of the borrower’s potential operating or financial difficulties or the underlying collateral has experienced a decline in value. These weaknesses have caused management to heighten the attention given to these credits.
Management generally classifies loans as non-accrual when it does not expect collection of full principal and interest under the original terms of the loan or payment of principal or interest has become 90 days past due. Once we classify a loan as non-accrual we no longer accrue interest on such loan and reverse any interest previously accrued but not collected. We will generally restore a non-accrual loan to accrual status when the borrower brings delinquent principal and interest payments current and we expect to collect future monthly principal and interest payments. We recognize interest on non-accrual loans only when received.
As previously discussed in the provision for loan losses section of this report, at December 31, 2010, we had three loans totaling $2.7 million that were 90 days past due and were classified as non-accrual. This compares to three loans in the amount of $1.6 million at December 31, 2009 which were 90 days past due and were classified as non-accrual.
The table below outlines the transfer of loans from and to non-accrual status for twelve month period:
Non-Accrual Loans (Dollars in thousands) | |
| | | Legacy Loans | | | | | | Acquired Loans | | | Total | |
| | | # of Borrowers | | | Loan Balance | | | # of Borrowers | | | Loan Balance | | | Loan Balance | |
| | | | | | | | | | | | | | | | |
| Beginning Balance, December 31, 2010 | | 3 | | | $ | 2,711 | | | | | | $ | - | | | $ | 2,711 | |
| Acquired April 1, 2011 | | | | | | - | | | | 18 | | | | 5,357 | | | | 5,357 | |
| Transferred In | | 1 | | | | 78 | | | | 3 | | | | 395 | | | | 473.00 | |
| Payments received | | | | | | - | | | | (3 | ) | | | (1,119 | ) | | | (1,119 | ) |
| Repossessed | | (1 | ) | | | (237 | ) | | | | | | | - | | | | (237 | ) |
| Charged off | | | | | | (495 | ) | | | | | | | - | | | | (495 | ) |
| Transferred to other real estate owned | | (1 | ) | | | (810 | ) | | | (1 | ) | | | (50 | ) | | | (860 | ) |
| Ending balance, December 31, 2011 | | 2 | | | $ | 1,247 | | | | 17 | | | $ | 4,583 | | | $ | 5,830 | |
Non-Accrual Legacy Loans and Legacy Other Real Estate Owned
At December 31, 2011, two non-accrual legacy loans totaling $1,247,312 were past due and classified as non-accrual. The first loan in the amount of $1,169,337 is a residential land acquisition and development loan secured by real estate and described below. At December 31, 2011, the non-accrued interest on this loan was $212,484, none of which was included in interest income. The borrower and guarantor on this loan have filed bankruptcy. During the first quarter of 2011, we charged $446,980 to the allowance for loan losses and reduced the balance on this loan from $1,616,317 to $1,169,337. We have an additional $65,000 of the allowance for loan losses specifically allocated to this loan. We had identified a potential buyer for this note who had agreed to purchase it at a price slightly lower than the current carrying value. In October of 2011, the prospective purchaser of the promissory note rescinded his offer. In February 2012, the property that secures the promissory note was sold at foreclosure for an amount less than our carrying fair value. We anticipate ratification of the foreclosure will occur during the second quarter of 2012 and that we will receive approximately $966,000 from the sales proceeds and charge approximately $203,000 to the allowance for loan losses.
The second loan is a commercial loan secured by a blanket lien on the borrower’s assets and a second deed of trust on the guarantors’ personal residence. The borrower has ceased operations and the collateral has no value. In the first quarter of 2012, we charged the entire balance due to the allowance for loan losses and have filed a judgment against the guarantors. At December 31, 2011, we had allocated the entire loan balance to the allowance for loan losses.
At December 31, 2010, we had three loans totaling $2,710,619 past due and classified as non-accrual. The first loan in the amount of $810,291 is the same loan that we previously reported in our December 31, 2009 and December 31, 2008 financial statements. At December 31, 2010, we had obtained a “lift stay” on the property and were awaiting ratification of foreclosure. We received this ratification in January 2011 and transferred this property to other real estate owned. At December 31, 2010, the non-accrued interest on this loan was $212,937.
The second loan in the amount of $1,616,317 is the residential acquisition and development loan secured by real estate discussed above. At December 31, 2010, we considered this loan impaired and had allocated $450,000 of the allowance for loan losses to this loan. At December 31, 2010, the interest not accrued on this loan was $101,867.
The third loan at December 31, 2010 was a luxury boat loan in the amount of $284,011. The borrower on this loan has also filed bankruptcy. At December 31, 2010, the interest not accrued on this loan was $3,728. During the first quarter of 2011, we repossessed the boat, charged $47,261 to the allowance for loan losses and recorded the remaining balance of $236,750 as repossessed property in other assets. During the fourth quarter of 2011, we sold this boat and recorded a loss in other operating expense of $120,741 on the sale.
At December 31, 2009, we had three loans totaling $1,586,499 past due and classified as non-accrual. The first loan is the same loan that we reported in our December 31, 2008 financial statements. During 2009, we received $40,384 in payments on this loan and the balance was $810,291. In October 2009, the borrower re-entered bankruptcy under Chapter 11 of the United States Bankruptcy Code. As outlined above, in 2010, we obtained a “lift stay” on the commercial property that secures this loan and proceeded with foreclosure.
Non-Accrual Acquired Loans and Other Real Estate Owned
At December 31, 2011, we had 25 non-accrual acquired loans to 17 borrowers totaling $4.6 million. Of these, the borrowers on 14 loans totaling $2.4 million are generally making monthly payments according to their contractual terms, albeit in a slow manner. The loans were placed on non-accrual by MB&T because of their slow payment history and/or the borrower’s industry was significantly impacted by the weaknesses in the economy. One additional loan with a carrying balance of $100,000 was paid in full in July 2011. During the third quarter of 2011, we received payment in full on three notes for the total principal balance of $1.1 million and transferred the value of $50,000 for one property to other real estate owned. During the fourth quarter of 2011, we transferred three notes totaling $395,109 to non-accrual status.
We have two borrowers owned by the same individual and the fair value of four loans totals $775,000. We were unable to conclude negotiations with the individual to obtain additional collateral that was satisfactory to us and we have proceeded with foreclosure. Residential land secures these loans. The fair value is equivalent to our assessment of the current value of the real estate less any carrying costs or expenses to sell.
We have one borrower with one note secured by commercial real estate and the fair value of the loan is $300,000. The borrower recently exited from bankruptcy protection. We plan to foreclose on this property. The fair value is equivalent to our assessment of the current value of the real estate less any carrying costs or expenses to sell.
We have one borrower with a loan secured by real estate and the fair value of the loan is $250,000. The borrower has filed bankruptcy and we are currently working towards obtaining a “lift stay” on the property that secures the loan. The fair value is equivalent to our assessment of the current value of the real estate less any carrying costs or expenses to sell.
The first loan that we transferred in during the fourth quarter of 2011 is a loan secured by real estate and the fair value of the loan is $347,474. The borrower has filed bankruptcy and we are currently in negotiations with the guarantor and the borrower. The fair value is equivalent to our assessment of the current value of the real estate less any carrying costs or expenses to sell.
The second loan that we transferred in during the fourth quarter of 2011 is an unsecured loan and the fair value of the loan is $47,635. We consider this loan impaired and have allocated the entire balance of this loan in the allowance for loan losses.
We classify any property acquired as a result of foreclosure on a mortgage loan as “other real estate owned” and record it at the lower of the unpaid principal balance or fair value at the date of acquisition and subsequently carry the property at the lower of cost or net realizable value. We charge any required write down of the loan to its net realizable value against the allowance for loan losses at the time of foreclosure. We charge any subsequent adjustments to net realizable value to expense. Upon foreclosure, Old Line Bank generally requires an appraisal of the property and, thereafter, appraisals of the property on at least an annual basis and external inspections on at least a quarterly basis.
As required by ASC Topic 310-Receivables and ASC Topic 450-Contingencies, we measure all impaired loans, which consist of all modified loans and other loans for which collection of all contractual principal and interest is not probable, based on the present value of expected future cash flows discounted at the loan’s effective interest rate, or at the loan’s observable market price or the fair value of the collateral if the loan is collateral dependent. If the measure of the impaired loan is less than the recorded investment in the loan, we recognize impairment through a valuation allowance and corresponding provision for loan losses. Old Line Bank considers consumer loans as homogenous loans and thus does not apply the impairment test to these loans. We write off impaired loans when collection of the loan is doubtful.
The tables below present a breakdown of the recorded book balance of non-performing loans and accruing past due loans at December 31, 2011.
| Non-Accrual and Past Due Loans and Troubled Debt Restructurings | |
| Recorded Book Balance | |
December 31, 2011 | |
| | | Legacy | | | Acquired | |
| | | # of Borrowers | | | Account Balance | | | Interest Not Accrued | | | # of Borrowers | | | Account Balance | | | Interest Not Accrued | |
| Real Estate | | | | | | | | | | | | | | | | | | |
| Commercial | | | | | $ | - | | | $ | - | | | | 7 | | | $ | 2,288,900 | | | $ | 1,164,630 | |
| Construction | | | 1 | | | | 1,169,337 | | | | 212,484 | | | | 2 | | | | 1,184,146 | | | | 255,560 | |
| Residential | | | | | | | - | | | | - | | | | 4 | | | | 1,019,942 | | | | 241,093 | |
| Commercial | | | 1 | | | | 77,975 | | | | 1,735 | | | | 4 | | | | 90,039 | | | | 33,041 | |
| Consumer | | | | | | | - | | | | - | | | | | | | | - | | | | - | |
| Total non-performing loans | | | 2 | | | $ | 1,247,312 | | | $ | 214,219 | | | | 17 | | | $ | 4,583,027 | | | $ | 1,694,324 | |
| | | | | | | | | | | | | | | | | | | | | | | | | |
| Accruing past due loans: | | | | | | | | | | | | | | | | | | | | | | | | |
| 30-59 days past due | | | | | | | | | | | | | | | | | | | | | | | | |
| Real estate | | | 1 | | | | 421,805 | | | | | | | | 3 | | | | 474,651 | | | | | |
| Commercial | | | | | | | - | | | | | | | | | | | | - | | | | | |
| Consumer | | | | | | | - | | | | | | | | 16 | | | | 22,698 | | | | | |
| Total 30-59 days past due | | | 1 | | | | 421,805 | | | | | | | | 19 | | | | 497,349 | | | | | |
| 60-89 days past due | | | | | | | | | | | | | | | | | | | | | | | | |
| Real estate | | | 2 | | | | 311,762 | | | | | | | | 2 | | | | 338,431 | | | | | |
| Commercial | | | 1 | | | | 11,043 | | | | | | | | | | | | - | | | | | |
| Consumer | | | | | | | - | | | | | | | | 1 | | | | 3,494 | | | | | |
| Total 60-89 days past due | | | 3 | | | | 322,805 | | | | | | | | 3 | | | | 341,925 | | | | | |
| 90 or more days past due | | | | | | | | | | | | | | | | | | | | | | | | |
| Consumer | | | 1 | | | | 34,370 | | | | | | | | | | | | - | | | | | |
| Total accruing past due loans | | | 5 | | | | 778,980 | | | | | | | | 22 | | | | 839,274 | | | | | |
| | | | | | | | | | | | | | | | | | | | | | | | | |
| Accruing Troubled Debt Restructurings | | | | | | | | | | | | | | | | | | | | | | | | |
| Real Estate | | | 3 | | | $ | 5,037,879 | | | | | | | | | | | $ | - | | | | | |
| Consumer | | | 1 | | | | 142,671 | | | | | | | | 2 | | | | 154,088 | | | | | |
| Total Accruing Troubled Debt Restructurings | | | 4 | | | $ | 5,180,550 | | | | | | | | 2 | | | $ | 154,088 | | | | | |
The table below presents a breakdown of the non-performing legacy loans and accruing legacy past due loans at December 31, 2010.
| Legacy | |
Non-Accrual and Past Due Loans December 31, 2010 | |
| | | # of Borrowers | | | Account Balance | | | Interest Not Accrued | |
| Real Estate | | �� | | | | | | | |
| Commercial | | | 2 | | | $ | 2,426,608 | | | $ | 314,804 | |
| Construction | | | | | | | - | | | | - | |
| Residential | | | | | | | - | | | | - | |
| Commercial | | | | | | | - | | | | - | |
| Consumer | | | 1 | | | | 284,011 | | | | 3,728 | |
| Total non-performing loans | | | 3 | | | $ | 2,710,619 | | | $ | 318,532 | |
| | | | | | | | | | | | | |
| Accruing past due loans: | | | | | | | | | | | | |
| 30-89 days past due | | | | | | $ | - | | | | | |
| 90 or more days past due | | | | | | | - | | | | | |
| Total accruing past due loans | | | | | | $ | - | | | | | |
Bank owned life insurance
We have invested $16.4 million in life insurance policies on our executive officers, other officers of the Bank, and retired officers of MB&T. In June 2005, we purchased $3.3 million of BOLI on the lives of our executive officers, Messrs. Cornelsen and Burnett and Ms. Rush. With a new $4 million investment made in February 2007, we increased the insurance on Messrs. Cornelsen and Burnett and expanded the coverage of the insurance policies to insure the lives of several other officers of Old Line Bank, including Sandi F. Burnett. During the twelve months ended December 31, 2011, the cash surrender value of the insurance policies increased by $7.7 million as a result of the transfer of $7.5 million at fair value from MB&T and earnings which were partially offset by the payment of a death benefit that resulted from the loss of a colleague during the period. We anticipate the earnings on these policies will partially offset our employee benefit expenses as well as our obligations under our Salary Continuation Agreements and Supplemental Life Insurance Agreements that we entered into with our executive officers in January 2006 as well as those that MB&T had entered into with their executive officers. There is no obligation to provide post retirement death benefits associated with the BOLI policies owned by Old Line Bank prior to the acquisition of MB&T. We have accrued a $204,515 liability associated with the post retirement death benefits of the BOLI policies acquired from MB&T.
On January 3, 2006, Old Line Bank entered into Salary Continuation Agreements and Supplemental Life Insurance Agreements with Mr. Cornelsen, Mr. Burnett and Ms. Rush and started accruing for the related post retirement salary benefits. Under these agreements, benefits accrue over time from the date of the agreement until the executive reaches the age of 65. Upon full vesting of the benefit, the executives will be paid the following annual amounts for 15 years: Mr. Cornelsen $77,773; Mr. Burnett $24,651; Ms. Burnett $66,310; and Ms. Rush $77,773. Mr. Burnett will receive an additional $5,895 per year if he continues his employment with us until he reaches age 68. Under the Supplemental Life Insurance Agreements, Old Line Bank is obligated to cause the payment of death benefits to the executives’ designated beneficiaries in the following amounts: Mr. Cornelsen $1.4 million; Mr. Burnett $372,860; Ms. Burnett $335,309; Ms. Rush $764,425; and we have aggregate insurance on all other officers, retired officers of MB&T, and former employees totaling $32.2 million. Old Line Bank has funded these obligations through the BOLI outlined above.
Prepaid pension
MB&T had an employee pension plan (MB&T Pension Plan) that was frozen on June 9, 2003 and no additional benefits accrued subsequent to that date. We have notified all plan participants that we have terminated this plan effective August 1, 2011. We have liquidated the securities the plan held, deposited the proceeds into interest bearing certificates of deposit and a money market account and expect to distribute the remaining balances prior to December 31, 2012. We are unable to predict any income or loss that may occur as a result of the termination. At this time we do not expect to incur any significant expenses with the termination of this plan. At December 31, 2011, the plan had excess assets over liabilities of $1.0 million and we have recorded this amount as an asset on our balance sheet. Additional information related to the status of this plan can be found in Note 15 of the financial statements.
Other real estate owned
As a result of the acquisition of Maryland Bankcorp, we have segmented the other real estate owned into two components, real estate obtained as a result of loans originated by Old Line Bank (legacy) and other real estate acquired from MB&T or obtained as a result of loans originated by MB&T (acquired). We are currently aggressively either marketing these properties for sale or improving them in preparation for sale. During the twelve months ended December 31, 2011, we sold three properties and recorded gains on these sales of $248,005. The following outlines the transactions in other real estate owned during the period (000’s).
| Other Real Estate Owned | |
| | | Legacy | | | Acquired | | | Total | |
| Beginning balance | | $ | 1,153,039 | | | $ | - | | | $ | 1,153,039 | |
| Acquired April 1, 2011 | | | - | | | | 1,834,451 | | | | 1,834,451 | |
| Transferred in | | | 825,290 | | | | 289,000 | | | | 1,114,290 | |
| Investment in improvements | | | - | | | | 88,965 | | | | 88,965 | |
| Write down in value | | | (100,000 | ) | | | | | | | (100,000 | ) |
| Sales | | | (6,497 | ) | | | (79,639 | ) | | | (86,136 | ) |
| Total end of period | | $ | 1,871,832 | | | $ | 2,132,777 | | | $ | 4,004,609 | |
Goodwill
During the second quarter of 2011, we recorded goodwill of $116,723 associated with the acquisition of Maryland Bankcorp. As outlined in Footnote 2 of our financial statements, this amount represented the difference between the estimated fair value of tangible and intangible assets acquired and liabilities assumed at acquisition date. During the third quarter of 2011, the goodwill increased $25,000 as a result of additional liabilities that we identified during the period. During the fourth quarter of 2011, we receive a valuation of the pension plan asset at acquisition date and at December 31, 2011. As a result of this valuation, we recorded a $492,067 increase to goodwill to reflect the costs incurred by the pension plan as of the acquisition date.
Core deposit intangible
As a result of the acquisition of Maryland Bankcorp, during the second quarter of 2011, we recorded a core deposit intangible of $5.0 million. This amount represented the premium that we paid to acquire MB&T’s core deposits over the fair value of such deposits. We will amortize the core deposit intangible on an accelerated basis over its estimated useful life of 18 years. At December 31, 2011, the core deposit intangible was $4.4 million.
Deposits
We seek deposits within our market area by paying competitive interest rates, offering high quality customer service and using technology to deliver deposit services effectively.
At December 31, 2011, the deposit portfolio had grown to $690.8 million, a $350.3 million or 102.88% increase over the December 31, 2010 level of $340.5 million. Non-interest bearing deposits increased $102.6 million during the period to $170.1 million from $67.5 million primarily due to the acquisition of MB&T, the establishment of new customer demand deposit accounts and expansion of existing demand deposit accounts. Interest-bearing deposits grew $247.6 million to $520.6 million from $273.0 million. The growth in interest bearing deposits was the result of the acquisition of MB&T, expansion of existing customer relationships and new customers. The following table outlines the growth in interest bearing deposits:
| December 31, | | 2011 | | | 2010 | | | $ Change | | | % Change | |
| | | (Dollars in thousands) | |
| Certificates of deposit | | $ | 336,068 | | | $ | 192,530 | | | $ | 143,538 | | | | 74.55 | % |
| Interest bearing checking | | | 123,907 | | | | 70,998 | | | | 52,909 | | | | 74.52 | % |
| Savings | | | 60,654 | | | | 9,504 | | | | 51,150 | | | | 538.19 | % |
| Total | | $ | 520,629 | | | $ | 273,032 | | | $ | 247,597 | | | | 90.68 | % |
At December 31, 2010, the deposit portfolio had grown to $340.5 million, a $54.2 million or an 18.93% increase over the December 31, 2009 level of $286.3 million. Non-interest bearing deposits increased $26.6 million during the period to $67.5 million from $40.9 million primarily due to the establishment of new customer demand deposit accounts and expansion of existing demand deposit accounts. Interest bearing deposits grew $27.5 million to $273.0 million from $245.5 million. Approximately $27.5 million of the increase was in money market accounts and $1.9 million was in savings accounts. These increases were offset by a $1.9 million decrease in certificates of deposit. The growth in these categories was the result of expansion of existing customer relationships, the new money market accounts provided through Promontory Interfinancial Network discussed below and new customers.
We acquire brokered certificate of deposits through the Promontory Interfinancial Network (Promontory). Through this deposit matching network and its certificate of deposit account registry service (CDARS) and money market account service, we have the ability to offer our customers access to FDIC insured deposit products in aggregate amounts exceeding current insurance limits. When we place funds through Promontory on behalf of a customer, we receive matching deposits through the network’s reciprocal deposit program. We can also place deposits through this network without receiving matching deposits. At December 31, 2011, we had $24.8 million in CDARS and $14.1 million in money market accounts through Promontory’s reciprocal deposit program compared to $21.1 million and $5.7 million, respectively, at December 31, 2010. At December 31, 2011, we had received $52.0 million in deposits through the Promontory network that were not reciprocal deposits. We had no other brokered certificates of deposit as of December 31, 2011 and 2010. We expect that we will continue to use brokered deposits as an element of our funding strategy when required to maintain an acceptable loan to deposit ratio.
The following is a summary of the maturity distribution of certificates of deposit as of December 31, 2011.
| | | Certificate of Deposit Maturity Distribution | |
| | | December 31, 2011 | |
| | | Three Months or Less | | | Three Months to Twelve Months | | | Over Twelve Months | | | Total | |
| | | (Dollars in thousands) | |
| Certificates of deposit | | | | | | | | | | | | |
| Less than $100,000 | | $ | 17,102 | | | $ | 52,847 | | | $ | 60,529 | | | $ | 130,478 | |
| Greater than or equal to $100,000 | | | 76,698 | | | | 71,665 | | | | 57,228 | | | | 205,591 | |
| Total | | $ | 93,800 | | | $ | 124,512 | | | $ | 117,757 | | | $ | 336,069 | |
Borrowings
Old Line Bancshares has available a $3 million unsecured line of credit. Old Line Bank has available lines of credit, including overnight federal funds and repurchase agreements from its correspondent banks totaling $29.5 million as of December 31, 2011. Old Line Bank has an additional secured line of credit from the Federal Home Loan Bank of Atlanta (FHLB) of $241.1 million at December 31, 2011. As a condition of obtaining the line of credit from the FHLB, the FHLB requires that Old Line Bank purchase shares of capital stock in the FHLB. Prior to allowing Old Line Bank to borrow under the line of credit, the FHLB also requires that Old Line Bank provide collateral to support borrowings. Therefore, we have provided collateral to support up to $72.3 million of borrowings. Of this, we had borrowed $10 million at December 31, 2011. We may increase availability by providing additional collateral.
Short-term borrowings consisted of short-term promissory notes issued to Old Line Bank’s customers. Old Line Bank offers its commercial customers an enhancement to the basic non-interest bearing demand deposit account. This service electronically sweeps excess funds from the customer’s account into a short term promissory note with Old Line Bank. These obligations are payable on demand, are secured by investments or are unsecured, re-price daily and have maturities of one to 270 days. At December 31, 2011, Old Line Bank had $7.7 million outstanding in these short term unsecured promissory notes with an average interest rate of 0.20% and $20.9 million outstanding in secured promissory notes with an average interest rate of 0.50%. We recorded these secured promissory notes with the acquisition of MB&T. At December 31, 2010, Old Line Bank had $5.7 million outstanding with an average interest rate of 0.50%.
At December 31, 2011 and December 31, 2010, Old Line Bank had two advances in the amount of $5.0 million each, from the FHLB totaling $10.0 million.
On December 12, 2007, Old Line Bank borrowed $5.0 million from the FHLB. The interest rate on this advance is 3.3575% and interest is payable on the 12th day of each March, June, September and December, commencing on March 12, 2008. On December 12, 2008, or any interest payment date thereafter, the FHLB has the option to convert the interest rate on this advance to a fixed rate three (3) month LIBOR. The maturity date on this advance is December 12, 2012.
On December 19, 2007, Old Line Bank borrowed an additional $5.0 million from the FHLB. The interest rate on this borrowing is 3.119% and is payable on the 19th day of each month. On January 22, 2008 or any interest payment date thereafter, the FHLB has the option to convert the interest rate on this advance from a fixed rate to a one (1) month LIBOR based variable rate. This borrowing matures on December 19, 2012.
The following table outlines our borrowings as of December 31, 2011 and December 31, 2010.
| Borrowings | |
| December 31, | | 2011 | | | 2010 | |
| | | Amount | | | Rate | | | Maximum Amount Borrowed During Any Month End Period | | | Amount | | | Rate | | | Maximum Amount Borrowed During Any Month End Period | |
| Short term promissory notes | | $ | 7,784,561 | | | | 0.30 | % | | $ | 12,271,568 | | | $ | 5,669,332 | | | | 0.50 | % | | $ | 28,790,253 | |
| Repurchase agreements | | | 20,888,096 | | | | 0.50 | % | | | 22,979,870 | | | | - | | | | | | | | - | |
| FHLB advance due Dec. 2012 | | | 5,000,000 | | | | 3.36 | % | | | 5,000,000 | | | | - | | | | | | | | - | |
| FHLB advance due Dec. 2012 | | | 5,000,000 | | | | 3.12 | % | | | 5,000,000 | | | | - | | | | | | | | - | |
| Total short term borrowings | | | 38,672,657 | | | | | | | | 45,251,438 | | | | 5,669,332 | | | | | | | | 28,790,253 | |
| | | | | | | | | | | | | | | | | | | | | | | | | |
| FHLB advance due Dec. 2012 | | | - | | | | | | | | | | | | 5,000,000 | | | | 3.36 | % | | | | |
| FHLB advance due Dec. 2012 | | | - | | | | | | | | | | | | 5,000,000 | | | | 3.12 | % | | | | |
| Senior note, fixed at 6.28% | | | 6,284,479 | | | | 6.28 | % | | | | | | | 6,371,947 | | | | 6.28 | % | | | | |
| Total long term borrowings | | $ | 6,284,479 | | | | | | | | | | | $ | 16,371,947 | | | | | | | | | |
On August 25, 2006, Pointer Ridge entered into an Amended and Restated Promissory Note in the principal amount of $6.6 million. This loan accrues interest at a rate of 6.28% through September 5, 2016. After September 5, 2016, the rate adjusts to the greater of (i) 6.28% plus 200 basis points or (ii) the Treasury Rate (as defined in the Amended Promissory Note) plus 200 basis points. At December 31, 2011 and 2010, Pointer Ridge had borrowed $6.3 million and $6.5 million, respectively, under the Amended Promissory Note. We have guaranteed to the lender payment of up to 62.50% of the loan payment plus any costs the lender incurs resulting from any omissions or alleged acts or omissions by Pointer Ridge arising out of or relating to misapplication or misappropriation of money, rents received after an event of default, waste or damage to the property, failure to maintain insurance, fraud or material misrepresentation, filing of bankruptcy or Pointer Ridge’s failure to maintain its status as a single purpose entity.
For additional information about our borrowings, see Notes 11 and 12 to our consolidated financial statements.
Liquidity
Our overall asset/liability strategy takes into account our need to maintain adequate liquidity to fund asset growth and deposit runoff. Our management monitors the liquidity position daily in conjunction with Federal Reserve guidelines. As outlined in the borrowing section of this report, we have credit lines, unsecured and secured, available from several correspondent banks totaling $32.5 million. Additionally, we may borrow funds from the FHLB and the Federal Reserve Bank of Richmond. We can use these credit facilities in conjunction with the normal deposit strategies, which include pricing changes to increase deposits as necessary. We can also sell available for sale investment securities or pledge investment securities as collateral to create additional liquidity. From time to time we may sell or participate out loans to create additional liquidity as required. Additional sources of liquidity include funds held in time deposits and cash from the investment and loan portfolios.
Our immediate sources of liquidity are cash and due from banks, federal funds sold and time deposits in other banks. On December 31, 2011, we had $43.4 million in cash and due from banks, $119,235 in interest bearing accounts, and $83,114 in federal funds sold. As of December 31, 2010, we had $14.3 million in cash and due from banks, $109,170 in interest bearing accounts, $180,536 in federal funds sold and other overnight investments and $297,000 in time deposits in other banks.
Old Line Bank has sufficient liquidity to meet its loan commitments as well as fluctuations in deposits. We usually retain maturing certificates of deposit as we offer competitive rates on certificates of deposit. Management is not aware of any demands, trends, commitments, or events that would result in Old Line Bank’s inability to meet anticipated or unexpected liquidity needs.
During the recent period of turmoil in the financial markets, some institutions experienced large deposit withdrawals that caused liquidity problems. We did not have any significant withdrawals of deposits or any liquidity issues. Although we plan for various liquidity scenarios, if turmoil in the financial markets occurs and our depositors lose confidence in us, we could experience liquidity issues.
Capital
Our stockholders’ equity amounted to $68.5 million at December 31, 2011 and $37.7 million at December 31, 2010. We are considered “well capitalized” under the risk-based capital guidelines adopted by the Federal Reserve. Stockholders’ equity increased during the twelve month period primarily because of the capital received in the acquisition of Maryland Bankcorp of $17.8 million, the $6.3 million in capital received in the private placement in January of 2011, net income attributable to Old Line Bancshares, Inc. of $5.4 million, the $132,661 adjustment for stock based compensation awards, the $40,788 received from stock options exercised and the $2.1 million after tax unrealized gain on available for sale securities. These items were partially offset by the $821,497 common stock cash dividend and the $22,340 unrealized loss on the pension fund.
The following table shows Old Line Bancshares, Inc.’s regulatory capital ratios and the minimum capital ratios currently required by its banking regulator to be “well capitalized.” For a discussion of these capital requirements, see “Supervision and Regulation – Capital Adequacy Guidelines.”
| Risk Based Capital Analysis | | | |
| (Dollars in thousands) | | | |
| | | | | | | | | | | | |
| December 31, | | 2011 | | | 2010 | | | 2009 | | | |
| | | | | | | | | | | | |
| Tier 1 Capital | | | | | | | | | | | �� |
| Preferred and common stock | | $ | 68 | | | $ | 39 | | | $ | 39 | | | |
| Additional paid-in capital | | | 53,489 | | | | 29,207 | | | | 29,034 | | | |
| Retained earnings | | | 12,094 | | | | 7,535 | | | | 6,498 | | | |
| Less: disallowed assets | | | 5,054 | | | | - | | | | - | | | |
| Total Tier 1 Capital | | | 60,597 | | | | 36,781 | | | | 35,571 | | | |
| | | | | | | | | | | | | | | |
| Tier 2 Capital: | | | | | | | | | | | | | | |
| Allowance for loan losses | | | 3,741 | | | | 2,468 | | | | 2,482 | | | |
| Total Risk Based Capital | | $ | 64,338 | | | $ | 39,249 | | | $ | 38,053 | | | |
| | | | | | | | | | | | | | | |
| Risk weighted assets | | $ | 571,434 | | | $ | 317,029 | | | $ | 277,989 | | | |
| | | | | | | | | | | | | | | |
| | | | | | | | | | | | | | Regulatory Minimum | To be Well Capitalized |
| Capital Ratios: | | | | | | | | | | | | | | |
| Tier 1 risk based capital ratio | | | 10.6 | % | | | 11.6 | % | | | 12.8 | % | 4.0% | 6.0% |
| Total risk based capital ratio | | | 11.3 | % | | | 12.4 | % | | | 13.7 | % | 8.0% | 10.0% |
| Leverage ratio | | | 7.8 | % | | | 9.2 | % | | | 10.0 | % | 4.0% | 5.0% |
Return on Average Assets and Average Equity
The ratio of net income to average equity and average assets and certain other ratios are as follows:
| | | December 31, | |
| | | 2011 | | | 2010 | | | 2009 | |
| | | (Dollars in thousands) | |
| | | | | | | | | | |
| Average total assets | | $ | 677,529 | | | $ | 394,022 | | | $ | 341,973 | |
| | | | | | | | | | | | | |
| Average equity | | | 57,422 | | | | 36,329 | | | | 39,010 | |
| | | | | | | | | | | | | |
| Net income attributable to Old Line Bancshares, Inc. | | | 5,380 | | | | 1,503 | | | | 2,036 | |
| | | | | | | | | | | | | |
| Cash dividends declared-common stock | | | 821 | | | | 466 | | | | 463 | |
| | | | | | | | | | | | | |
| Dividend payout ratio for period | | | 15.27 | % | | | 31.00 | % | | | 22.74 | % |
| | | | | | | | | | | | | |
| Return on average assets | | | 0.79 | % | | | 0.38 | % | | | 0.60 | % |
| | | | | | | | | | | | | |
| Return on average equity | | | 9.37 | % | | | 4.14 | % | | | 5.22 | % |
| | | | | | | | | | | | | |
| Average stockholders’ equity to | | | | | | | | | | | | |
| average total assets | | | 8.48 | % | | | 9.22 | % | | | 11.41 | % |
Contractual Obligations, Commitments, Contingent Liabilities, and Off-balance Sheet Arrangements
We are party to financial instruments with off balance sheet risk in the normal course of business. These financial instruments primarily include commitments to extend credit, lines of credit and standby letters of credit. We use these financial instruments to meet the financing needs of our customers. These financial instruments involve, to varying degrees, elements of credit, interest rate, and liquidity risk. These do not represent unusual risks and management does not anticipate any losses which would have a material effect on Old Line Bancshares, Inc. We also have operating lease obligations.
Outstanding loan commitments and lines and letters of credit at December 31 of 2011, 2010 and 2009 are as follows:
| December 31, | | 2011 | | | 2010 | | | 2009 | |
| | | (Dollars in thousands) | |
| | | | | | | | | | |
| Commitments to extend credit and available credit lines: | | | | | | | | | |
| Commercial | | $ | 46,966 | | | $ | 34,485 | | | $ | 21,153 | |
| Construction | | | 21,398 | | | | 11,512 | | | | 14,573 | |
| Consumer | | | 13,195 | | | | 7,256 | | | | 9,015 | |
| | | $ | 81,559 | | | $ | 53,253 | | | $ | 44,741 | |
| | | | | | | | | | | | | |
| Standby letters of credit | | $ | 8,226 | | | $ | 7,901 | | | $ | 3,883 | |
Commitments to extend credit are agreements to lend to a customer as long as there is no violation of any condition established in the contract. We generally require collateral to support financial instruments with credit risk on the same basis as we do for balance sheet instruments. Management generally bases the collateral required on the credit evaluation of the counter party. Commitments generally include expiration dates or other termination clauses and may require payment of a fee. Available credit lines represent the unused portion of lines of credit previously extended and available to the customer so long as there is no violation of any contractual condition. These lines generally have variable interest rates. Since we expect many of the commitments to expire without being drawn upon, and since it is unlikely that customers will draw upon their lines of credit in full at any time, the total commitment amount or line of credit amount does not necessarily represent future cash requirements. We evaluate each customer's credit worthiness on a case by case basis. During periods of economic turmoil, we reevaluate many of our commitments to extend credit. Because we conservatively underwrite these facilities at inception, we generally do not have to withdraw any commitments. We are not aware of any loss that we would incur by funding our commitments or lines of credit.
Commitments for real estate development and construction, which totaled $21.4 million, or 26.23% of the $81.6 million, are generally short term and turn over rapidly, with principal repayment from permanent financing arrangements upon completion of construction or from sales of the properties financed.
Standby letters of credit are conditional commitments issued to guarantee the performance of a customer to a third party. Our exposure to credit loss in the event of non-performance by the customer is the contract amount of the commitment. The credit risk involved in issuing letters of credit is essentially the same as that involved in extending loan facilities to customers. In general, we make loan commitments, credit lines and letters of credit on the same terms, including with respect to collateral, as outstanding loans. We evaluate each customer's credit worthiness and the collateral required on a case by case basis.
We have various financial obligations, including contractual obligations and commitments. The following table presents, as of December 31, 2011 significant fixed and determinable contractual obligations to third parties by payment date.
| Contractual Obligations | |
| (Dollars in thousands) | |
| | | | | | | | | | | | | | | | |
| | | Within one year | | | One to three years | | | Three to five years | | | Over five years | | | Total | |
| | | | | | | | | | | | | | | | |
| Non-interest bearing deposits | | $ | 170,138 | | | $ | - | | | $ | - | | | $ | - | | | $ | 170,138 | |
| Interest bearing deposits | | | 382,655 | | | | 122,435 | | | | 15,539 | | | | - | | | | 520,629 | |
| Short term borrowings | | | 38,673 | | | | - | | | | - | | | | - | | | | 38,673 | |
| Long term borrowings | | | 94 | | | | 208 | | | | 5,982 | | | | - | | | | 6,284 | |
| Purchase obligations | | | 2,807 | | | | 2,095 | | | | 1,947 | | | | 5,842 | | | | 12,691 | |
| Operating leases | | | 1,372 | | | | 2,510 | | | | 2,491 | | | | 10,365 | | | | 16,738 | |
| Total | | $ | 595,739 | | | $ | 127,248 | | | $ | 25,959 | | | $ | 16,207 | | | $ | 765,153 | |
Our operating lease obligations represent rental payments for thirteen branches, four loan production offices and our main office. We lease our main office and our Bowie branch location from Pointer Ridge. We have excluded 62.50% of these lease payments in consolidation. The interest bearing obligations include accrued interest. Purchase obligations amounts represent estimated obligations under agreements to purchase goods or services that are enforceable and legally binding. In 2012, the purchase obligations amounts include principal and interest due on participation loans, estimated obligations under data processing contracts, income tax payable and accounts payable for goods and services. In subsequent years, the purchase obligations amounts primarily relate to estimated obligations under data processing contracts.
Reconciliation of Non-GAAP Measures
Below is a reconciliation of the FTE adjustments and the GAAP basis information presented in this report:
Twelve months ended December 31, 2011
| | | Net Interest Income | | | Yield | | | Net Interest Spread | |
| GAAP net interest income | | $ | 27,101,342 | | | | 4.52 | % | | | 4.31 | % |
| Tax equivalent adjustment | | | | | | | | | | | | |
| Federal funds sold | | | 1 | | | | - | | | | - | |
| Investment securities | | | 377,848 | | | | 0.06 | | | | 0.06 | |
| Loans | | | 170,830 | | | | 0.03 | | | | 0.03 | |
| Total tax equivalent adjustment | | | 548,679 | | | | 0.09 | | | | 0.09 | |
| Tax equivalent interest yield | | $ | 27,650,021 | | | | 4.61 | % | | | 4.40 | % |
Twelve months ended December 31, 2010
| | | Net Interest Income | | | Yield | | | Net Interest Spread | |
| GAAP net interest income | | $ | 13,566,068 | | | | 3.82 | % | | | 3.57 | % |
| Tax equivalent adjustment | | | | | | | | | | | | |
| Federal funds sold | | | 3 | | | | - | | | | - | |
| Investment securities | | | 47,642 | | | | 0.01 | | | | 0.01 | |
| Loans | | | 112,797 | | | | 0.03 | | | | 0.03 | |
| Total tax equivalent adjustment | | | 160,442 | | | | 0.04 | | | | 0.04 | |
| Tax equivalent interest yield | | $ | 13,726,510 | | | | 3.86 | % | | | 3.61 | % |
Twelve months ended December 31, 2009
| | | Net Interest Income | | | Yield | | | Net Interest Spread | |
| GAAP net interest income | | $ | 11,516,002 | | | | 3.73 | % | | | 3.39 | % |
| Tax equivalent adjustment | | | | | | | | | | | | |
| Federal funds sold | | | 1 | | | | | | | | | |
| Investment securities | | | 59,779 | | | | 0.02 | | | | 0.02 | |
| Loans | | | 66,590 | | | | 0.02 | | | | 0.02 | |
| Total tax equivalent adjustment | | | 126,370 | | | | 0.04 | | | | 0.04 | |
| Tax equivalent interest yield | | $ | 11,642,372 | | | | 3.77 | % | | | 3.43 | % |
Impact of Inflation and Changing Prices and Seasonality
Management has prepared the financial statements and related data presented herein in accordance with generally accepted accounting principles which require the measurement of financial position and operating results in terms of historical dollars, without considering changes in the relative purchasing power of money over time due to inflation.
Unlike industrial companies, virtually all the assets and liabilities of a financial institution are monetary in nature. As a result, interest rates have a more significant impact on a financial institution’s performance than the effects of general levels of inflation. Interest rates do not necessarily move in the same direction or in the same magnitude as the price of goods and services, and may frequently reflect government policy initiatives or economic factors not measured by price index. As discussed in Item 7A, we strive to manage our interest sensitive assets and liabilities in order to offset the effects of rate changes and inflation.
Application of Critical Accounting Policies
We prepare our financial statements in accordance with accounting principles generally accepted in the United States of America and follow general practices within the industry in which we operate. Application of these principles requires management to make estimates, assumptions, and judgments that affect the amounts reported in the financial statements and accompanying notes. We base these estimates, assumptions, and judgments 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.
The most significant accounting policies that we follow are presented in Note 1 to the consolidated financial statements. These policies, along with the disclosures presented in the other financial statement notes and in this financial review, provide information on how we value significant assets and liabilities in the financial statements and how we determine those values. Based on the valuation techniques used and the sensitivity of financial statement amounts to the methods, assumptions, and estimates underlying those amounts, management has identified the determination of the allowance for loan losses as the accounting area that requires the most subjective or complex judgments, and as such could be most subject to revision as new information becomes available.
The allowance for loan losses represents management’s best estimate of the losses known and inherent in the loan portfolio that are both probable and reasonable to estimate, based on, among other factors, prior loss experience, volume and type of lending conducted, estimated value of any underlying collateral, economic conditions (particularly as such conditions relate to Old Line Bank’s market area), regulatory guidance, peer statistics, management’s judgment, past due loans in the loan portfolio, loan charge off experience and concentrations of risk (if any). Determining the amount of the allowance for loan losses is considered a critical accounting estimate because it requires significant estimates, assumptions, and judgments. The loan portfolio also represents the largest asset type on the consolidated balance sheets.
We evaluate the adequacy of the allowance for loan losses based upon loan categories except for delinquent loans and loans for which management has knowledge about possible credit problems of the borrower or knowledge of problems with loan collateral, which management evaluates separately and assigns loss amounts based upon the evaluation. We apply loss ratios to each category of loan other than commercial loans (including letters of credit and unused commitments), where we further divide the loans by risk rating and apply loss ratios by risk rating, to determine estimated loss amounts. Categories of loans are installment and other consumer loans (other than boat loans), boat loans, mortgage loans (commercial real estate, residential real estate and real estate construction) and commercial loans.
Management has significant discretion in making the judgments inherent in the determination of the provision and allowance for loan losses, including in connection with the valuation of collateral and the financial condition of the borrower, and in establishing loss ratios and risk ratings. The establishment of allowance factors is a continuing exercise and allowance factors may change over time, 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 or in management’s interpretation of those factors will have a direct impact on the amount of the provision, and a corresponding effect on income and assets. Also, errors in management’s perception and assessment of the allowance factors could result in the allowance not being adequate to cover losses in the portfolio, and may result in additional provisions or charge offs, which would adversely affect income and capital. For additional information regarding the allowance for loan losses, see the “Provision for Loan Losses” section of this annual report.
New Authoritative Accounting Guidance
Accounting Standards Updates (ASU) No. 2009-16, “Transfers and Servicing (Topic- 860)-Accounting for Transfers of Financial Assets” amends prior accounting guidance to enhance reporting about transfers of financial assets, including securitizations, and where companies have continuing exposure to the risks related to transferred financial assets. ASU 2009-16 also requires additional disclosures about all continuing involvement with transferred financial assets including information about gains and losses resulting from transfers during the period. The provisions of ASU 2009-16 became effective on January 1, 2010 and did not have a significant impact on our consolidated results of operations or financial position.
ASU No. 2009-17, “Consolidations (Topic 810)-Improvements to Financial Reporting by Enterprises Involved with Variable Interest Entities” amends prior guidance to change how a company determines when an entity that is sufficiently capitalized or is not controlled through voting (or similar rights) should be consolidated. The determination of whether a company is required to consolidate an entity is based on, among other things, an entity’s purpose and design and a company’s ability to direct the activities of the entity that most significantly impact the entity’s economic performance. ASU 2009-17 requires additional disclosures about the reporting entity’s involvement with variable interest entities and any significant changes in risk exposure due to that involvement as well as its affect on the entity’s financial statements. As further discussed below, ASU No. 2010-10, “Consolidations (Topic 810),” deferred the effective date of ASU 2009-17 for a reporting entity’s interests in investment companies. The provisions of ASU 2009-17 became effective on January 1, 2010 and they did not have a material impact on our consolidated results of operations or financial position.
ASU No. 2010-06, “Fair Value Measurements and Disclosures (Topic 820)-Improving Disclosures About Fair Value Measurements” requires expanded disclosures related to fair value measurements including (i) the amounts of significant transfers of assets or liabilities between Levels 1 and 2 of the fair value hierarchy and the reasons for the transfers, (ii) the reasons for transfers of assets or liabilities in or out of Level 3 of the fair value hierarchy, with significant transfers disclosed separately, (iii) the policy for determining when transfers between the levels of the fair value hierarchy are recognized and (iv) for recurring fair value measurements of assets and liabilities in Level 3 of the fair value hierarchy, a gross presentation of information about purchases, sales, issuances and settlements. ASU 2010-06 further clarifies that (i) companies should provide fair value measurement disclosures for each class of assets and liabilities (rather than major category), which would generally be a subset of assets or liabilities within a line item in the statement of financial position and (ii) companies should provide disclosures about the valuation techniques and inputs used to measure fair value for both recurring and non-recurring fair value measurements for each class of assets and liabilities included in Levels 2 and 3 of the fair value hierarchy. ASU No. 2010-06 requires the disclosures related to the gross presentation of purchases, sales, issuances and settlements of assets and liabilities included in Level 3 of the fair value hierarchy beginning January 1, 2011. The remaining disclosure requirements and clarifications made by ASU 2010-06 became effective on January 1, 2010. See Notes 2-Acquisition of Maryland Bankcorp, Inc. and 18-Fair Value Measures, to our consolidated financial statements.
ASU No. 2010-10, “Consolidations (Topic 810)-Amendments for Certain Investment Funds” defers the effective date of the amendments to the consolidation requirements made by ASU 2009-17 to a company’s interest in an entity (i) that has all of the attributes of an investment company, as specified under ASC Topic 946, “Financial Services-Investment Companies,” or (ii) for which it is industry practice to apply measurement principles of financial reporting that are consistent with those in ASC Topic 946. As a result of the deferral, companies are not required to apply the ASU 2009-17 amendments to the Subtopic 810-10 consolidation requirements to its interest in an entity that meets the criteria to qualify for the deferral. ASU 2010-10 also clarifies that any interest held by a related party should be treated as though it is an entity’s own interest when evaluating the criteria for determining whether such interest represents a variable interest. ASU 2010-10 also clarifies that companies should not use a quantitative calculation as the sole basis for evaluating whether a decision maker’s or service provider’s fee is variable interest. The provisions of ASU 2010-10 became effective as of January 1, 2010 and did not have a material impact on our consolidated results of operations or financial position.
ASU No. 2010-11, “Derivatives and Hedging (Topic 815)-Scope Exception Related to Embedded Credit Derivatives” clarifies that the only form of an embedded credit derivative that is exempt from the embedded derivative bifurcation requirement are those that relate to the subordination of one financial instrument to another. Entities that have contracts containing an embedded credit derivative feature in a form other than subordination may need to separately account for the embedded credit derivative feature. The provisions of ASU 2010-11 became effective on July 1, 2010 and did not have a material impact on our consolidated results of operations or financial position.
ASU No. 2010-20 “Receivables (Topic 310)-Disclosures about the Credit Quality of Financing Receivables and the Allowance for Credit Losses” requires entities to provide disclosures designed to facilitate financial statement users’ evaluation of (i) the nature of credit risk inherent in the entity’s portfolio of financing receivables, (ii) how that risk is analyzed and assessed in arriving at the allowance for credit losses and (iii) the changes and reasons for those changes in the allowance for credit losses. Disclosures must be disaggregated by portfolio segment, the level at which an entity develops and documents a systemic method for determining its allowance for credit losses, and class of financing receivable, which is generally a disaggregation of portfolio segment. The required disclosures include, among other things, a carry forward of the allowance for credit losses as well as information about modified, impaired, non-accrual and past due loans and credit quality indicators. ASU 2010-2 became effective for financial statements as of December 31, 2010 as it relates to disclosures required as of the end of the reporting period. Disclosures that relate to activity during a reporting period are required for financial statements that include periods beginning on or after January 1, 2011 and did not have a material impact on our consolidated results of operations or financial position.
ASU No. 2010-28 “When to Perform Step 2 of the Goodwill Impairment Test for Reporting Units with Zero or Negative Carrying Amounts (Topic 350)” modifies Step 1 of the goodwill impairment test for reporting units with zero or negative carrying amounts. For these reporting units, an entity is required to perform Step 2 of the goodwill impairment test if it is more likely than not that a goodwill impairment exists. In determining whether it is more likely than not that goodwill impairment exists, an entity should consider whether there are any adverse qualitative factors indicating impairment may exist. This update became effective for the interim and annual reporting periods beginning after December 15, 2010 and did not have a material impact on our consolidated results of operations or financial position.
ASU No. 2010-29 “Business Combinations (Topic 805) Disclosure of Supplementary Pro Forma Information for Business Combinations” contains amendments that specify that if a public entity presents comparative financial statements, the entity should disclose revenue and earnings of the combined entity as though the business combination(s) that occurred during the current year had occurred as of the beginning of the comparable prior annual reporting period only. ASU 2010-29 also expands supplemental pro forma disclosures under Topic 350 to include a description of the nature and amount of material, non-recurring pro forma adjustments directly attributable to the business combination included in reported pro forma revenue and earnings. ASU 2010-29 became effective prospectively for business combinations for which the acquisition date is on or after the beginning of the first annual reporting period beginning on or after December 15, 2010. See Note 2 to our consolidated financial statements for the impact on our consolidated financial statements and results of operations.
ASU No. 2011-02 “A Creditor’s Determination of Whether a Restructuring Is a Troubled Debt Restructuring” amends FASB ASC 310-40 “Troubled Debt Restructurings by Creditors”. The amendments specify that in evaluating whether a restructuring constitutes a troubled debt restructuring, a creditor must separately conclude that both of the following conditions exist: the restructuring constitutes a concession and the debtor is experiencing financial difficulties. The amendments clarify the guidance on these points and give examples of both conditions. This update became effective for interim or annual reporting periods beginning on or after June 15, 2011. We have included the required disclosures in Note 6 to our consolidated financial statements.
ASU No. 2011-03 “Reconsideration of Effective Control for Repurchase Agreements” amends FASB ASC 860-10, “Transfers and Servicing-Overall”. The amendments remove from the assessment of effective control (1) the criterion requiring the transferor to have the ability to repurchase or redeem the financial asset on substantially the agreed terms, even in the event of default by the transferee, and (2) the collateral maintenance implementation guidance related to that criterion. This update becomes effective for interim and annual reporting periods beginning on or after December 15, 2011. We are currently evaluating the impact of adopting the new guidance on our results and it did not have a material impact on our consolidated financial statements or results of operations.
ASU No. 2011-04 “Amendments to Achieve Common Fair Value Measurement and Disclosure Requirements in U.S. GAAP and IFRS” amends FASB ASC 820 “Fair Value Measurement”. The amendments improve the comparability of fair value measurements presented and disclosed in financial statements prepared in accordance with U.S. GAAP and International Financial Reporting Standards (“IFRS”). Among the many areas affected by this update are the concept of highest and best use, the fair value of an instrument included in stockholders’ equity and disclosures about fair value measurement, particularly disclosures about fair value measurements categorized within Level 3 of the fair value hierarchy. This update became effective for the interim and annual reporting periods beginning after December 15, 2011 and it did not have a material impact on our consolidated financial statements or results of operations.
ASU No. 2011-05 “Presentation of Comprehensive Income” amends FASB ASC 220 “Comprehensive Income”. The amendments in this update eliminate the option to present components of other comprehensive income as part of the statement of changes in stockholders’ equity. An entity will have the option to present the total comprehensive income as part of the statement of changes in stockholders’ equity. An entity will have the option to present the total comprehensive income, the components of net income and the components of other comprehensive income either in a single continuous statement of comprehensive income or in two separate but consecutive statements. An entity will be required to present the face of financial statements reclassification adjustments for items that are reclassified from other comprehensive income to net income. This update becomes effective for interim and annual reporting periods beginning after December 15, 2011. Included in our consolidated financial statements is a single continuous statement of comprehensive income and the guidance did not have a material impact on our consolidated financial statements or results of operations.
ASU No. 2011-08 “Intangibles-Goodwill and Other Testing Goodwill for Impairment” amends Topic 350 “Intangibles-Goodwill and Other” to give entities the option to first assess qualitative factors to determine whether the existence of events or circumstances leads to a determination that it is more likely than not that the fair value of a reporting unit is less than its carrying amount, then performing the two step impairment test by calculating the fair value of the reporting unit comparing the fair value with the carrying amount of the reporting unit. This amendment is effective for annual and interim impairment tests beginning after December 15, 2011 and did not have a material impact on our consolidated financial statements or results of operations.
ASU 2011-11 “Balance Sheet-Disclosures about Offering Assets and Liabilities” amends Topic 210 “Balance Sheet” to require an entity to disclose both gross and net information about financial instruments such as sales and repurchase agreements and reverse sale and repurchase agreement and securities borrowing/lending arrangements, and derivative instruments that are eligible for offset in the statement of financial position and/or subject to a master netting arrangement or similar agreement. ASU 2011-11 is effective for annual and interim periods beginning on January 1, 2013, and we do not expect that it will have a material impact on our consolidated financial statements or results of operations.
ASU 2011-12 “Comprehensive Income-Deferral of the Effective Date for Amendments to the Presentation of Reclassifications of Items out of Accumulated Other Comprehensive Income in Accounting Standards Update 2011-05” defers changes in ASU No. 2011-05 that relate to the presentation of reclassification adjustments to allow the FASB time to redeliberate whether to require presentation of such adjustments on the face of the financial statements to show the effects of the reclassification out of accumulated other comprehensive income. ASU 2011-12 allows entities to continue to report reclassifications out of accumulated other comprehensive income consistent with the presentation requirements in effect before ASU No. 2011-05. All other requirements in ASU No. 2011-05 are not affected by ASU No. 2011-12. ASU 2011-12 is effective for annual and interim periods beginning after December 15, 2011 and it did not have a material impact on our consolidated financial statements or results of operations.
Item 7A. Quantitative and Qualitative Disclosures About Market Risk
Market risk is a broad term for the risk of economic loss due to adverse changes in the fair value of a financial instrument. Various factors, including interest rates, foreign exchange rates, commodity prices, or equity prices, may cause these changes. We are subject to market risk primarily through the effect of changes in interest rates on our portfolio of assets and liabilities. Foreign exchange rates, commodity prices, or equity prices do not pose significant market risk to us.
Interest Rate Sensitivity Analysis and Interest Rate Risk Management
A principal objective of Old Line Bank’s asset/liability management policy is to minimize exposure to changes in interest rates by an ongoing review of the maturity and re-pricing of interest earning assets and interest bearing liabilities. The Asset and Liability Committee of the Board of Directors oversees this review.
The Asset and Liability Committee establishes policies to control interest rate sensitivity. Interest rate sensitivity is the volatility of a bank’s earnings resulting from movements in market interest rates. Management monitors rate sensitivity in order to reduce vulnerability to interest rate fluctuations while maintaining adequate capital levels and acceptable levels of liquidity. Monthly financial reports supply management with information to evaluate and manage rate sensitivity and adherence to policy. Old Line Bank’s asset/liability policy’s goal is to manage assets and liabilities in a manner that stabilizes net interest income and net economic value within a broad range of interest rate environments. Adjustments to the mix of assets and liabilities are made periodically in an effort to achieve dependable, steady growth in net interest income regardless of the behavior of interest rates in general.
As part of the interest rate risk sensitivity analysis, the Asset and Liability Committee examines the extent to which Old Line Bank’s assets and liabilities are interest rate sensitive and monitors the interest rate sensitivity gap. An interest rate sensitive asset or liability is one that, within a defined time period, either matures or experiences an interest rate change in line with general market rates. The interest rate sensitivity gap is the difference between interest earning assets and interest bearing liabilities scheduled to mature or reprice within such time period. A gap is considered positive when the amount of interest rate sensitive assets exceeds the amount of interest rate sensitive liabilities. A gap is considered negative when the amount of interest rate sensitive liabilities exceeds the interest rate sensitive assets. During a period of rising interest rates, a negative gap would tend to adversely affect net interest income, while a positive gap would tend to result in an increase in net interest income. During a period of declining interest rates, a negative gap would tend to result in an increase in net interest income, while a positive gap would tend to adversely affect net interest income. If repricing of assets and liabilities were equally flexible and moved concurrently, the impact of any increase or decrease in interest rates on net interest income would be minimal.
Old Line Bank currently has a negative gap, which suggests that the net interest income on interest earning assets may decrease during periods of rising interest rates. However, a simple interest rate “gap” analysis by itself may not be an accurate indicator of how changes in interest rates will affect net interest income. Changes in interest rates may not uniformly affect income associated with interest earning assets and costs associated with interest bearing liabilities. In addition, the magnitude and duration of changes in interest rates may have a significant impact on net interest income. Although certain assets and liabilities may have similar maturities or periods of repricing, they may react in different degrees to changes in market interest rates. Interest rates on certain types of assets and liabilities fluctuate in advance of changes in general market interest rates, while interest rates on other types may lag behind changes in general market rates. In the event of a change in interest rates, prepayment and early withdrawal levels also could deviate significantly from those assumed in calculating the interest rate gap. The ability of many borrowers to service their debts also may decrease in the event of an interest rate increase.
The table below presents Old Line Bank’s interest rate sensitivity at December 31, 2011. Because certain categories of securities and loans are prepaid before their maturity date even without regard to interest rate fluctuations, we have made certain assumptions to calculate the expected maturity of securities and loans.
| | | Interest Sensitivity Analysis | |
| | | December 31, 2011 | |
| | | Maturing or Repricing | |
| | | Within 3 Months | | | 4-12 Months | | | 1-5 Years | | | Over 5 Years | | | Total | |
| | | (Dollars in thousands) | |
| Interest Earning Assets: | | | | | | | | | | | | | | | |
| Interest bearing accounts | | $ | 119 | | | $ | - | | | $ | - | | | $ | - | | | $ | 119 | |
| Time deposits in other banks | | | - | | | | - | | | | - | | | | - | | | | - | |
| Federal funds sold | | | 83 | | | | - | | | | - | | | | - | | | | 83 | |
| Investment securities | | | 256 | | | | 1,025 | | | | 19,138 | | | | 141,366 | | | $ | 161,785 | |
| Loans | | | 103,327 | | | | 78,916 | | | | 292,507 | | | | 67,537 | | | | 542,287 | |
| Total interest earning assets | | | 103,785 | | | | 79,941 | | | | 311,645 | | | | 208,903 | | | | 704,274 | |
| | | | | | | | | | | | | | | | | | | | | |
| Interest Bearing Liabilities: | | | | | | | | | | | | | | | | | | | | |
| Interest-bearing transaction deposits | | | 83,018 | | | | 40,889 | | | | - | | | | - | | | | 123,907 | |
| Savings accounts | | | 20,218 | | | | 20,218 | | | | 20,218 | | | | - | | | | 60,654 | |
| Time deposits | | | 93,800 | | | | 124,512 | | | | 117,756 | | | | - | | | | 336,068 | |
| Total interest-bearing deposits | | | 197,036 | | | | 185,619 | | | | 137,974 | | | | - | | | | 520,629 | |
| FHLB advances | | | 10,000 | | | | - | | | | - | | | | - | | | | 10,000 | |
| Other borrowings | | | 28,673 | | | | - | | | | - | | | | 6,284 | | | | 34,957 | |
| Total interest-bearing liabilities | | | 235,709 | | | | 185,619 | | | | 137,974 | | | | 6,284 | | | | 565,586 | |
| | | | | | | | | | | | | | | | | | | | | |
| Period Gap | | $ | (131,924 | ) | | $ | (105,678 | ) | | $ | 173,671 | | | $ | 202,619 | | | $ | 138,688 | |
| | | | | | | | | | | | | | | | | | | | | |
| Cumulative Gap | | $ | (131,924 | ) | | $ | (237,602 | ) | | $ | (63,931 | ) | | $ | 138,688 | | | | | |
| | | | | | | | | | | | | | | | | | | | | |
| Cumulative Gap/Total Assets | | | (36.93 | %) | | | (66.51 | %) | | | (17.90 | %) | | | 38.82 | % | | | | |
The following consolidated financial statements are filed with this report:
Report of Independent Registered Public Accounting Firm
Consolidated Balance Sheets – December 31, 2011, 2010 and 2009
Consolidated Statements of Income – For the years ended December 31, 2011, 2010 and 2009
Consolidated Statements of Changes in Stockholders’ Equity – For the years ended December 31, 2011, 2010 and 2009
Consolidated Statements of Cash Flows – For the years ended December 31, 2011, 2010 and 2009
Notes to Consolidated Financial Statements
Report of Independent Registered Public Accounting Firm
The Board of Directors and Stockholders
Old Line Bancshares, Inc.
Bowie, Maryland
We have audited the accompanying consolidated balance sheets of Old Line Bancshares, Inc. and Subsidiaries as of December 31, 2011, 2010, and 2009, and the related consolidated statements of income, comprehensive income, changes in stockholders' equity, and cash flows for each of the years in the three-year period ended December 31, 2011. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audits.
We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board in the United States of America. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. The Company is not required to have, nor were we engaged to perform, an audit of its internal control over financial reporting. Our audit included consideration of internal control over financial reporting as a basis for designing audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the Company's internal control over financial reporting. Accordingly, we express no such opinion. An audit also includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of Old Line Bancshares, Inc. and Subsidiaries as of December 31, 2011, 2010, and 2009, and the results of its operations and its cash flows for each of the years in the three-year period ended December 31, 2011, in conformity with accounting principles generally accepted in the United States of America.
Baltimore, Maryland
March 23, 2012
101 E. Chesapeake Avenue, Suite 300, Baltimore, Maryland 21286
410-583-6990 FAX 410-583-7061
Website: www.Rowles.com
| Old Line Bancshares, Inc. & Subsidiaries | |
| Consolidated Balance Sheets | |
| | | | | | | | | | |
| December 31, | | 2011 | | | 2010 | | | 2009 | |
| Assets | | | | | | | | | |
| Cash and due from banks | | $ | 43,434,375 | | | $ | 14,325,266 | | | $ | 7,402,137 | |
| Interest bearing accounts | | | 119,235 | | | | 109,170 | | | | 3,953,312 | |
| Federal funds sold | | | 83,114 | | | | 180,536 | | | | 81,138 | |
| Total cash and cash equivalents | | | 43,636,724 | | | | 14,614,972 | | | | 11,436,587 | |
| Time deposits in other banks | | | - | | | | 297,000 | | | | 15,031,102 | |
| Investment securities available for sale | | | 161,784,835 | | | | 33,049,795 | | | | 28,012,948 | |
| Investment securities held to maturity | | | - | | | | 21,736,469 | | | | 5,806,507 | |
| Loans, less allowance for loan losses | | | 539,297,666 | | | | 299,606,430 | | | | 265,008,669 | |
| Equity securities at cost | | | 3,946,042 | | | | 2,562,750 | | | | 2,957,650 | |
| Premises and equipment | | | 23,215,429 | | | | 16,867,561 | | | | 17,326,099 | |
| Accrued interest receivable | | | 2,448,542 | | | | 1,252,970 | | | | 1,055,249 | |
| Prepaid income taxes | | | - | | | | 189,523 | | | | - | |
| Deferred income taxes | | | 7,244,029 | | | | 265,551 | | | | 178,574 | |
| Bank owned life insurance | | | 16,416,566 | | | | 8,703,175 | | | | 8,422,879 | |
| Prepaid Pension | | | 1,030,551 | | | | - | | | | - | |
| Other real estate owned | | | 4,004,609 | | | | 1,153,039 | | | | - | |
| Goodwill | | | 633,790 | | | | - | | | | - | |
| Core deposit intangible | | | 4,418,892 | | | | - | | | | - | |
| Other assets | | | 2,964,626 | | | | 1,610,715 | | | | 1,982,262 | |
| Total assets | | $ | 811,042,301 | | | $ | 401,909,950 | | | $ | 357,218,526 | |
| | | | | | | | | | | | | |
| Liabilities and Stockholders' Equity | | | | | | | | | | | | |
| Deposits | | | | | | | | | | | | |
| Non-interest bearing | | $ | 170,138,329 | | | $ | 67,494,744 | | | $ | 40,883,419 | |
| Interest bearing | | | 520,629,456 | | | | 273,032,442 | | | | 245,464,373 | |
| Total deposits | | | 690,767,785 | | | | 340,527,186 | | | | 286,347,792 | |
| Short term borrowings | | | 38,672,657 | | | | 5,669,332 | | | | 16,149,939 | |
| Long term borrowings | | | 6,284,479 | | | | 16,371,947 | | | | 16,454,067 | |
| Accrued interest payable | | | 397,211 | | | | 434,656 | | | | 517,889 | |
| Income taxes payable | | | 475,687 | | | | - | | | | 175,543 | |
| Accrued pension | | | 4,342,664 | | | | - | | | | - | |
| Other liabilities | | | 1,605,180 | | | | 1,248,079 | | | | 941,165 | |
| Total liabilities | | | 742,545,663 | | | | 364,251,200 | | | | 320,586,395 | |
| | | | | | | | | | | | | |
| Stockholders' equity | | | | | | | | | | | | |
Common stock, par value $0.01 per share; authorized 15,000,000 shares; issued and outstanding 6,817,694 in 2011, 3,891,705 in 2010 and 3,862,364 in 2009 | | | 68,177 | | | | 38,917 | | | | 38,624 | |
| Additional paid-in capital | | | 53,489,075 | | | | 29,206,617 | | | | 29,034,954 | |
| Retained earnings | | | 12,093,742 | | | | 7,535,268 | | | | 6,498,446 | |
| Accumulated other comprehensive income | | | 2,388,972 | | | | 272,956 | | | | 368,880 | |
| Total Old Line Bancshares, Inc. stockholders' equity | | | 68,039,966 | | | | 37,053,758 | | | | 35,940,904 | |
| Non-controlling interest | | | 456,672 | | | | 604,992 | | | | 691,227 | |
| Total stockholders' equity | | | 68,496,638 | | | | 37,658,750 | | | | 36,632,131 | |
| Total liabilities and stockholders' equity | | $ | 811,042,301 | | | $ | 401,909,950 | | | $ | 357,218,526 | |
The accompanying notes are an integral part of these consolidated financial statements
| Old Line Bancshares, Inc. & Subsidiaries | |
| Consolidated Statements of Income | |
| | |
| Years Ended December 31, | | 2011 | | | 2010 | | | 2009 | |
| | | | | | | | | | |
| Interest revenue | | | | | | | | | |
| Loans, including fees | | $ | 28,432,701 | | | $ | 16,599,612 | | | $ | 15,304,608 | |
| U.S. Treasury securities | | | 7,251 | | | | - | | | | 7,230 | |
| U.S. government agency securities | | | 332,248 | | | | 163,787 | | | | 296,560 | |
| Mortgage backed securities | | | 2,635,172 | | | | 1,399,979 | | | | 1,059,386 | |
| Municipal securities | | | 745,369 | | | | 79,758 | | | | 84,797 | |
| Federal funds sold | | | 6,087 | | | | 7,255 | | | | 1,148 | |
| Other | | | 161,685 | | | | 258,440 | | | | 342,127 | |
| Total interest revenue | | | 32,320,513 | | | | 18,508,831 | | | | 17,095,856 | |
| Interest expense | | | | | | | | | | | | |
| Deposits | | | 4,389,694 | | | | 3,920,338 | | | | 4,553,099 | |
| Borrowed funds | | | 829,477 | | | | 1,022,425 | | | | 1,026,755 | |
| Total interest expense | | | 5,219,171 | | | | 4,942,763 | | | | 5,579,854 | |
| Net interest income | | | 27,101,342 | | | | 13,566,068 | | | | 11,516,002 | |
| Provision for loan losses | | | 1,800,000 | | | | 1,082,000 | | | | 900,000 | |
| Net interest income after provision for loan losses | | | 25,301,342 | | | | 12,484,068 | | | | 10,616,002 | |
| Non-interest revenue | | | | | | | | | | | | |
| Service charges on deposit accounts | | | 1,208,466 | | | | 306,548 | | | | 307,012 | |
| Gains on sales or calls of investment securities | | | 140,149 | | | | - | | | | 158,551 | |
| Other than temporary impairment on equity securities | | | (123,039 | ) | | | - | | | | - | |
| Earnings on bank owned life insurance | | | 701,509 | | | | 336,834 | | | | 376,165 | |
| Gains on sales of other real estate owned | | | 248,005 | | | | 192,724 | | | | - | |
| Other fees and commissions | | | 566,187 | | | | 515,896 | | | | 978,039 | |
| Total non-interest revenue | | | 2,741,277 | | | | 1,352,002 | | | | 1,819,767 | |
| Non-interest expense | | | | | | | | | | | | |
| Salaries | | | 7,755,401 | | | | 4,681,679 | | | | 4,037,027 | |
| Employee benefits | | | 2,269,190 | | | | 1,284,993 | | | | 1,012,014 | |
| Occupancy | | | 2,521,960 | | | | 1,296,088 | | | | 1,085,768 | |
| Equipment | | | 609,597 | | | | 416,094 | | | | 354,531 | |
| Data processing | | | 816,815 | | | | 452,675 | | | | 340,870 | |
| FDIC insurance and State of Maryland assessments | | | 613,881 | | | | 527,807 | | | | 561,850 | |
| Merger and integration | | | 574,321 | | | | 574,369 | | | | - | |
| Core deposit premium | | | 584,024 | | | | - | | | | - | |
| Other operating | | | 5,139,154 | | | | 2,175,800 | | | | 1,864,821 | |
| Total non-interest expense | | | 20,884,343 | | | | 11,409,505 | | | | 9,256,881 | |
| Income before income taxes | | | 7,158,276 | | | | 2,426,565 | | | | 3,178,888 | |
| Income taxes | | | 1,926,624 | | | | 996,750 | | | | 1,055,522 | |
| Net income | | | 5,231,652 | | | | 1,429,815 | | | | 2,123,366 | |
| Less: Net income (loss) attributable to the non-controlling interest | | | (148,319 | ) | | | (72,849 | ) | | | 87,216 | |
| Net income attributable to Old Line Bancshares, Inc. | | | 5,379,971 | | | | 1,502,664 | | | | 2,036,150 | |
| Preferred stock dividend and discount accretion | | | - | | | | - | | | | 485,993 | |
| Net income available to common stockholders | | $ | 5,379,971 | | | $ | 1,502,664 | | | $ | 1,550,157 | |
| | | | | | | | | | | | | |
| Basic earnings per common share | | $ | 0.86 | | | $ | 0.39 | | | $ | 0.40 | |
| Diluted earnings per common share | | $ | 0.86 | | | $ | 0.38 | | | $ | 0.40 | |
| Dividend per common share | | $ | 0.13 | | | $ | 0.12 | | | $ | 0.12 | |
The accompanying notes are an integral part of these consolidated financial statements
