United States Securities and Exchange Commission
Washington, D.C. 20549
FORM 10-K
☒ ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the fiscal year ended December 31, 2015
or
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the transition period from _____to _____
Commission file number 0-23090
BAY BANCORP, INC.
(Exact name of registrant as specified in its charter)
MARYLAND | | 52-1660951 |
(State or other jurisdiction
of incorporation or organization) | | (IRS Employer
Identification No.) |
7151 Columbia Gateway Drive, Suite A, Columbia, Maryland 21046
(Address of principal executive offices) (Zip Code)
Registrant’s telephone number, including area code (410) 312-5400
Securities registered pursuant to Section 12(b) of the Act:
Title of Each Class: | | Name of Each Exchange on Which Registered: |
Common Stock, par value $1.00 per share | | NASDAQ Capital Market |
Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. Yes ☐ No ☑
Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or 15(d) of the Act. Yes ☐ No ☑
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes ☑ No ☐
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes ☑ No ☐
Indicate by check mark if disclosures of delinquent filers pursuant to Item 405 of Regulation S-K (Section 229.405 of this chapter) is not contained herein, and will not be contained, to the best of the registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. ☐
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 definition of “accelerated filer”, “large accelerated filer”, and “smaller reporting company” in Rule 12b-2 of the Exchange Act). (check one): Large accelerated filer ☐Accelerated filer ☐ Non-accelerated filer ☐Smaller reporting company ☑
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act). Yes ☐ No ☑
The aggregate market value of the registrant’s outstanding voting and non-voting common equity held by non-affiliates was $39,389,127, computed by reference to the closing sales price of such equity as of the last business day of the registrant’s most recently completed second fiscal quarter (June 30, 2015). For the purposes of this calculation, directors, executive officers, and the controlling investor are considered affiliates.
At March 18, 2016, the number of shares outstanding of the registrant’s common stock was 11,062,932.
Documents Incorporated by Reference
Portions of the registrant’s definitive proxy statement for the 2016 Annual Meeting of Stockholders to be filed with the SEC pursuant to Regulation 14A are incorporated by reference into Part III of this Annual Report on Form 10-K.
BAY BANCORP, INC.
TABLE OF CONTENTS
PART I
As used in this Annual Report, the term “the Company” refers to Bay Bancorp, Inc. and, unless the context clearly requires otherwise, the terms “we,” “us,” and “our,” refer to Bay Bancorp, Inc. and its consolidated subsidiaries.
FORWARD-LOOKING STATEMENTS
This Annual Report on Form 10-K contains forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended (the “Exchange Act”). Such statements include projections, predictions, expectations or statements as to beliefs or future events or results, or refer to other matters that are not purely statements of historical facts. Forward-looking statements are subject to known and unknown risks, uncertainties and other factors that could cause the actual results to differ materially from those contemplated by the statements. The forward-looking statements contained in this Annual Report are based on various factors and were derived using numerous assumptions. In some cases, you can identify these forward-looking statements by words like “may”, “will”, “should”, “expect”, “plan”, “anticipate”, “intend”, “believe”, “estimate”, “predict”, “potential”, or “continue” or the negative of those words and other comparable words. You should be aware that those statements reflect only our predictions. If known or unknown risks or uncertainties should materialize, or if underlying assumptions should prove inaccurate, actual results could differ materially from past results and those anticipated, estimated or projected. You should bear this in mind when reading this annual report and not place undue reliance on these forward-looking statements.
Forward-looking statements are not guarantees of future performance and are subject to risks and uncertainties that are difficult to identify and/or predict. Actual results may differ materially from these forward-looking statements because of, among other factors:
| · | | changes in our plans and strategies and the results thereof; |
| · | | the impact of acquisitions and other strategic transactions; |
| · | | unexpected changes in the housing market, business markets, and/or general economic conditions in our market area, or a slower-than-anticipated economic recovery, which might lead to increased or decreased demand for loans, deposits and other products and services; |
| · | | unexpected changes in market interest rates or monetary policy; |
| · | | the impact of new laws, regulations and governmental policies and guidelines that might require changes to our business model; |
| · | | changes in laws, regulations and governmental policies and guidelines that might impact our ability to collect on outstanding loans or otherwise negatively impact our business; |
| · | | higher than anticipated loan losses or the insufficiency of the allowance for credit losses; |
| · | | our potential exposure to various types of market risks, such as interest rate risk and credit risk; |
| · | | our ability to recover the fair values of available for sale securities; |
| · | | our obligation to fund commitments to extend credit and unused lines of credit; |
| · | | changes in consumer confidence, spending and savings habits relative to the services we provide; |
| · | | continued relationships with major customers; |
| · | | competition from other financial institutions in originating loans, attracting deposits, and providing various financial services that may affect our profitability; |
| · | | the ability to continue to grow our business internally and through acquisition and successful integration of bank entities while controlling our costs; |
| · | | changes in competitive, governmental, regulatory, accounting, technological and other factors that may affect us specifically or the banking industry generally, including as a result of the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010 (the “Dodd-Frank Act”); |
| · | | changes in our sources and availability of liquidity; |
| · | | the impact of pending and future legal proceedings; and |
| · | | losses that we may realize from off-balance sheet arrangements. |
You should also consider carefully the risk factors discussed in Item 1A of Part I of this annual report, which address additional factors that could cause our actual results to differ from those set forth in the forward-looking statements and could materially and adversely affect our business, operating results and financial condition. The risks discussed in this annual report are factors that, individually or in the aggregate, management believes could cause our actual results to differ materially from expected and historical results. You should understand that it is not possible to predict or identify all such factors. Consequently, you should not consider such disclosures to be a complete discussion of all potential risks or uncertainties.
The forward-looking statements speak only as of the date on which they are made, and, except to the extent required by federal securities laws, we undertake no obligation to update any forward-looking statement to reflect events or circumstances after the date on which the statement is made or to reflect the occurrence of unanticipated events. In addition, we cannot assess the impact of each factor on our business or the extent to which any factor, or combination of factors, may cause actual results to differ materially from those contained in any forward-looking statements.
ITEM 1. BUSINESS
GENERAL
Bay Bancorp, Inc., a Maryland corporation organized in 1990, is a savings and loan holding company headquartered in Columbia, Maryland, that is the parent company of Bay Bank, FSB, a federal savings bank that is also headquartered in Columbia, Maryland (the “Bank”). Until November 1, 2013, the Company operated under the name Carrollton Bancorp. Effective November 1, 2013, the Company’s name was changed to Bay Bancorp, Inc.
On April 19, 2013, the Company completed its merger with Jefferson Bancorp, Inc. (“Jefferson”) with the Company as the surviving corporation (the “Jefferson Merger”). The Jefferson Merger was accounted for as a reverse acquisition, which means that for accounting and financial reporting purposes, Jefferson was deemed to have acquired the Company in the Jefferson Merger even though the Company was the legal successor in the Jefferson Merger, and the historical financial statements of Jefferson have become the Company’s historical financial statements. Consequently, the assets and liabilities and the operations that are reflected in the historical consolidated financial statements prior to the Jefferson Merger are those of Jefferson, and the historical consolidated financial statements after the Jefferson Merger include the assets and liabilities of Jefferson and the Company, historical operations of Jefferson and operations of the combined Company after April l9, 2013.
On May 15, 2014, the Company entered into a Securities Purchase Agreement (the “Purchase Agreement”) with Financial Services Partners Fund I, LLC (“FSPF”), and seven directors and executive officers of the Company (collectively, the “Investors”). Pursuant to the Purchase Agreement, the Company agreed to sell an aggregate of 1,422,764 shares of the Company’s common stock, par value $1.00 per share, to the Investors at a purchase price of $4.92 per share, which was the closing bid price of a share of common stock on May 14, 2014 as reported on The NASDAQ Capital Market. The closing of this transaction occurred on May 15, 2014, and the Company received aggregate gross proceeds of $7,000,000 from the transaction. The Company contributed these proceeds to the Bank, to bolster its regulatory capital and provide funds for future acquisitions and general working capital purposes.
On May 30, 2014, the Bank acquired certain assets and assumed substantially all deposits and certain other liabilities (the “Slavie Acquisition”) of Slavie Federal Savings Bank (“Slavie”), which was closed on May 30, 2014 by the Office of the Comptroller of the Currency (the “OCC”). The Slavie Acquisition was completed in accordance with the terms of the Purchase and Assumption Agreement All Deposits, with the FDIC. The Bank did not acquire any of Slavie’s other real estate owned. Additionally, the Bank did not at closing commit to purchase any owned or leased bank premises of Slavie; however, the Bank was granted an option to elect following closing to purchase any or all of the banking premises owned by Slavie, or in the case of leased banking premises, to assume the lease. The Bank terminated the lease for Slavie’s Bel Air location in October 2014 and extended its current lease at the Overlea branch. See Note 2 for further information regarding the Slavie Acquisition.
During 2015, Bay purchased 170,492 shares of its common stock, at an average price of $5.03 per share, pursuant to the stock purchase program that the Board of Directors approved on July 30, 2015. The program authorizes
Bay to purchase up to 250,000 shares of its common stock over a 12-month period in open market and/or through privately negotiated transactions, at Bay’s discretion. The Board may modify, suspend or discontinue the program at any time. In addition to the 79,508 shares remaining for purchase under the 2015 Repurchase Program, on February 24, 2016, the Company’s Board of Directors approved an additional stock purchase program that authorizes the Company to purchase up 250,000 shares of its common stock over a 12-month period in open market and/or through privately negotiated transactions. The stock purchase program was publicly-announced on February 26, 2016.
On December 18, 2015, the Company and Hopkins Bancorp, Inc. (“Hopkins”), the parent company of Hopkins Federal Savings Bank (“Hopkins Bank”), jointly announced the execution of a definitive merger agreement (the “Merger Agreement”) that provides for (i) the merger of Hopkins with and into the Company, with the Company as the surviving corporation and (ii) the merger of Hopkins Bank with and into the Bank, with the Bank as the surviving FSB (collectively, the “Hopkins Merger”). At December 31, 2015, Hopkins had assets of approximately $239.8 million. Under the terms of the Merger Agreement, the Company will acquire the outstanding shares of Hopkins common stock for cash equal to 105% of Hopkins’ tangible book value as of the closing, after giving effect to Hopkins’ payment of all of its transaction-related expenses, up to $625,000 in cash bonuses that Hopkins may, subject to regulatory approval, choose to pay to certain directors and employees at the closing (the “Hopkins Bonuses”), and a $16.0 million cash dividend that Hopkins proposes to pay to its stockholders prior to the closing (the “Hopkins Dividend”). Based on Hopkins’ tangible book value at September 30, 2015 and 241,552 shares of Hopkins common stock outstanding, and after giving effect to Hopkins’ payment of the Bonuses, the Hopkins Dividend and its anticipated transaction-related expenses, the consideration to be paid for the outstanding shares of Hopkins common stock would be approximately $23.8 million in cash, with the stockholders of Hopkins receiving cash of approximately $98.44 for each share of Hopkins common stock owned at the effective time of the Hopkins Merger. The Company will have the right to terminate the Merger Agreement if the merger consideration would exceed $25.7 million, and Hopkins will have the right to terminate the Merger Agreement if the merger consideration would be less than $21.4 million. The Company anticipates that the Hopkins Merger will be consummated in the second quarter of 2016, but the Hopkins Merger is subject to regulatory approval so no assurance can be given as to when, if at all, the Hopkins Merger will be effective. Additional information regarding the Hopkins Merger may be found in the Company’s Current Report on Form 8-K that was filed with the Securities and Exchange Commission (the “SEC”) on December 21, 2015.
We are focused on providing superior financial and customer service to small and medium-sized commercial and retail businesses, owners of these businesses and their employees, to business professionals and to individual consumers located in the central Maryland region, through our network of 11 branch locations. We attract deposit customers from the general public and use such funds, together with other borrowed funds, to make loans. Our results of operations are primarily determined by the difference between interest income earned on our interest-earning assets, primarily interest and fee income on loans, and interest paid on our interest-bearing liabilities, including deposits and borrowings.
Our mortgage division is in the business of originating residential mortgage loans and then selling them to investors. The mortgage banking business is structured to provide a source of fee income largely from the process of originating residential mortgage loans for sale in the secondary market. Mortgage banking products include Federal Housing Administration and Federal Veterans Administration loans, conventional and nonconforming first and second mortgages, and construction and permanent financing. Loans originated by the mortgage division are generally sold into the secondary market or retained by us as part of our balance sheet strategy.
The Bank has five wholly-owned subsidiaries. Carrollton Community Development Corporation (“CCDC”) is a subsidiary that was created to promote, develop, and improve the housing and economic conditions of people in Maryland. Historically, CCDC has generated revenue through the origination of loans, but it did not originate any loans in 2014 or 2015 and is in the process of being dissolved. The Bank’s three limited liability company subsidiaries manage and dispose of real estate acquired through foreclosure or by deed in lieu of foreclosure. Bay Financial Services, Inc. is an inactive subsidiary that was established to provide brokerage services and a variety of financial planning and investment options to customers.
AVAILABILITY OF INFORMATION
We make available through the Investor Relations area of our website, at www.baybankmd.com, annual reports on Form 10-K, quarterly reports on Form 10-Q, news releases on Form 8-K, and any amendments to those reports filed or furnished pursuant to Section 13(a) or 15(d) of the Exchange Act. In general, we intend that these reports be available as soon as practicable after they are filed with or furnished to the Securities and Exchange Commission (“SEC”). The SEC maintains a website (www.sec.gov) where these filings are also available through the SEC’s EDGAR system. There is no charge for access to these filings through either our site or the SEC’s site.
MARKET AREA
We consider our core markets to be the communities within the Baltimore Metropolitan Statistical Area, particularly Baltimore City and the Maryland counties of Baltimore, Anne Arundel, Howard and Harford, as well as south along the Baltimore-Washington corridor with an expanded focus on Prince George’s and Montgomery counties. To this end, we added a Corridor Market President and two new Directors to the bank and holding company board of directors who are active in these counties and relocated the corporate headquarters to our Columbia, Maryland location. Lending activities are broader, including the entire State of Maryland, and, to a limited extent, the surrounding states. All of our revenue is generated within the United States.
COMPETITION
Our principal competitors for deposits are other financial institutions, including other savings institutions, commercial banks, credit unions, and local banks and branches or affiliates of other larger banks located in our primary market area. Competition among these institutions is based primarily on interest rates and other terms offered, service charges imposed on deposit accounts, the quality of services rendered, and the convenience of banking facilities. Additional competition for depositors' funds comes from mutual funds, U.S. Government securities, insurance companies and private issuers of debt obligations and suppliers of other investment alternatives for depositors such as securities firms. Competition from credit unions has intensified in recent years as historical federal limits on membership have been relaxed. Because federal law subsidizes credit unions by giving them a general exemption from federal income taxes, credit unions have a significant cost advantage over banks and savings associations, which are fully subject to federal income taxes. Credit unions may use this advantage to offer rates that are highly competitive with those offered by banks and thrifts.
Current federal law allows the acquisition of banks by bank holding companies nationwide. Further, federal and Maryland law permit interstate banking. Recent legislation has broadened the extent to which financial services companies, such as investment banks and insurance companies, may control commercial banks. As a consequence of these developments, competition in our principal market may increase, and a further consolidation of financial institutions in Maryland may occur.
STRATEGY
We operate on the premise that the consolidation activities in the banking industry have created an opportunity for a well-capitalized community bank to satisfy banking needs that are no longer being adequately met in the local market. Large national and regional banks are catering to larger customers and provide an impersonal experience, and typical community banks, because of their limited capacity, are unable to meet the needs of many small-to-medium-sized businesses. Specifically, as a result of bank mergers in the 1990s, many banks in the Baltimore metropolitan area became local branches of large regional and national banks. Although size gave the larger banks some advantages in competing for business from large corporations, including economies of scale and higher lending limits, we believe that these larger, national banks remain focused on a mass market approach which de-emphasizes personal contact and service. We also believe that the centralization of decision-making power at these large institutions has resulted in a lack of customer service. At many of these institutions, determinations are made at the out-of-state “home office" by individuals who lack personal contact with customers as well as an understanding of the customers' needs and scope of the relationship with the institution. We believe that this trend is ongoing, and continues to be particularly frustrating to owners of small and medium-sized businesses, business professionals and individual consumers who traditionally have
been accustomed to dealing directly with a bank executive who had an understanding of their banking needs with the ability to deliver a prompt response.
We attempt to differentiate ourselves from the competition through personalized service, flexibility in meeting the needs of customers, prompt decision making and the availability of senior management to meet with customers and prospective customers.
PRODUCTS AND SERVICES
General
Our primary market focus is on making loans to and gathering deposits from small and medium-sized businesses and their owners, professionals and executives, real estate investors and individual consumers in our primary market area. We lend to customers throughout Maryland, with our core market being the Baltimore Metropolitan Statistical Area and along the Baltimore-Washington corridor. To a limited extent, we lend to customers in neighboring states. Our lending activities consist generally of short to medium term commercial lending, commercial mortgage lending for both owner occupied and investor properties, residential mortgage lending and consumer lending, both secured and unsecured. A substantial portion of our loan portfolio consists of loans to businesses secured by real estate and/or other business assets.
Lending Activities
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. All loan approvals require two signatures; no individual commercial loan authority is given to relationship managers. Loans to $1,000,000 must be signed by the relationship manager and approved by Credit Administration. Loans between $1,000,001 and $2,500,000 must be approved by the Chief Credit Officer and Chief Lending Officer. Loans between $2,500,001 and $5,000,000 must be approved by the Credit and Risk Management Committee. Loans between $5,000,001 and $6,500,000 must be approved by the Directors’ Loan Committee with the prior approval of the Credit and Risk Management Committee. Loans greater than $6,500,000 require full Board approval. Under the leadership of our executive management team, we believe that we employ experienced lending officers, secure appropriate collateral and carefully monitor the financial conditions of our borrowers and the concentration of loans in our 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. 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.
The Bank also retains an outside, independent firm to review the loan portfolio. This firm performs a detailed annual review. We use the results of the firm’s report primarily to validate the risk ratings applied to loans in the portfolio and identify any systemic weaknesses in underwriting, documentation or management of the portfolio. Results of the annual review are presented to executive management, the audit committee of the board and the full board of directors and are available to and used by regulatory examiners when they review the Bank’s asset quality.
The Bank maintains the normal checks and balances on the loan portfolio not only through the underwriting process but through the utilization of an internal credit administration group that both assists in the underwriting and serves as an additional reviewer of underwriting. The separately managed loan administration group also has oversight for documentation, compliance and timeliness of collection activities. Our outsourced internal audit firm also reviews documentation, compliance and file management.
Commercial Lending
Our commercial lending consists of lines of credit, revolving credit facilities, accounts receivable and inventory financing, term loans, equipment loans, small business administration (SBA) loans, stand-by 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, contract administration and acquisition activities. These loans typically have maturities of seven years or less. 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 and inventory, equipment, indemnity deeds of trust and other collateral such as marketable securities, cash value of life insurance, and time deposits at the 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. To help manage this risk, we establish parameters/covenants at the inception of the loan to provide early warning signals before payment default. We normally seek to obtain appropriate collateral and personal guarantees from the borrower’s principal owners. We are able, given our business model, to proactively monitor the financial condition of the business.
Commercial Real Estate Lending
We finance commercial real estate for our clients, for both owner-occupied properties and investor properties (including residential properties). We generally will finance owner-occupied and investor commercial real estate at a maximum loan-to-value ratio of 80%. Our underwriting policies and processes focus on the underlying credit of the owner-occupied real estate and on the rental income stream (including rent terms and strength of tenants) for investor commercial real estate as well as an assessment of the underlying real estate. Risks inherent in managing a commercial real estate portfolio relate to vacancy rates/absorption rates for surrounding properties, sudden or gradual drops in property values as well as changes in the economic climate. We attempt to mitigate these risks by carefully underwriting loans of this type as well as by following appropriate loan-to-value standards. We are cash flow lenders and never rely solely on property valuations in reaching a lending decision. Personal guarantees are often required for commercial real estate loans as they are for other commercial loans. Most of our real estate loans carry fixed interest rates and amortize over 20 – 25 years with five- to 10-year maturities. Properties securing our commercial real estate loans primarily include office buildings, office condominiums, distribution facilities, retail properties, manufacturing plants and apartment projects. Substantially all of our commercial real estate loans are secured by properties located in our primary market area.
Commercial real estate loans generally carry higher interest rates and have shorter terms than one- to four-family residential mortgage loans. Commercial real estate loans, however, entail significant additional risks as compared with residential mortgage lending, as they typically involve larger loan balances concentrated with single borrowers or groups of related borrowers. In addition, the payment of loans secured by income producing properties typically depends on the successful operation of the property, as repayment of the loan generally is dependent, in large part, on sufficient income from the property to cover operating expenses and debt service. Changes in economic conditions that are not in the control of the borrower or lender could affect the value of the collateral for the loan or the future cash flow of the property. Additionally, any decline in real estate values may be more pronounced for commercial real estate than residential properties.
Construction Lending
Construction lending can cover funding for land acquisition, land development and/or construction of residential or commercial structures. Our construction loans generally bear a variable rate of interest and have terms of one to two years. Funds are advanced on a percentage-of-completion basis. These loans are generally repaid at the end of the development or construction phase, although loans for commercial construction will often convert into a permanent commercial real estate loans at the end of the term of the loan. Loan to value parameters range from 65% of the value of raw land to 75% for developed land and 80% for commercial or multifamily construction and residential construction. These loan-to-value ratios represent the upper limit of advance rates to remain in compliance with Bank policy. Typically, loan-to-value ratios should be somewhat lower than these upper limits, requiring the borrower to provide significant equity at the inception of the loan. Our underwriting looks not only at the value of the property but
the expected cash flows to be generated by sale of the parcels or leasing of the completed construction. The borrower must have solid experience in this type of construction and personal guarantees are required.
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. If the estimate of construction or development cost proves to be inaccurate, we may be required to advance additional funds beyond the amount originally committed in order to protect the value of the property. Moreover, if the estimated value of the completed project proves to be inaccurate, the borrower may hold a property with a value that is insufficient to assure full repayment. To mitigate these risks, in addition to the underwriting considerations noted above, we maintain an in-house construction monitoring unit that has oversight for the projects and we require both site visits and frequent reporting before funds are advanced.
Residential Real Estate Lending
We originate a variety of consumer-oriented residential real estate loans. Residential mortgage loans consist primarily of first mortgage loans to individuals, most of which have a loan-to-value not exceeding 89.9%. The remainder of this portion of our portfolio consists of home equity lines of credit and fixed rate home equity loans. Our residential real estate loans are generally for owner-occupied single family homes. These loans are generally for a primary residence although we will occasionally originate loans for a second home where the borrower has strong credit. Our residential real estate loans are generally either fixed rate loans with thirty-year terms for conventional mortgages , ten-year terms for jumbo mortgages or five-, seven-, and 10-year adjustable rate mortgages with a 30-year amortization.
Our home equity loans and home equity lines of credit are primarily secured by a second mortgage on owner-occupied one-to-four family residences. Our home equity loans are originated at fixed or adjustable interest rates and with terms of between five and 20-years and are fully amortizing. Our home equity lines allow for the borrower to draw against the line for ten years, after which the outstanding balance is amortized over twenty years. Home equity lines of credit carry a variable rate of interest and are interest only during the draw period. Home equity loans and lines of credit are generally underwritten with a maximum combined loan-to-value ratio of 80% although in some instances the combined loan-to-value ratio may reach 89.9%. We require appraisals or valuations on all real estate loans – both commercial and residential. At the time we close a home equity loan or line of credit, we record a mortgage to perfect our security interest in the underlying collateral. Home equity loans and lines of credit greater than $50,000 also require title insurance, and borrowers must obtain hazard insurance, and flood insurance, if applicable.
Home equity loans and lines of credit generally have greater risk than one-to-four family residential mortgage loans. In these cases, we face the risk that collateral for a defaulted loan may not provide an adequate source of repayment of the outstanding loan balance. In particular, because home equity loans are secured by second mortgages, decreases in real estate values could adversely affect the value of the property serving as collateral for these loans. Thus, the recovery of such property could be insufficient to compensate us for the value of these loans.
Our home equity loan portfolio gives us a diverse client base. Most of these loans are in our primary market area, and the diversity of the individual loans in the portfolio reduces our potential risk.
Consumer Lending
We offer various types of secured and unsecured consumer loans. Generally, our consumer loans are made 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 43% of their 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 real estate loans because many consumer loans are unsecured or are secured by rapidly depreciating assets. 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 also 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.
Loan Originations, Purchases, Sales, Participations and Servicing
All loans that we originate are underwritten pursuant to our policies and procedures, which incorporate standard underwriting guidelines. We originate both fixed and variable rate loans. Our loan origination activity may be adversely affected by a rising interest rate environment that typically results in decreased loan demand. We occasionally sell participations in commercial loans to correspondent banks if the amount of the loan exceeds our internal limits. More rarely, we purchase loan participations from correspondent banks in the local market as well. Those loans are underwritten in-house with the same standards as loans directly originated. Our residential real estate loans originated for resale are discussed under “Mortgage Banking Activities” below.
Loan Approval Procedures and Authority
Our lending activities follow written, non-discriminatory underwriting standards and loan origination procedures established by our board of directors. The loan approval process is intended to assess the borrower’s ability to repay the loan, the viability of the loan, and the adequacy of the value of the collateral that will secure the loan, if applicable. To assess a business borrower’s ability to repay, we review and analyze, among other factors: current income, credit history including the Bank’s prior experience with the borrower, cash flow, any secondary sources of repayment, other debt obligations in regards to the equity/net worth of the borrower and collateral available to the Bank to secure the loan.
We require appraisals or valuations of all real property securing one-to-four family residential and commercial real estate loans and home equity loans and lines of credit. All appraisers are state licensed or state certified appraisers, and a list of approved appraisers is maintained and updated on an annual basis.
Deposit Activities
Deposits are the major source of our funding. We offer a broad array of consumer and business deposit products that include demand, money market, and savings accounts, as well as time deposits. We offer through key technology partnerships a competitive array of commercial cash management products, which allow us to attract demand deposits. 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.
We offer Certificate of Deposit Registry Service (“CDARS”) and Insured Cash Sweep (“ICS”) deposits to our customers. These programs allow customers to deposit more than would normally be covered by FDIC insurance. CDARS and ICS are nationwide programs that allow participating banks to “swap” customer deposits so that no customer has greater than the insurable maximum in one bank, while allowing the customer the convenience of maintaining a relationship with only one bank.
Mortgage Banking Activities
In addition to originating residential mortgages to hold in our portfolio, we also originate residential mortgage loans for resale in the secondary mortgage market through our mortgage division. These loans are also underwritten pursuant to standard underwriting guidelines. While our intent is to sell all loans originated as loans held for sale, we occasionally are unable to sell a loan due to some underwriting defect. These loans are transferred to the loan portfolio at the lower of their cost or fair value as of the date of transfer. Loans held for sale are sold with servicing rights released; gains or losses are recorded at the sale commitment date.
We originate residential mortgage loans primarily as a correspondent lender. Because the loans are originated within investor guidelines and designated automated underwriting and product specific requirements as part of the loan
application, sold loans have limited recourse provisions. Most contracts with investors contain recourse periods. In general, we may be required to repurchase a previously sold mortgage loan, return the service release premium and/or pay an administrative fee if there is non-compliance with defined loan origination or documentation standards. In addition, we may have an obligation to repurchase a loan if the mortgagor has defaulted or paid the loan off early in the loan term. The potential default repurchase period varies by investor but can be up to nine months after sale of the loan to the investor.
We enter into commitments to originate residential mortgage loans whereby the interest rate on the loan is determined prior to funding (i.e. IRLCs). Such IRLCs on mortgage loans to be sold into the secondary market are considered derivatives. To protect against the price risk inherent in residential mortgage loan commitments, we utilizes "best efforts” forward sales contracts in delivering loans to investors. Under a "best efforts" contract, we commit to deliver an individual mortgage loan of a specified principal amount and quality to an investor and the investor commits to the price representing a premium on the day the borrower commits to an interest rate that it will pay for the loan it purchases from the Company if the loan to the underlying borrower closes. We protect ourselves from changes in interest rates through the use of forward sales commitments. The market values of IRLCs and forward sales contracts are not readily ascertainable because they are not actively traded. Because of the high correlation between IRLCs and forward sales contracts, we are not generally exposed to gains or losses on loans as a result of changes in interest rates.
Other Banking Products
We offer our customers wire transfer services, ACH services, ATM and check cards, automated teller machines at most of our full service branch locations, safe deposit boxes at some full service locations and credit cards through a third party processor. In addition to traditional deposit services, we offer telephone banking services, mobile banking, internet banking services and internet bill paying services to our customers. We also offer remote deposit capture to our commercial customers and mobile capture to our business and consumer customers.
EMPLOYEES
As of December 31, 2015, the Bank had 144 full-time and 12 part-time employees. None of our employees are represented by a union or covered under a collective bargaining agreement. Management considers its employee relations to be excellent.
SUPERVISION AND REGULATION
General
The Company is a savings and loan holding company registered with the Board of Governors of the Federal Reserve System (the “Federal Reserve”) under the Home Owners Loan Act of 1933, as amended (the “HOL Act”), and, as such, is subject to the supervision, examination and reporting requirements of the HOL Act and the regulations of the Federal Reserve. As a publicly traded company whose common stock is registered under Section 12(b) of the Exchange Act and listed on the NASDAQ Capital Market, the Company is also subject to regulation and supervision by the SEC and The NASDAQ Stock Market, LLC (“NASDAQ”).
The Bank is supervised and examined by the Office of the Comptroller of the Currency (“OCC”) and is also subject to examination by the FDIC. This regulation and supervision establishes a comprehensive framework of activities in which an institution may engage and is intended primarily for the protection of the FDIC’s deposit insurance funds and depositors, and not for the protection of stockholders. Under this system of federal regulation, financial institutions are periodically examined to ensure that they satisfy applicable standards with respect to their capital adequacy, assets, management, earnings, liquidity and sensitivity to market interest rates. The Bank also is a member of and owns stock in the Federal Home Loan Bank of Atlanta (the “FHLB”), which is one of the 12 regional banks in the Federal Home Loan Bank System. The Bank also is regulated to a lesser extent by the Federal Reserve, which governs reserves to be maintained against deposits and other matters. The OCC examines the Bank and prepares reports for the consideration of its board of directors on any operating deficiencies. The Bank’s relationship with its depositors and borrowers also is regulated to a great extent by federal law and, to a much lesser extent, state law, especially in matters
concerning the ownership of deposit accounts and the form and content of the Bank’s loan documents. In addition to the foregoing, there are a myriad of other federal and state laws and regulations that affect, impact or govern the business of banking, including consumer lending, deposit-taking, and trust operations.
All non-bank subsidiaries of the Company are subject to examination by the Federal Reserve, and, as affiliates of the Bank, are subject to examination by the OCC and the FDIC.
Any change in these laws by Congress or in these regulations by the Federal Reserve, the OCC or the FDIC could have a material adverse impact on the Company, the Bank and their operations.
Certain of the regulatory requirements that are applicable to the Bank and Company are described below. This description of statutes and regulations is not intended to be a complete description of such statutes and regulations and their effects on the Company and the Bank, and is qualified in its entirety by reference to the actual statutes and regulations.
Recent Regulatory Reforms
The Dodd-Frank Act, which was enacted in July 2010, significantly restructures the financial regulatory regime in the United States. Although the Dodd-Frank Act’s provisions that have received the most public attention generally have been those applying to or more likely to affect larger institutions such as banks and bank holding companies with total consolidated assets of $50 billion or more, it contains numerous other provisions that affect all financial institutions, including the Company and the Bank. The Dodd-Frank Act contains a wide variety of provisions (many of which are not yet effective) affecting the regulation of savings and loan holding companies and depository institutions, including restrictions related to mortgage originations, risk retention requirements as to securitized loans, and the establishment of a financial consumer protection agency, known as the Consumer Financial Protection Bureau (the “CFPB”), that is empowered to promulgate and enforce new consumer protection regulations and revise and enforce existing regulations in many areas of consumer compliance.
Moreover, not only are the states’ attorneys general entitled to enforce consumer protection rules issued by the CFPB, but states are permitted to adopt their own consumer protection laws that are more strict than those created under the Dodd-Frank Act. Recently, U.S. financial regulatory agencies have increasingly used general consumer protection statutes to address unethical or otherwise bad business practices that may not necessarily fall directly under the purview of a specific banking or consumer finance law. Prior to the Dodd-Frank Act, there was little formal guidance as to the parameters for compliance with the federal “unfair or deceptive acts or practices” (“UDAP”) laws. However, the UDAP provisions have been expanded under the Dodd-Frank Act to apply to “unfair, deceptive or abusive acts or practices”, which has been delegated to the CFPB for supervision.
The legislation also broadens the base for FDIC insurance assessments. Assessments will now be based on the average consolidated total assets less tangible equity capital of a financial institution. The Dodd-Frank Act also permanently increased the maximum amount of deposit insurance for banks, savings institutions and credit unions to $250,000 per depositor, retroactive to January 1, 2008. Lastly, the Dodd-Frank Act will increase stockholder influence over boards of directors by requiring companies to give stockholders the opportunity to approve or disapprove, by non-binding advisory votes, executive compensation and, in certain circumstances, so-called “golden parachute” payments. The legislation also directs the Federal Reserve to promulgate rules prohibiting excessive compensation paid to bank holding company executives, regardless of whether the company is publicly traded or not.
During 2013, significant media attention was given to the Dodd-Frank Act’s amendment of the Bank Holding Company Act of 1956 (the “BHC Act”) to require the U.S. financial regulatory agencies to adopt rules that prohibit banking institutions and their affiliates from engaging in proprietary trading and investing in and sponsoring certain unregistered investment companies (defined as hedge funds and private equity funds). The statutory provision is commonly called the “Volcker Rule”. The U.S. financial regulatory agencies adopted final rules implementing the Volcker Rule on December 10, 2013. The Volcker Rule became effective on July 21, 2012 and the final rules initially had an effective date of April 1, 2014, but the U.S. financial regulatory agencies issued an order extending the period during which institutions have to conform their activities and investments to the requirements of the Volcker Rule to July
21, 2015. On December 18, 2014, the Federal Reserve granted an additional one year extension to July 21, 2016, for certain “legacy covered fund” investments and relationships entered into by banking entities prior to December 31, 2013. The Federal Reserve also indicated that it planned to grant an additional one year extension to July 21, 2017, at a later date. We completed our evaluation of the impact of the Volcker Rule and the final rules adopted thereunder and determined that they will not have a material effect on our operations, as we believe that we do not engage in the businesses prohibited by the Volcker Rule. We may incur costs related to the adoption of additional policies and systems to ensure compliance with the Volcker Rule, but we do not expect that such costs would be material.
Many of the Dodd-Frank Act’s provisions are subject to final rulemaking by the U.S. financial regulatory agencies, and the Dodd-Frank Act’s impact on our business will depend to a large extent on how and when such rules are adopted and implemented by the primary U.S. financial regulatory agencies. We continue to analyze the impact of rules adopted under the Dodd-Frank Act on our business, but the full impact will not be known until the rules and related regulatory initiatives are finalized and their combined impact can be understood. We do anticipate that the Dodd-Frank Act will increase our regulatory compliance burdens and costs and may restrict the financial products and services that we offer to our customers in the future. In particular, the Dodd-Frank Act will require us to invest significant management attention and resources so that we can evaluate the impact of and ensure compliance with this law and its rules.
Federal Banking Regulation
Business Activities
As an FSB, the Bank derives its lending and investment powers from the HOL Act and the regulations, pronouncements or guidance of the OCC. Under these laws and regulations, the Bank may invest in mortgage loans secured by residential and nonresidential real estate, commercial business and consumer loans, certain types of securities and certain other loans and assets. Specifically, the Bank may originate, invest in, sell, or purchase unlimited loans on the security of residential real estate, while loans on nonresidential real estate generally may not, on a combined basis, exceed 400% of the Bank’s total capital. In addition, secured and unsecured commercial loans and certain types of commercial personal property leases may not exceed 20% of the Bank’s assets; however, amounts in excess of 10% of assets may only be used for small business loans. Further, the Bank may generally invest up to 35% of its assets in consumer loans, corporate debt securities and commercial paper on a combined basis, and up to the greater of its capital or 5.0% of its assets in unsecured construction loans. The Bank may invest up to 10% of its assets in tangible personal property, for rental or sale. The Bank also may establish subsidiaries that may engage in activities not otherwise permissible for the Bank directly, including real estate investment and insurance agency activities. A violation of the lending and investment limitations may be subject to the same enforcement mechanisms of the primary federal regulator as other violations of a law or regulation.
Capital Requirements
Federal regulations require federally insured depository institutions to meet several minimum capital standards: a common equity Tier 1 capital to risk-based assets ratio of 4.5%, a Tier 1 capital to risk-based assets ratio of 6.0%, a total capital to risk-based assets of 8.0%, and a 4.0% Tier 1 capital to total assets leverage ratio. These capital requirements were effective January 1, 2015 and are the result of a final rule implementing recommendations of the Basel Committee on Banking Supervision and certain requirements of the Dodd-Frank Act (the “Basel III Capital Rules”).
In determining the amount of risk-weighted assets for purposes of calculating risk-based capital ratios, all assets, including certain off-balance sheet assets (e.g., recourse obligations) are multiplied by a risk weight factor assigned by the regulations based on the risks believed inherent in the type of asset. Higher levels of capital are required for asset categories believed to present greater risk. Common equity Tier 1 capital is generally defined as common stockholders’ equity and retained earnings. Tier 1 capital is generally defined as common equity Tier 1 and additional Tier 1 capital. Additional Tier 1 capital includes certain noncumulative perpetual preferred stock and related surplus and minority interests in equity accounts of consolidated subsidiaries. Total capital includes Tier 1 capital (common equity Tier 1 capital plus additional Tier 1 capital) and Tier 2 capital. Tier 2 capital is comprised of capital instruments and
related surplus, meeting specified requirements, and may include cumulative preferred stock and long-term perpetual preferred stock, mandatory convertible securities, intermediate preferred stock and subordinated debt. Also included in Tier 2 capital is the allowance for loan and lease losses limited to a maximum of 1.25% of risk-weighted assets and, for institutions that have exercised an opt-out election regarding the treatment of Accumulated Other Comprehensive Income, up to 45% of net unrealized gains on available-for-sale equity securities with readily determinable fair market values. Calculation of all types of regulatory capital is subject to deductions and adjustments specified in the regulations. In assessing an institution’s capital adequacy, the OCC takes into consideration, not only these numeric factors, but qualitative factors as well, and has the authority to establish higher capital requirements for individual institutions where deemed necessary.
In addition to establishing the minimum regulatory capital requirements, the regulations limit capital distributions and certain discretionary bonus payments to management if the institution does not hold a “capital conservation buffer” consisting of 2.5% of common equity Tier 1 capital to risk-weighted asset above the amount necessary to meet its minimum risk-based capital requirements. The capital conservation buffer requirement is being phased in beginning January 1, 2016 at 0.625% of risk-weighted assets and increasing each year until fully implemented at 2.5% on January 1, 2019.
At December 31, 2015, the Bank’s capital exceeded all applicable regulatory requirements and the Bank was considered well capitalized.
Loans-to-One Borrower
Generally, an FSB may not make a loan or extend credit to a single or related group of borrowers in excess of 15% of unimpaired capital and surplus. An additional amount may be loaned, equal to 10% of unimpaired capital and surplus, if the loan is secured by readily marketable collateral, which generally does not include real estate. As of December 31, 2015, the Bank was in compliance with the loans-to-one-borrower limitations.
Qualified Thrift Lender Test
As an FSB, the Bank is subject to a qualified thrift lender (“QTL”) test. Under the QTL test, the Bank must maintain at least 65% of its “portfolio assets” in “qualified thrift investments” in at least nine months of the most recent 12-month period. “Portfolio assets” generally means the total assets of a savings institution, less the sum of specified liquid assets up to 20% of total assets, goodwill and other intangible assets, and the value of property used in the conduct of the FSB’s business.
“Qualified thrift investments” include various types of loans made for residential and housing purposes, investments related to those purposes, including certain mortgage-backed and related securities, and loans for personal, family, household and certain other purposes up to a limit of 20% of portfolio assets. “Qualified thrift investments” also include 100% of an institution’s credit card loans, education loans and small business loans. The Bank also may satisfy the QTL test by qualifying as a “domestic building and loan association” as defined in the Internal Revenue Code of 1986. At December 31, 2015, the Bank satisfied the QTL test. An FSB that fails the QTL test must operate under specified restrictions, including limits on growth, branching, new investment and dividends. As a result of the Dodd-Frank Act, noncompliance with the QTL test is subject to regulatory enforcement action as a violation of law.
Capital Distributions
OCC regulations govern capital distributions by an FSB, which include cash dividends, stock repurchases and other transactions charged to the FSB’s capital account. An FSB must file an application for approval of a capital distribution if:
| · | | the total capital distributions for the applicable calendar year exceed the sum of the FSB’s net income for that year to date plus the FSB’s retained net income for the preceding two years; |
| · | | the FSB would not be at least adequately capitalized following the distribution; |
| · | | the distribution would violate any applicable statute, regulation, agreement or OCC imposed condition; or |
| · | | the FSB is not eligible for expedited treatment of its filings. |
Even if an application is not otherwise required, every FSB that is a subsidiary of a holding company must still file a notice with the OCC at least 30 days before the board of directors declares a dividend or approves a capital distribution.
The OCC may disapprove an application or object to a notice of proposed distribution if:
| · | | the FSB would be undercapitalized following the distribution; |
| · | | the proposed capital distribution raises safety and soundness concerns; or the capital distribution would violate a prohibition contained in any statute, regulation or agreement. |
In addition, the Federal Deposit Insurance Act of 1991 (the “FDI Act”) provides that an insured depository institution shall not make any capital distribution if the institution would be undercapitalized after making such distribution.
Liquidity
An FSB is required to maintain a sufficient amount of liquid assets to ensure its safe and sound operation. Historically, the regulation and monitoring of liquidity has been addressed as a supervisory matter, without required formulaic measures. The liquidity framework under the Basel III Capital Rules requires banks and their holding companies to measure their liquidity against specific liquidity tests that, although similar in some respects to liquidity measures historically applied by banks and regulators for management and supervisory purposes, going forward would be required by regulation. One test, referred to as the LCR, is designed to ensure that the banking entity maintains an adequate level of unencumbered high-quality liquid assets equal to the entity’s expected net cash outflow for a 30-day time horizon (or, if greater, 25% of its expected total cash outflow) under an acute liquidity stress scenario. The other test, referred to as the net stable funding ratio (“NSFR”), is designed to promote more medium- and long-term funding of the assets and activities of banking entities over a one year time horizon. These requirements will incent banking entities to increase their holdings of U.S. Treasury securities and other sovereign debt as a component of assets and increase the use of long-term debt as a funding source. In October 2013, the federal banking agencies proposed rules implementing the LCR for advanced approaches banking organizations and a modified version of the LCR for savings and loan holding companies with at least $50 billion in total consolidated assets that are not advanced approach banking organizations, neither of which would apply to the Company or the Bank.
Community Reinvestment Act and Fair Lending Laws
All FSBs have a responsibility under the Community Reinvestment Act (“CRA”) and related regulations of the OCC to help meet the credit needs of their communities, including low and moderate income borrowers. In connection with its examination of an FSB, the OCC is required to assess the FSB’s record of compliance with the CRA. In addition, the Equal Credit Opportunity Act and the Fair Housing Act prohibit lenders from discriminating in their lending practices on the basis of characteristics specified in those statutes. An FSB’s failure to comply with the provisions of the CRA could, at a minimum, result in denial of certain corporate applications such as branches or mergers, or in restrictions on its activities. The failure to comply with the Equal Credit Opportunity Act and the Fair Housing Act could result in enforcement actions by the OCC, as well as other federal regulatory agencies and the Department of Justice. As of December 31, 2015, the Bank’s CRA rating was “Satisfactory.” All FDIC-insured institutions are required to make available to the public their most recent CRA performance evaluation.
Transactions with Related Parties
An FSB’s authority to engage in transactions with its affiliates is limited by OCC regulations and by Sections 23A and 23B of the Federal Reserve Act and its implementing Regulation W promulgated by the Federal Reserve. An affiliate is generally a company that controls or is under common control with an insured depository institution such as the Bank. The Company is an affiliate of the Bank. In general, transactions between an insured depository institution and its affiliates are subject to certain quantitative and collateral requirements. In addition, OCC regulations prohibit an FSB from lending to any of its affiliates that are engaged in activities that are not permissible for bank holding companies and from purchasing the securities of any affiliate, other than a subsidiary. Finally, transactions with affiliates must be consistent with safe and sound banking practices, not involve low quality assets and be on terms that are at least as favorable to the institution as comparable transactions with non-affiliates. The OCC requires FSBs to maintain detailed records of all transactions with affiliates.
The Bank’s authority to extend credit to its directors, executive officers and 10% stockholders, as well as to entities controlled by such persons, is currently governed by the requirements of Sections 22(g) and 22(h) of the Federal Reserve Act and Regulation O of the Federal Reserve. Among other things, these provisions require that extensions of credit to insiders:
| (i) | | be made on terms that are substantially the same as, and follow credit underwriting procedures that are not less stringent than, those prevailing for comparable transactions with unaffiliated persons and that do not involve more than the normal risk of repayment or present other unfavorable features; and |
| (ii) | | not exceed certain limitations on the amount of credit extended to such persons, individually and in the aggregate, which limits are based, in part, on the amount of the Bank’s capital. |
In addition, extensions of credit in excess of certain limits must be approved by the Bank’s board of directors.
Enforcement
The OCC has primary enforcement responsibility over FSBs and has the authority to bring enforcement action against all “institution-affiliated parties,” including directors, officers, stockholders, attorneys, appraisers and accountants who knowingly or recklessly participate in wrongful action likely to have an adverse effect on an FSB. Formal enforcement action by the OCC may range from the issuance of a capital directive or cease and desist order, to removal of officers and/or directors of the institution, and the appointment of a receiver or conservator. Civil penalties cover a wide range of violations and actions, and range up to $25,000 per day, unless a finding of reckless disregard is made, in which case penalties may be as high as $1 million per day. The FDIC also has the authority to terminate deposit insurance or to recommend to the OCC that enforcement action be taken with respect to a particular savings institution. If action is not taken by the OCC, the FDIC has authority to take action under specified circumstances.
Standards for Safety and Soundness
Federal law requires each federal banking agency to prescribe certain standards for all insured depository institutions. These standards relate to, among other things, internal controls, information systems and audit systems, loan documentation, credit underwriting, interest rate risk exposure, asset growth, compensation, and other operational and managerial standards as the agency deems appropriate. Interagency guidelines set forth the safety and soundness standards that the federal banking agencies use to identify and address problems at insured depository institutions before capital becomes impaired. If the appropriate federal banking agency determines that an institution fails to meet any standard prescribed by the guidelines, the agency may require the institution to submit to the agency an acceptable plan to achieve compliance with the standard. If an institution fails to meet these standards, the appropriate federal banking agency may require the institution to implement an acceptable compliance plan. Failure to implement such a plan can result in further enforcement action, including the issuance of a cease and desist order or the imposition of civil money penalties.
Prompt Corrective Action Regulations
Under the Federal Prompt Corrective Action statute, the OCC is required to take supervisory actions against undercapitalized savings institutions under its jurisdiction, the severity of which depends upon the institution’s level of capital. The previously mentioned final capital rule effective January 1 , 2015 revised the prompt corrective action categories to incorporate the revised minimum capital requirements, effective the same date. See the discussion above under the heading, “Capital Requirements.”
Under the revised categories, a savings institution that has total risk-based capital of less than 8%, a leverage ratio that is less than 4%, a Tier 1 risk-based capital ratio that is less than 6%, or a common equity Tier 1 ratio of less than 4.5% is considered to be undercapitalized. A savings institution that has total risk-based capital less than 6%, a Tier 1 risk-based capital ratio of less than 4%, a leverage ratio that is less than 3%, or a common equity Tier 1 ratio of less than 3% is considered to be “significantly undercapitalized.” A savings institution that has a tangible capital to assets ratio equal to or less than 2% is deemed to be “critically undercapitalized."
Generally, the banking regulator is required to appoint a receiver or conservator for an FSB that is “critically undercapitalized.” The regulations also provide that a capital restoration plan must be filed with the OCC within 45 days of the date a bank receives notice that it is “undercapitalized,” “significantly undercapitalized” or “critically undercapitalized.” A parent holding company for the institution involved must guarantee performance under the capital restoration plan up to the lesser of the institution’s capital deficiency when deemed undercapitalized or 5% of the institution’s assets. In addition, numerous mandatory supervisory actions become immediately applicable to the FSB, including, but not limited to, restrictions on growth, investment activities, capital distributions and affiliate transactions. The OCC may also take any one of a number of discretionary supervisory actions against undercapitalized FSBs, including the issuance of a capital directive and individual minimum capital requirements and the replacement of senior executive officers and directors.
At December 31, 2015, the Bank met the criteria for being considered “well-capitalized”.
Insurance of Deposit Accounts
The Dodd-Frank Act permanently increased the maximum amount of deposit insurance for banks, savings institutions and credit unions to $250,000 per depositor, retroactive to January 1, 2008.
Effective April 1, 2011, the FDIC implemented a requirement of the Dodd-Frank Act to revise its assessment system to base it on each institution’s total assets less tangible capital instead of deposits. The FDIC also revised its assessment schedule so that it ranges from 2.5 basis points for the least risky institutions to 45 basis points for the riskiest.
Insurance of deposits may be terminated by the FDIC 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 regulatory condition imposed in writing. We do not know of any practice, condition or violation that might lead to termination of deposit insurance.
Prohibitions Against Tying Arrangements
FSBs are prohibited, subject to some exceptions, from extending credit to or offering any other service, or fixing or varying the consideration for such extension of credit or service, on the condition that the customer obtain some additional service from the institution or its affiliates or not obtain services of a competitor of the institution.
Federal Home Loan Bank System
The Bank is a member of the FHLB, which is one of 12 regional banks in the Federal Home Loan Bank System. The FHLB System provides a central credit facility primarily for member institutions as well as other entities involved in
home mortgage lending. The Bank is required to acquire and hold shares of capital stock of the FHLB as a condition of membership. As of December 31, 2015, the Bank was in compliance with this requirement.
Other Regulations
Interest and other charges collected or contracted for by the Bank are subject to state usury laws and federal laws concerning interest rates. The Bank’s operations are also subject to federal laws applicable to credit transactions, such as the:
| · | | Truth-In-Lending Act, governing disclosures of credit terms to consumer borrowers; |
| · | | Home Mortgage Disclosure Act, requiring financial institutions to provide information to enable the public and public officials to determine whether a financial institution is fulfilling its obligation to help meet the housing needs of the community it serves; |
| · | | Equal Credit Opportunity Act, prohibiting discrimination on the basis of race, creed or other prohibited factors in extending credit; |
| · | | Fair Credit Reporting Act, governing the use and provision of information to credit reporting agencies; |
| · | | Fair Debt Collection Act, governing the manner in which consumer debts may be collected by collection agencies; |
| · | | Truth in Savings Act; and |
| · | | Rules and regulations of the various federal agencies charged with the responsibility of implementing such federal laws. |
The operations of the Bank also are subject to the:
| · | | Right to Financial Privacy Act, which imposes a duty to maintain confidentiality of consumer financial records and prescribes procedures for complying with administrative subpoenas of financial records; |
| · | | Electronic Funds Transfer Act and Regulation E promulgated thereunder, which govern automatic deposits to and withdrawals from deposit accounts and customers’ rights and liabilities arising from the use of automated teller machines and other electronic banking services; |
| · | | Check Clearing for the 21st Century Act (also known as “Check 21”), which gives “substitute checks,” such as digital check images and copies made from that image, the same legal standing as the original paper check; |
| · | | The Uniting and Strengthening America by Providing Appropriate Tools Required to Intercept and Obstruct Terrorism Act, commonly referred to as the "USA Patriot Act", which requires FSBs to, among other things, establish broadened anti-money laundering compliance programs, and due diligence policies and controls to ensure the detection and reporting of money laundering. Such required compliance programs are intended to supplement existing compliance requirements that also apply to financial institutions under the Bank Secrecy Act and the Office of Foreign Assets Control regulations; and |
| · | | The Gramm-Leach-Bliley Act, which places limitations on the sharing of consumer financial information by financial institutions with unaffiliated third parties. Specifically, the Gramm-Leach-Bliley Act requires all financial institutions offering financial products or services to retail customers to provide such customers with the financial institution’s privacy policy and provide such customers the opportunity to “opt out” of the sharing of certain personal financial information with unaffiliated third parties. |
Bank Secrecy Act
Under the Bank Secrecy Act (“BSA”), a financial institution is required to have systems in place to detect certain transactions, based on the size and nature of the transaction. Financial institutions are generally required to report cash transactions in excess of $10,000 to the United States Treasury. In addition, financial institutions are required to file suspicious activity reports for transactions in excess of $5,000 and which the financial institution knows, suspects, or has reason to suspect involves illegal funds, is designed to evade the requirements of the BSA, or has no lawful purpose. The USA Patriot Act enacted prohibitions against specified financial transactions and account relationships, as well as enhanced due diligence standards intended to prevent the use of the United States financial system for money laundering and terrorist financing activities. The USA Patriot Act requires banks and other depository institutions, brokers, dealers and certain other businesses involved in the transfer of money to establish anti-money laundering programs, including employee training and independent audit requirements meeting minimum standards specified by the act, to follow standards for customer identification and maintenance of customer identification records, and to compare customer lists against lists of suspected terrorists, terrorist organizations and money launderers. The USA Patriot Act also requires federal bank regulators to evaluate the effectiveness of an applicant in combating money laundering in determining whether to approve a proposed bank acquisition.
Supervision and Regulation of Mortgage Banking Operations
Our mortgage banking business is subject to the rules and regulations of the U.S. Department of Housing and Urban Development (“HUD”), the Federal Housing Administration (“FHA”), the Veterans' Administration (“VA”), and Fannie Mae with respect to originating, processing, selling and servicing mortgage loans. Those rules and regulations, among other things, prohibit discrimination and establish underwriting guidelines, which include provisions for inspections and appraisals, require credit reports on prospective borrowers, and fix maximum loan amounts. Lenders such as us are required annually to submit audited financial statements to Fannie Mae, FHA and VA. Each of these regulatory entities has its own financial requirements. We are also subject to examination by the Federal Reserve, Fannie Mae, FHA and VA at all times to assure compliance with the applicable regulations, policies and procedures. Mortgage origination activities are subject to, among others, the Equal Credit Opportunity Act, Federal Truth-in-Lending Act, Fair Housing Act, Fair Credit Reporting Act, the National Flood Insurance Act and the Real Estate Settlement Procedures Act and related regulations that prohibit discrimination and require the disclosure of certain basic information to mortgagors concerning credit terms and settlement costs. Our mortgage banking operations also are affected by various state and local laws and regulations and the requirements of various private mortgage investors.
In January 2013, the CFPB issued eight final regulations governing mainly consumer mortgage lending. These regulations became effective in January 2014.
One of these rules, effective on January 10, 2014, requires mortgage lenders to make a reasonable and good faith determination based on verified and documented information that a consumer applying for a mortgage loan has a reasonable ability to repay the loan according to its terms. This rule also defines “qualified mortgages.” In general, a “qualified mortgage” is a mortgage loan without negative amortization, interest-only payments, balloon payments, or a term exceeding 30 years, where the lender determines that the borrower has the ability to repay, and where the borrower’s points and fees do not exceed 3% of the total loan amount. Qualified mortgages that that are not “higher-priced” are afforded a safe harbor presumption of compliance with the ability to repay rules. Qualified mortgages that are “higher-priced” garner a rebuttable presumption of compliance with the ability to repay rules.
The CFPB regulations also: (i) require that “higher-priced” mortgages must have escrow accounts for taxes and insurance and similar recurring expenses; (ii) expand the scope of the high-rate, high-cost mortgage provisions by, among other provisions, lowering the rates and fees that lead to coverage and including home equity lines of credit; (iii) revise rules for mortgage loan originator compensation; (iv) add prohibitions against mandatory arbitration provisions and financing single premium credit insurances; and (v) impose a broader requirement for providing borrowers with copies of all appraisals on first-lien dwelling secured loans.
Effective January 10, 2014, the CFPB’s final Truth-in-Lending Act rules relating to mortgage servicing impose new obligations to credit payments and provide payoff statements within certain time periods and provide new notices
prior to interest rate and payment adjustments. Effective on that same date, the CFPB’s final Real Estate Settlement Procedures Act rules add new obligations on the servicer when a mortgage loan is in default.
On November 20, 2013, the CFPB issued a final rule on integrated mortgage disclosures under the Truth-in-Lending Act and the Real Estate Settlement Procedures Act, for which compliance was required by October 3, 2015. As of December 31, 2015, we are in compliance with these integrated mortgage disclosure rules.
Holding Company Regulation
General
The Company is a non-diversified savings and loan holding company within the meaning of the HOL Act. As such, the Company is registered with the Federal Reserve and is subject to Federal Reserve regulations, examinations and reporting requirements. In addition, the Federal Reserve has enforcement authority over the Company and its non-insured subsidiaries. Among other things, this authority permits the Federal Reserve to restrict or prohibit activities that are determined to be a serious risk to the subsidiary savings institution.
Permissible Activities
Under present law, the business activities of the Company are generally limited to those activities permissible for financial holding companies under Section 4(k) of the BHC Act or for multiple savings and loan holding companies. A financial holding company may engage in activities that are financial in nature, including underwriting equity securities and insurance as well as activities that are incidental to financial activities or complementary to a financial activity. A multiple savings and loan holding company is generally limited to activities permissible for bank holding companies under Section 4(c) (8) of the BHC Act, subject to the prior approval of the Federal Reserve, and certain additional activities authorized by Federal Reserve regulations.
Federal law prohibits a savings and loan holding company, including the Company, directly or indirectly, or through one or more subsidiaries, from acquiring more than 5% of another savings institution or holding company thereof, without prior written approval of the Federal Reserve. It also prohibits the acquisition or retention of, with certain exceptions, more than 5% of a nonsubsidiary company engaged in activities that are not closely related to banking or financial in nature, or acquiring or retaining control of an institution that is not federally insured. In evaluating applications by holding companies to acquire savings institutions, the Federal Reserve must consider the financial and managerial resources, future prospects of the company and institution involved, the effect of the acquisition on the risk to the federal deposit insurance fund, the convenience and needs of the community and competitive factors.
The Federal Reserve is prohibited from approving any acquisition that would result in a multiple savings and loan holding company controlling savings institutions in more than one state, subject to two exceptions:
| (i) | | the approval of interstate supervisory acquisitions by savings and loan holding companies; and |
| (ii) | | the acquisition of a savings institution in another state if the laws of the state of the target savings institution specifically permit such acquisition. |
The states vary in the extent to which they permit interstate savings and loan holding company acquisitions.
Capital
Savings and loan holding companies have not historically been subject to specific regulatory capital requirements. The Dodd-Frank Act, however, required the Federal Reserve to promulgate consolidated capital requirements for depository institution holding companies that are no less stringent, both quantitatively and in terms of components of capital, than those applicable to their subsidiary depository institutions. Instruments such as cumulative preferred stock and trust-preferred securities, which were previously includable within Tier 1 capital by bank holding companies, within certain limits, would no longer be includable as Tier 1 capital, subject to certain grandfathering. The
previously discussed final rule regarding regulatory capital requirements implements the Dodd-Frank Act as to savings and loan holding companies. Consolidated regulatory capital requirements identical to those applicable to the subsidiary depository institutions applied to savings and loan holding companies as of January 1, 2015. As is the case with institutions themselves, the capital conservation buffer will be phased in between 2016 and 2019.
Dividends
The Federal Reserve has issued a policy statement regarding the payment of dividends by bank holding companies that it has made applicable to savings and loan holding companies as well. In general, the policy provides that dividends should be paid only out of current earnings and only if the prospective rate of earnings retention by the holding company appears consistent with the organization’s capital needs, asset quality and overall financial condition. Regulatory guidance provides for prior regulatory review of capital distributions in certain circumstances such as where the company’s net income for the past four quarters, net of dividends previously paid over that period, is insufficient to fully fund a dividend or the company’s overall rate of earnings retention is inconsistent with the company’s capital needs and overall financial condition. The ability of a holding company to pay dividends may be restricted if a subsidiary bank becomes undercapitalized. These regulatory policies could affect the ability of the Company to pay dividends or otherwise engage in capital distributions and stock repurchases.
Source of Strength Doctrine
The “source of strength doctrine” requires bank holding companies to provide financial assistance to their subsidiary depository institutions in the event the subsidiary depository institution experiences financial distress. The Dodd-Frank Act extends the source of strength doctrine to savings and loan holding companies. The Federal Reserve has issued regulations requiring that all bank holding companies and savings and loan holding companies serve as a source of strength to their subsidiary depository institutions by providing capital, liquidity and other support in times of financial distress.
Sarbanes-Oxley Act of 2002
The Sarbanes-Oxley Act of 2002 (the “Sarbanes-Oxley Act”) established a broad range of corporate governance and accounting measures intended to increase corporate responsibility and protect investors by improving the accuracy and reliability of disclosures under federal securities laws. We are subject to Sarbanes-Oxley Act because we are required to file periodic reports with the SEC under the Exchange Act. Among other things, Sarbanes-Oxley Act, its implementing regulations and related NASDAQ Stock Market rules have established membership requirements and additional responsibilities for our audit committee, imposed restrictions on the relationship between us and our outside auditors (including restrictions on the types of non-audit services our auditors may provide to us), imposed additional financial statement certification responsibilities for our chief executive officer and chief financial officer, expanded the disclosure requirements for corporate insiders, and required management to evaluate our disclosure controls and procedures and our internal control over financial reporting.
ITEM 1A. RISK FACTORS
We take on a certain amount of risk in every business decision or activity. The challenge of risk management is not to eliminate risk, but to identify and measure our risks and then to effectively manage those risks in order to optimize stockholder value. As a banking institution, our risks fall into five broad categories of risk: credit risk, market risk, liquidity risk, operational risk, and reputational risk. The following discussion highlights the most significant risk factors of which we are aware that could affect us. Additional risks and uncertainties that we either are not aware of or do not believe to be material could also adversely affect us. If any of the following risk factors were to occur, our business, financial condition, or results of operations could be materially and adversely affected. Before making an investment decision, you should carefully consider the potential risks described below together with all of the other information included or incorporated by reference in this report.
Risks Relating to the Company and its Affiliates
The Company’s future success depends on the successful growth of its subsidiaries.
The Company’s primary business activity for the foreseeable future will be to act as the holding company of the Bank and its other direct and indirect subsidiaries. Therefore, the Company’s future profitability will depend on the success and growth of these subsidiaries. In the future, part of our growth may come from buying other depository institutions and buying or establishing other companies. Such entities may not be profitable after they are purchased or established, and they may lose money, particularly at first. A new bank or company may bring with it unexpected liabilities, bad loans, or bad employee relations, or the new bank or company may lose customers.
We could experience significant difficulties and complications in connection with our growth and acquisition strategy, including the proposed Hopkins Merger.
We grew significantly in 2013 and 2014 through acquisitions and have applied for approval of the Hopkins Merger that is expected to close in the second quarter of 2016. We intend to continue to grow both organically and by acquiring financial institutions and branches. However, the market for acquisitions is highly competitive. We may not be as successful in identifying financial institutions and branch acquisition candidates, integrating acquired institutions or preventing deposit erosion at acquired institutions or branches as we currently anticipate. Even if we are successful with this strategy, we may not be able to manage this growth adequately and profitably due to unforeseen risks including:
| · | | Potential exposure to unknown or contingent liabilities of acquired banks; |
| · | | Potential exposure to asset quality issues of acquired banks; |
| · | | Potential disruption to our existing business; |
| · | | Potential diversion of the time and attention of our management; and |
| · | | Potential loss of key employees and customers of the banks and other businesses that we acquire. |
We may also encounter unforeseen expenses, as well as difficulties and complications in integrating expanded operations and new employees without disruption to our overall operations. Following each acquisition, we must expend substantial resources to integrate the entities. To manage future growth effectively, we will have to maintain and enhance financial and accounting systems and controls, as well as integrate new personnel and manage expanded operations. There can be no assurance that we will be able to effectively manage our expanding operations. If we are unable to manage growth effectively, our business, financial condition, and results of operations could be materially and adversely affected.
Finally, we may expend significant cash and other resources in connection with a proposed acquisition, such as the Hopkins Merger, that, ultimately, may not be approved by our regulators or the institution’s stockholders, or may not close due to unforeseen circumstances, such as inaccurate representations and warranties made by a party in the definitive acquisition agreement, a party’s breach of its covenants contained in the definitive acquisition agreement, material changes in conditions, and other situations that may be negotiated and agreed upon by the parties. In addition, we may change our strategies in contemplation of such an acquisition and its anticipated effects on our financial condition and/or results of operations. If an acquisition does not close, then these factors could have a material adverse effect on our future financial condition and results of operations and/or could cause our future financial condition and results of operations to differ materially from our expectations. Moreover, a failed acquisition could significantly harm our reputation and cause our investors and customers to lose confidence in us.
We face intense competition in our target markets.
The financial services industry, including commercial banking, mortgage banking, consumer lending and home equity lending, is highly competitive, and we will continue to encounter strong competition for deposits, loans and other
financial services in our target markets in each of our lines of business. Our principal competitors in our target markets are other FSBs, commercial banks and credit unions. However, additional competition is and will continue to be provided by mutual funds, money market funds, finance companies, trust companies, insurers, leasing companies, credit unions and mortgage companies with respect to some of our products and services. Many of our non-bank competitors are not subject to the same degree of regulation as us and thus have advantages over us in providing certain services. Many of our bank and credit union competitors are significantly larger than us and have greater access to capital and other resources, higher lending limits and larger branch networks. These competitive factors may have a material adverse effect on the profitability of our lending and deposit operations.
We may be adversely affected by conditions in the local market where we operate and by the national economy.
Our business activities are concentrated in the greater Baltimore metropolitan area of Maryland. As a result, our financial condition and results of operations are sensitive to changes in local economic and business conditions. In addition, a significant decline in general economic conditions nationally caused by inflation, recession, acts of terrorism, outbreak of hostilities or other international or domestic occurrences, unemployment, changes in securities markets, declines in the housing market, a tightening credit environment or other factors could impact these local economic conditions and, in turn, have an adverse effect on our financial condition and results of operations.
Although economic conditions have improved since the economic recession ended in June 2009, certain sectors, such as real estate and manufacturing, remain weak. Future declines in real estate values, home sales volumes, and financial stress on borrowers as a result of an uncertain economic environment could have an adverse effect on our customers, which could adversely affect our financial condition and results of operations. In addition, local governments and many businesses are still experiencing difficulty due to lower consumer spending. Any deterioration in local economic conditions could drive losses beyond that which is provided for in our allowance for loan losses. We may also face the following risks in connection with these events:
| · | | Economic conditions that negatively affect housing prices and the job market have resulted, and could again result, in deterioration in credit quality of our loan portfolios, and such deterioration in credit quality has had, and could continue to have, a negative impact on our business; |
| · | | Market developments may affect consumer confidence levels and may cause adverse changes in payment patterns, causing increases in delinquencies and default rates on loans and other credit facilities; and/or |
| · | | The processes we use to estimate the allowance for loan losses and reserves may no longer be reliable because they rely on complex judgments that may no longer be capable of accurate estimation. |
Our ability to assess the creditworthiness of customers and to estimate the losses inherent in our loan portfolio is made more complex by these deteriorating market and economic conditions. A prolonged national economic recession or deterioration of conditions in our local markets could drive losses beyond that which is provided for in our allowance for credit losses and result in the following consequences:
| · | | Increases in loan delinquencies; |
| · | | Increases in nonperforming assets and foreclosures; |
| · | | Decreases in demand for our products and services, which could adversely affect our liquidity position; and/or |
| · | | Decreases in the value of the collateral securing our loans, especially real estate, which could reduce customers’ borrowing power. |
The occurrence of any of the above or similar conditions could have an adverse effect on our borrowers or their customers, which could adversely affect our business, financial condition, results of operations and cash flows.
The activities and financial condition of other financial institutions with which we do business could adversely affect us.
Our ability to engage in routine funding transactions could be adversely affected by the actions and commercial soundness of other financial institutions. Financial services institutions are interrelated as a result of trading, clearing, counterparty or other relationships. We have exposure to many different industries and counterparties, including counterparties in the financial industry, such as commercial banks and other institutional clients. As a result, defaults by, or even rumors or questions about, one or more financial services institutions, or the financial services industry generally, have led to market-wide liquidity problems and could lead to losses or defaults by us or by other institutions. Many of these transactions will expose us to credit risk in the event of default of a counterparty or client. In addition, this credit risk may be exacerbated when the collateral we hold cannot be realized upon liquidation or is liquidated at prices not sufficient to recover the full amount of the financial instrument exposure due to us. There is no assurance that any such losses would not materially and adversely affect our results of operations.
Our allowance for loan losses may not be sufficient to cover actual loan losses.
To absorb probable, incurred loan losses that we may realize, we recognize an allowance for loan losses based on, among other things, national and regional economic conditions, historical loss experience, and delinquency trends. However, we cannot estimate loan losses with certainty, and we cannot assure you that charge offs in future periods will not exceed the allowance for loan losses. If charge offs exceed our allowance, our earnings would be adversely affected. In addition, regulatory agencies, as an integral part of their examination process, review our allowance for loan losses and may require additions to the allowance based on their judgment about information available to them at the time of their examination.
Because our loan portfolio includes a substantial amount of commercial real estate loans, our earnings will be particularly sensitive to the financial and credit risks associated with these types of loans.
The financial and credit risk associated with commercial real estate loans is a result of several factors, including the concentration of principal in a limited number of loans and borrowers, the size of loan balances, which is generally larger than consumer-type loans, and the effects of general economic conditions. Any significant failure of our customers to either pay on time or comply with the conditions of their loans would adversely affect our results of operations.
Our commercial real estate loan portfolio represented approximately 43% of the total loan portfolio as of December 31, 2015. Underwriting and portfolio management activities cannot eliminate all risks related to these loans. Commercial real estate loans will typically be larger than consumer loans and may pose higher risks than other types of loans. This portfolio is bifurcated into “investor” and “owner-occupied” classes, with investor loans representing approximately 67% of the commercial real estate loan portfolio and 29% of the total loan portfolio. The primary source of repayment for investor commercial real estate loans is through the income stream generated by the property or successful development and sale of their properties. We may incur losses on investor commercial real estate loans due to declines in occupancy rates, rental rates and capitalization rates, which may decrease property values and may potentially decrease the likelihood that a borrower may find permanent financing alternatives.
At December 31, 2015, owner-occupied commercial real estate loans represented approximately 33% of the commercial real estate loan portfolio and 14% of the total loan portfolio. The primary source of repayment for owner-occupied real estate loans is the cash flow produced by the related commercial enterprise, and the value of the real estate is a secondary source of repayment of the loan. If we are required to liquidate the collateral securing a loan to satisfy the debt, our earnings and capital could be adversely affected.
The Bank’s lending activities subject the Bank to the risk of environmental liabilities.
A significant portion of the Bank’s loan portfolio is secured by real property. During the ordinary course of business, the Bank may foreclose on and take title to properties securing certain loans. In doing so, there is a risk that hazardous or toxic substances could be found on these properties. If hazardous or toxic substances are found, the Bank
may be liable for remediation costs, as well as for personal injury and property damage. Environmental laws may require the Bank to incur substantial expenses and may materially reduce the affected property’s value or limit the Bank’s ability to use or sell the affected property. In addition, future laws or more stringent interpretations or enforcement policies with respect to existing laws may increase the Bank’s exposure to environmental liability. Although the Bank has policies and procedures to perform an environmental review before initiating any foreclosure action on real property, these reviews may not be sufficient to detect all potential environmental hazards. The remediation costs and any other financial liabilities associated with an environmental hazard could have a material adverse effect on our financial condition and results of operations.
We may not be able to access funding sufficient to support our asset growth.
Our business plan and marketing strategy is based on access to funding from local customer deposits, such as checking and savings accounts and certificates of deposits. Deposit levels may be affected by a number of factors, including rates paid by competitors, general interest rate levels, FDIC insurance costs, returns available to customers on alternative investments and general economic conditions. If local customer deposits are not sufficient to fund our asset growth, we will look to outside sources such as advances from the FHLB. Since the FHLB provides secured funding, our ability to access advances from the FHLB will be dependent upon whether and to the extent we can provide collateral. We may also look to brokered deposits or branch acquisitions as a source of liquidity. An inability to obtain alternative funding to supplement our local core deposits or FHLB advances, or a substantial, unexpected, or prolonged change in the level or cost of liquidity could have a negative effect on our business, financial condition and results of operations.
Fluctuations in interest rates could reduce our profitability as we expect to realize income primarily from the difference between interest earned on loans and investments and interest paid on deposits and borrowings.
Our earnings are significantly dependent on net interest income, as we realize income primarily from the difference between interest earned on loans and investments and the interest paid on deposits and borrowings. We will experience “gaps” in the interest rate sensitivities of our assets and liabilities, meaning that either our interest-bearing liabilities will be more sensitive to changes in market interest rates than our interest-earning assets, or vice versa. In either event, if market interest rates should move contrary to our position, this “gap” may work against us, negatively affecting our earnings. We are unable to predict fluctuations of market interest rates, which are affected by many factors, including inflation, recession, rise in unemployment, tightening money supply, and disorder and instability in domestic and foreign financial markets. Although our asset-liability management strategy is intended to mitigate risk from changes in market interest rates, we may not be able to prevent changes in interest rates from having a material adverse effect on our results of operations and financial condition.
Our investment securities portfolio is subject to credit risk, market risk, and liquidity risk.
The investment securities portfolio has risk factors beyond our control that may significantly influence its fair value. These risk factors include, but are not limited to, rating agency downgrades, issuer defaults, lack of market pricing, and instability in the credit markets. Any changes in these risk factors could negatively affect our accumulated other comprehensive income and stockholders’ equity depending on the direction of the fluctuations. Furthermore, future downgrades, defaults or prepayments, including the liquidation of the underlying collateral in certain securities, could result in future classifications as other-than-temporarily impaired. This could have a material impact on our future earnings, although the impact on stockholders’ equity will be offset by any amount already included in other comprehensive income for securities that were temporarily impaired.
We are subject to operational risk.
Like all businesses, we are subject to operational risk, which represents the risk of loss resulting from inadequate or failed internal processes in our systems, human error, and external events. Operational risk also encompasses technology, compliance and legal risk, which is the risk of loss from violations of, or noncompliance with, rules, regulations, prescribed practices or ethical standards, as well as the risk of our noncompliance with contractual and other obligations. We are also exposed to operational risk through our outsourcing arrangements, and the effect that any
changes in circumstances or capabilities of these outsourcing vendors can have on our ability to continue to perform operational functions necessary to our business. Although we seek to mitigate operational risks through a system of internal controls which we regularly review and update, no system of controls, however well designed and maintained, is infallible. Control weaknesses or failures or other operational risks could result in charges, increased operational costs, harm to our reputation or foregone business opportunities.
Failure to maintain effective internal control over financial reporting could impair our ability to prevent fraud or report accurately and timely financial results, resulting in loss of investor confidence and adversely affecting our business and stock price.
We are required by the Sarbanes-Oxley Act to establish and maintain effective disclosure controls and procedures and an effective system of internal control over financial reporting. These control systems are intended to provide reasonable assurance that material information relating to us is made known to management and reported as required by the Exchange Act, to provide reasonable assurance regarding the reliability and preparation of our financial statements, and to provide reasonable assurance that fraud and other unauthorized uses of our assets are detected and prevented. Any failure to maintain an effective internal control environment could impact our ability to report financial results on an accurate and timely basis, which could result in regulatory actions, loss of investor confidence, and adversely impact our business and stock price.
We are dependent on key personnel, including our executive officers and directors, and the loss of such persons may adversely affect our operations and financial performance.
We are dependent on the continued services of our executive officers, whose skills and years of industry experience are critical to the successful implementation of our business strategy. Should the services of these key executives become unavailable, there can be no assurance that a suitable successor could be found who would be willing to be employed upon the terms and conditions that we would offer. A failure to replace any of these individuals promptly could have an adverse effect on our results of operations and financial performance. Additionally, the community involvement, diverse backgrounds, and extensive local business relationships of our directors is important to our success. If the composition of our board of directors were to change significantly, our banking business could suffer.
We are, and will continue to be, subject to extensive regulation in the conduct of our business operations, which could adversely affect our financial results.
The banking industry is heavily regulated. Banking regulations are primarily intended to protect the federal deposit insurance funds and depositors, not stockholders. These regulations affect lending practices, capital structure, investment practices, dividend policy and growth, among other things. For example, federal and state consumer protection laws and regulations will limit the manner in which we may offer and extend credit. From time to time, the United States Congress and state legislatures consider changing these laws and may enact new laws or amend existing laws to further regulate the financial services industry. Changes to statutes, regulations or regulatory policies, including changes in interpretation or implementation of statutes, regulations or policies, could affect us in substantial and unpredictable ways. Such changes could subject us to additional costs, limit the types of financial services and products we may offer and/or increase the ability of non-banks to offer competing financial services and products, among other things. Failure to comply with laws, regulations or policies could result in sanctions by regulatory agencies, civil money penalties and/or reputation damage, which could have a material adverse effect on our business, financial condition and results of operations. In addition, the laws governing bankruptcy generally favor debtors, making it more expensive or more difficult to collect from customers who have declared bankruptcy.
The full impact of the Dodd-Frank Act is unknown because significant rule making efforts are still required to fully implement all of its requirements, but it will likely materially increase our regulatory expenses.
The Dodd-Frank Act represents a comprehensive overhaul of the financial services industry within the United States and affects the lending, investment, trading and operating activities of all financial institutions. Significantly, the Dodd-Frank Act includes the following provisions that affect the Corporation and the Bank:
| · | | It established the CFPB, which has rulemaking authority over many of the statutes governing products and services offered to Bank customers. The creation of the CFPB will directly impact the scope and cost of products and services offered to consumers by the Bank and may have a significant effect on its financial performance. |
| · | | It revised the FDIC’s insurance assessment methodology so that premiums are assessed based upon the average consolidated total assets of the Bank less tangible equity capital. |
| · | | It permanently increased deposit insurance coverage to $250,000. |
| · | | It authorized the Federal Reserve to set debit interchange fees in an amount that is “reasonable and proportional” to the costs incurred by processors and card issuers. Under the final rule issued by the Federal Reserve, there is a cap of $0.21 per transaction (with a maximum of $0.24 per transaction permitted if certain requirements are met). Implementation of these caps went into effect on October 1, 2011. |
| · | | It imposes proprietary trading restrictions on insured depository institutions and their holding companies that prohibit them from engaging in proprietary trading except in limited circumstances, and prevents them from owning equity interests in excess of three percent (3%) of a bank’s Tier 1 capital in private equity and hedge funds. |
Based on the text of the Dodd-Frank Act and the implementing regulations (both effective and yet-to-be-published), it is anticipated that the costs to banks may increase or fee income may decrease significantly, which could adversely affect our results of operations, financial condition and/or liquidity. Moreover, compliance obligations will expose us to additional noncompliance risk and could divert management’s focus from the business of banking.
The Consumer Financial Protection Bureau may reshape the consumer financial laws through rulemaking and enforcement of the prohibitions against unfair, deceptive and abusive business practices. Compliance with any such change may impact our business operations.
The CFPB has broad rulemaking authority to administer and carry out the provisions of the Dodd-Frank Act with respect to financial institutions that offer covered financial products and services to consumers. The CFPB has also been directed to adopt rules identifying practices or acts that are unfair, deceptive or abusive in connection with any transaction with a consumer for a consumer financial product or service, or the offering of a consumer financial product or service. The concept of what may be considered to be an “abusive” practice is new under the law. The full scope of the impact of this authority has not yet been determined.
Bank regulators and other regulations, including the Basel III Capital Rules, may require higher capital levels, impacting our ability to pay dividends or repurchase our stock.
The capital standards to which we are subject, including the standards created by the Basel III Capital Rules, may materially limit our ability to use our capital resources and/or could require us to raise additional capital by issuing common stock. The issuance of additional shares of common stock could dilute existing stockholders.
Rulemaking efforts by the Federal Reserve may negatively impact our noninterest income.
On November 12, 2009, the Federal Reserve announced the final rules amending Regulation E that prohibit financial institutions from charging fees to consumers for paying overdrafts on automated teller machine and one-time
debit card transactions, unless a consumer consents, or opts-in, to the overdraft service for those types of transactions. Compliance with this regulation is effective July 1, 2010 for new consumer accounts and August 15, 2010 for existing consumer accounts. These new rules negatively impacted the Banks’ noninterest income in 2014 and 2015 and may do the same in future periods.
In addition, the Federal Reserve has issued rules pursuant to the Dodd-Frank Act governing debit card interchange fees that apply to institutions with greater than $10 billion in assets. Although we are not subject to these rules, market forces may effectively require the Bank to adopt a debit card interchange fee structure that complies with these rules, in which case our noninterest income for future periods could be materially and adversely affected.
We may be adversely affected by other recent legislation and rule-making efforts.
In November 2009, the Federal Reserve announced amendments to Regulation E that prohibit financial institutions from charging fees to consumers for paying overdrafts on automated teller machine and one-time debit card transactions unless a consumer consents, or opts-in, to the overdraft service for those types of transactions. These amendments became effective on July 1, 2010 for new consumer accounts and August 15, 2010 for existing consumer accounts. The Banks’ non-interest income in 2014 and 2015 was adversely affected by these amendments, and it may continue to be adversely affected in future periods.
In addition, the Federal Reserve has issued rules pursuant to the Dodd-Frank Act governing debit card interchange fees that apply to institutions with greater than $10 billion in assets. Although we are not subject to these rules, market forces may effectively require the Bank to adopt a debit card interchange fee structure that complies with these rules, in which case our non-interest income for future periods could be materially and adversely affected.
The Gramm-Leach-Bliley Act (the “GLB Act”) repealed restrictions on banks affiliating with securities firms and it also permitted certain bank holding companies to become financial holding companies. Financial holding companies are permitted to engage in a host of financial activities, and activities that are incidental to financial activities, that are not permitted for bank holding companies who have not elected to become financial holding companies, including insurance and securities underwriting and agency activities, merchant banking, and insurance company portfolio investment activities. The GLB Act may increase the competition that we face from other financial institutions, which could adversely impact our financial condition and/or results of operations in future periods.
The Sarbanes-Oxley Act requires management of every publicly traded company to perform an annual assessment of the company’s internal control over financial reporting and to report on whether the system is effective as of the end of the company’s fiscal year. If our management were to discover and report significant deficiencies or material weaknesses in our internal control over financial reporting, then the market value of our securities and shareholder value could decline.
The USA Patriot Act requires certain financial institutions, such as the Bank, to maintain and prepare additional records and reports that are designed to assist the government’s efforts to combat terrorism. This law includes sweeping anti-money laundering and financial transparency laws and required additional regulations, including, among other things, standards for verifying client identification when opening an account and rules to promote cooperation among financial institutions, regulators and law enforcement entities in identifying parties that may be involved in terrorism or money laundering. If we fail to comply with this law, we could be exposed to adverse publicity as well as fines and penalties assessed by regulatory agencies.
Our business is, and will continue to be, dependent on technology and an inability to invest in technological improvements or obtain reliable technological support may adversely affect our results of operation and financial condition.
The financial services industry is undergoing rapid technological changes with frequent introductions of new technology-driven products and services. In addition to better serving customers, the effective use of technology increases efficiency and enables financial institutions to reduce costs. Our ability to grow and compete will depend in part upon the ability to address the needs of customers by using technology to provide products and services that will
satisfy their operational needs, while managing the costs of expanding our technology infrastructure. Many competitors have substantially greater resources to invest in technological improvements and third-party support. There can be no assurance that we will be able to effectively implement new technology-driven products and services or be successful in marketing these products and services to our customers. For the foreseeable future, we expect to rely on third-party service providers and on other third parties for services and technical support. If those products and services become unreliable or fail, the adverse impact on customer relationships and operations could be material.
System failure or breaches of our network security could lead to increased operating costs as well as litigation and other liabilities.
The computer systems and network infrastructure that we use could be vulnerable to unforeseen problems. Our operations are dependent in part 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 operations could have an adverse effect on customers. In addition, we must be able to protect the computer systems and network infrastructure utilized by us against physical damage, security breaches and service disruption 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 and deter potential customers.
We are dependent upon outside third parties for processing and handling of records and data, which subjects us to additional operational risks.
Like most community banks, we outsource substantially all of our data processing to third-party providers. These third-party providers could also expose us to operational and information security risk resulting from breakdowns or failures of their own systems or capacity constraints. If our third-party providers encounter difficulties, or if we have difficulties in communicating with them, our ability to adequately process and account for customer transactions could be affected, and our business operations could be adversely impacted and result in a loss of customers and business, subject us to additional regulatory scrutiny, or expose us to civil litigation and possible financial liability. Any of these occurrences could have a material adverse effect on our financial condition and results of operations.
We may be subject to certain risks related to originating and selling mortgage loans.
When mortgage loans are sold, it is customary for the seller to make representations and warranties to the purchaser about the mortgage loans and the manner in which they were originated. The whole loan sale agreements require the repurchase or substitution of mortgage loans in the event we breach any of these representations or warranties. In addition, there may be a requirement to repurchase mortgage loans as a result of borrower fraud or in the event of early payment default of the borrower on a mortgage loan. We receive a limited number of repurchase and indemnity demands from purchasers as a result of borrower fraud and early payment default of the borrower on mortgage loans. While we have enhanced our underwriting policies and procedures and maintain adequate reserves, these steps may not be effective or reduce the risk associated with loans sold in the past. If repurchase and indemnity demands increase materially, the Company’s results of operations could be adversely affected.
We depend on the accuracy and completeness of information about customers and counterparties.
In deciding whether to extend credit or enter into other transactions, we rely on information furnished by or on behalf of our customers and counterparties, including financial statements, credit reports and other financial information. We also rely on representations of those customers, counterparties or other third parties, such as independent auditors, as to the accuracy and completeness of that information. Reliance on inaccurate or misleading financial statements, credit reports or other financial information could have a material adverse impact on business and, in turn, results of operation and financial condition.
Consumers and businesses may decide not to use banks to complete their financial transactions.
Technology and other changes are allowing parties to complete financial transactions that historically have involved banks through alternative methods. The possibility of eliminating banks as intermediaries could result in the loss of interest and 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 deposits as a source of funds could have a material adverse effect on our results of operations and financial condition.
The Company’s largest stockholder is deemed to be a bank holding company, which exposes us to special risks.
H Bancorp LLC (“H Bancorp”), the surviving entity from the liquidation of FSPF, is deemed a bank holding company under the BHC Act with respect to the Bank and beneficially owns approximately 21.5% of the Company’s common stock. Under Federal Reserve guidelines, every bank holding company must serve as a “source of strength” for each of their bank subsidiaries. In addition, the FDI Act requires that an insured depository institution shall be liable for the loss incurred or anticipated by the FDIC arising from the default of a commonly controlled insured depository institution or any assistance provided by the FDIC to any commonly controlled insured depository institution in danger of default. The position of H Bancorp as a source of strength to other depository institutions may limit its ability to serve as a source of strength for us and could adversely affect our ability to access resources of H Bancorp. Federal bank regulatory agencies 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.
A bank for which H Bancorp is deemed to be a bank holding company may be required to indemnify, or cross-guarantee, the FDIC against losses the FDIC incurs with respect to any other bank controlled by H Bancorp. Accordingly, we may be obligated to provide financial assistance to any other financial institution to which H Bancorp is deemed to be a bank holding company. Any financial assistance that we would have to provide could reduce our capital and result in a reduction in the value of our stockholders’ equity.
We may not be able to raise additional capital on terms favorable to us or at all.
If we need additional capital to support our business, expand our operations or maintain our minimum capital requirements, we may not be able to raise funds through the issuance of additional shares of our common stock or other securities. Furthermore, the significant amount of common stock that our primary investor owns may discourage other potential investors from offering to acquire newly issued shares. Even if we are able to obtain capital through the issuance of additional shares of our common stock or other securities, the sale of these additional shares could significantly dilute the ownership interest of our existing stockholders.
Risks Relating to the Company’s Common Stock
The shares of common stock are not insured.
The shares of the Company’s common stock are not deposits and are not insured against loss by the FDIC or any other governmental or private agency.
Applicable banking and Maryland laws impose restrictions on the ability of the Company and the Bank to pay dividends and make other distributions on their capital securities, and, in any event, the payment of dividends is at the discretion of the boards of directors of the Company and the Bank.
The Company’s ability to pay cash dividends in the future will be largely dependent upon the receipt of dividends from the Bank, and the Bank’s ability to pay dividends will depend primarily on its future earnings and capital needs. Bank regulatory agencies have the ability to prohibit proposed dividends by a financial institution which would otherwise be permitted under applicable regulations if the regulatory body determines that such distribution would constitute an unsafe or unsound practice. Banks that are considered “troubled institutions” are prohibited by federal law from paying dividends altogether. In addition, FSBs, like the Bank, must either submit an application or prior notice to the OCC before making a distribution to its stockholders, and the OCC has the authority to deny or object to that distribution. In any event, the
declaration and payment of dividends and the amounts thereof are at the discretion of the board of directors. Thus, no assurance can be given that the Company or the Bank will declare or pay dividends in any future period.
The Bank’s ability to pay dividends to the Company is limited by regulatory agreement.
The Bank is a party to an Operating Agreement with the OCC (the “Operating Agreement”) that imposes certain minimal capital requirements on the Bank. In the Operating Agreement, the Bank agreed that it would not declare or pay any dividends or otherwise reduce its capital unless it is in compliance with the Operating Agreement, including these capital requirements. The Company and Bank have applied for regulatory approval to pay a one-time cash dividend related to the planned Merger with Hopkins. Due to the Bank’s desire to preserve capital to fund its growth, the Company currently does not anticipate paying dividends beyond the foregoing described need for the foreseeable future. Because the Company’s ability to pay dividends on its common stock is largely dependent on its receipt of dividends from the Bank, the Company likewise does not anticipate paying a dividend on its common stock for the foreseeable future.
The common stock is not heavily traded.
The Company’s common stock is listed on the NASDAQ Capital Market, but shares of the common stock are not heavily traded. Securities that are not heavily traded can be more volatile than stock trading in an active public market. Factors such as our financial results, the introduction of new products and services by us or our competitors, and various factors affecting the banking industry generally may have a significant impact on the market price of the shares the common stock. Management cannot predict the extent to which an active public market for any of the Corporation’s securities will develop or be sustained in the future. Accordingly, holders of the Company’s common stock may not be able to sell their shares at the volumes, prices, or times that they desire.
The Company’s Charter and Bylaws and Maryland law may discourage a corporate takeover.
The Company’s Amended and Restated Articles of Incorporation, as amended (the “Charter”), and its Amended and Restated Bylaws (the “Bylaws”) contain certain provisions designed to enhance the ability of the Board of Directors to deal with attempts to acquire control of the Company. First, the Charter gives the Board the authority to classify and reclassify unissued shares of stock of any class or series of stock by setting, fixing, eliminating, or altering in any one or more respects the preferences, rights, voting powers, restrictions and qualifications of, dividends on, and redemption, conversion, exchange, and other rights of, such securities. The Board could use this authority, along with its authority to authorize the issuance of securities of any class or series, to issue shares having terms favorable to management to a person or persons affiliated with or otherwise friendly to management. Second, the Bylaws require any stockholder who desires to nominate a director to abide by strict notice requirements.
Maryland law also contains anti-takeover provisions that apply to the Company. The Maryland Business Combination Act generally prohibits, subject to certain limited exceptions, corporations from being involved in any “business combination” (defined as a variety of transactions, including a merger, consolidation, share exchange, asset transfer or issuance or reclassification of equity securities) with any “interested stockholder” for a period of five years following the most recent date on which the interested stockholder became an interested stockholder. An interested stockholder is defined generally as a person who is the beneficial owner of 10% or more of the voting power of the outstanding voting stock of the corporation after the date on which the corporation had 100 or more beneficial owners of its stock or who is an affiliate or associate of the corporation and was the beneficial owner, directly or indirectly, of 10% or more of the voting power of the then outstanding stock of the corporation at any time within the two-year period immediately prior to the date in question and after the date on which the corporation had 100 or more beneficial owners of its stock. The Maryland Control Share Acquisition Act applies to acquisitions of “control shares”, which, subject to certain exceptions, are shares the acquisition of which entitle the holder, directly or indirectly, to exercise or direct the exercise of the voting power of shares of stock of the corporation in the election of directors within any of the following ranges of voting power: one-tenth or more, but less than one-third of all voting power; one-third or more, but less than a majority of all voting power or a majority or more of all voting power. Control shares have limited voting rights.
Although these provisions do not preclude a takeover, they may have the effect of discouraging, delaying or deferring a tender offer or takeover attempt that a stockholder might consider in his or her best interest, including those
attempts that might result in a premium over the market price for the common stock. These provisions could potentially adversely affect the market prices of the Company’s common stock.
ITEM 1B. UNRESOLVED STAFF COMMENTS
This Item 1B is not applicable because the Company is a “smaller reporting company”.
ITEM 2. PROPERTIES
Our headquarters are located in Columbia, Maryland. As of December 31, 2015, the Bank operated 11 full-service branches, of which six were owned by the Bank and five were leased. See Note 7 to the Notes to the Consolidated Financial Statements for additional information.
We own the following properties, which had an aggregate book value of $2.4 million at December 31, 2015:
Location | | Description | |
1740 East Joppa Road | | Full service branch with drive thru and leased office space | |
Towson, MD 21234 | | | |
| | | |
427 Crain Highway | | Full service branch with drive-thru | |
Glen Burnie, MD 21061 | | | |
| | | |
531 South Conkling Street | | Full service branch with drive-thru | |
Baltimore, MD 21224 | | | |
We lease the following facilities at an aggregate annual rental of approximately $1.6 million as of December 31, 2015:
Location | | Description | | Lease Expiration
Date (1) |
1066-70 Maiden Choice Lane | | Full service branch with detached drive-thru | | 30-Apr-16 |
Arbutus, MD 21229 | | | | |
| | | | |
9515 Deerco Road, Suites 400 and 408 | | Mortgage banking offices | | 28-Feb-17 |
Timonium, MD 21093 | | | | |
| | | | |
7151 Columbia Gateway Dr., Ste. A | | Executive, administrative, and operational offices as well as | | 30-Apr-19 |
Columbia, MD 21046 | | electronic banking and full service branch offices | | |
| | | | |
2328 West Joppa Road, | | Loan offices as well as a full service branch | | 30-Sep-19 |
Lutherville, MD 20193 | | | | |
| | | | |
3700 E. Northern Parkway | | Full service branch | | 31-Aug-17 |
Baltimore, MD 21200 | | | | |
| | | | |
344 N. Charles Street | | Full service branch | | 31-Mar-23 |
Baltimore, MD 21201 | | | | |
| | | | |
602 Hoagie Drive | | Full service branch | | 30-Nov-24 |
Bel Air, MD 21014 (2) | | | | |
| | | | |
10301 York Road | | Full service branch | | 31-May-26 |
Cockeysville, MD 21030 (2) | | | | |
| | | | |
4040 Schroeder Avenue | | Full service branch | | 31-Jan-28 |
Perry Hall, MD 21128 (2) | | | | |
| (1) | | Expiration date, assuming the Company does not exercise all extension options. |
| (2) | | Represents Ground leases for these facilities that are otherwise owned by the Bank. |
ITEM 3. LEGAL PROCEEDINGS
We are involved in various legal actions arising from normal business activities. In management’s opinion, the outcome of these matters, individually or in the aggregate, are not expected to have a material adverse impact on our results of operation or financial condition.
ITEM 4. MINE SAFETY DISCLOSURES
Not applicable.
PART II
ITEM 5. MARKET FOR BAY’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES
STOCK LISTING
The Company’s common stock is listed on The NASDAQ Capital Market under the symbol “BYBK”. As of March 18, 2016, there were 294 holders of record of the Company’s common stock, which does not include any beneficial owners of common stock whose shares are held in the names of various dealers, clearing agencies, banks, brokers and other fiduciaries, or by broker-dealers or other participants who hold or clear shares directly or indirectly through the Depository Trust Company, or its nominee, Cede & Co.
TRANSFER AGENT AND REGISTAR
The transfer agent for the Company’s common stock is American Stock Transfer & Trust Co. LLC, 6201 15th Avenue, Brooklyn, NY 11219.
DIVIDENDS
The Company’s ability to declare and pay dividends is limited by federal banking laws and Maryland corporation laws. Further, because the Company is primarily a holding company for the Bank and its other subsidiaries, the Company’s ability to pay dividends will largely depend on whether the Bank is able to pay dividends to the Company. Banking regulations limit the amount of dividends that may be paid without prior approval by an FSB's regulatory agencies. In addition to these regulations, in connection with the Jefferson Merger, the Bank entered into the Operating Agreement. Under the Operating Agreement, the Bank may not declare or pay any dividends or otherwise reduce its capital unless it is in compliance with the Operating Agreement, including its minimum capital requirements. The Bank has applied for regulatory approval to pay a large, one-time cash dividend to the Company so that the Company can acquire all of the outstanding shares of common stock of Hopkins in the Hopkins Merger. Due to the Bank’s desire to preserve capital to fund its growth, the Company currently does not anticipate paying dividends beyond the foregoing described need for the foreseeable future. Notwithstanding the foregoing, it should be noted that the declaration of dividends is at the discretion of the Company’s Board of Directors. Accordingly, there can be no assurance that dividends will be declared in any future period.
QUARTERLY STOCK INFORMATION
The high and low closing sales prices for the shares of the Company’s common stock for each quarterly period of 2015 and 2014 as reported on the NASDAQ Capital Market are set forth in the following table:
| | | | | | | |
| | High | | Low | |
2015 | | | | | | | |
1st Quarter | | $ | 5.21 | | $ | 4.31 | |
2nd Quarter | | | 5.48 | | | 5.12 | |
3rd Quarter | | | 5.40 | | | 4.87 | |
4th Quarter | | | 5.34 | | | 5.00 | |
| | | | | | | |
2014 | | | | | | | |
1st Quarter | | $ | 5.25 | | $ | 4.85 | |
2nd Quarter | | | 5.50 | | | 4.83 | |
3rd Quarter | | | 5.37 | | | 4.54 | |
4th Quarter | | | 4.79 | | | 4.33 | |
On March 18, 2016, the closing sales price of the common stock, ticker BYBK, as reported on the NASDAQ Capital Market was $4.949 per share.
ISSUER REPURCHASES
On July 30, 2015, the Company’s Board of Directors approved a stock purchase program (the “2015 Repurchase Program”) that authorizes the Company to purchase up to 250,000 shares of its common stock over a 12-month period in open market and/or through privately negotiated transactions. The stock purchase program was publicly-announced on August 11, 2015. In September 2015, the Company purchased 170,492 shares of its common stock at an average price per share of $5.03. In addition to the 79,508 shares remaining for purchase under the 2015 Repurchase Program, on February 24, 2016, the Company’s Board of Directors approved a new stock purchase program that authorizes the Company to purchase an additional 250,000 shares of its common stock over a 12-month period in open market and/or through privately negotiated transactions. The stock purchase program was publicly-announced on February 26, 2016.
During the quarter ended December 31, 2015, neither the Company nor any of its affiliates (as defined by Rule 10b-18 promulgated under the Exchange Act) repurchased any shares of the Company’s common stock.
EQUITY COMPENSATION PLAN INFORMATION
Pursuant to the SEC’s Regulation S-K Compliance and Disclosure Interpretation 106.01, the information regarding Bay’s equity compensation plans required by this Item pursuant to Item 201(d) of Regulation S-K is located in Item 12 of Part III of this Annual Report and is incorporated herein by reference.
ITEM 6. SELECTED FINANCIAL DATA
| | | | | | | | | | | | | | | | |
| | 2015 | | 2014 | | 2013(1) | | 2012 | | 2011 | |
Consolidated Income Statement Data: | | | | | | | | | | | | | | | | |
Interest income | | $ | 23,209,506 | | $ | 24,115,000 | | $ | 19,019,543 | | $ | 9,825,529 | | $ | 9,165,793 | |
Interest expense | | | 1,834,883 | | | 1,257,199 | | | 1,261,969 | | | 572,127 | | | 701,238 | |
Net interest income | | | 21,374,623 | | | 22,857,801 | | | 17,757,574 | | | 9,253,402 | | | 8,464,555 | |
Provision for loan losses | | | 1,142,522 | | | 801,688 | | | 842,207 | | | 733,817 | | | 1,256,656 | |
Net interest income after provision for loan losses | | | 20,232,101 | | | 22,056,113 | | | 16,915,367 | | | 8,519,585 | | | 7,207,899 | |
Bargain purchase gain | | | — | | | 524,432 | | | 2,860,199 | | | — | | | — | |
Other noninterest income | | | 5,373,969 | | | 7,181,749 | | | 6,084,779 | | | 412,682 | | | 1,953,098 | |
Merger related expense | | | 22,097 | | | 1,028,239 | | | 2,041,756 | | | 916,174 | | | — | |
Other noninterest expenses | | | 22,518,543 | | | 26,428,132 | | | 20,073,365 | | | 7,313,090 | | | 7,529,188 | |
Income before income taxes | | | 3,065,430 | | | 2,305,923 | | | 3,745,224 | | | 703,003 | | | 1,631,809 | |
Income taxes (benefit) | | | 1,134,665 | | | (726,785) | | | 504,090 | | | 645,450 | | | 828,605 | |
Net income | | $ | 1,930,765 | | $ | 3,032,708 | | $ | 3,241,134 | | $ | 57,553 | | $ | 803,204 | |
| | | | | | | | | | | | | | | | |
Shares outstanding and per share data: | | | | | | | | | | | | | | | | |
Average shares outstanding | | | 11,040,159 | | | 10,370,795 | | | 8,322,811 | | | 5,829,140 | | | 5,826,789 | |
Diluted average shares outstanding | | | 11,178,133 | | | 10,565,336 | | | 8,342,646 | | | 5,829,140 | | | 5,826,789 | |
Number of shares outstanding, at year-end | | | 11,062,932 | | | 11,014,517 | | | 9,379,753 | | | 5,831,963 | | | 5,820,854 | |
Net income - basic per share | | $ | 0.17 | | $ | 0.29 | | $ | 0.39 | | $ | 0.01 | | $ | 0.14 | |
Net income - diluted per share | | | 0.17 | | | 0.29 | | | 0.39 | | | 0.01 | | | 0.14 | |
Dividends declared per share | | | — | | | — | | | — | | | — | | | — | |
Book value per share at period end | | | 6.13 | | | 6.05 | | | 5.82 | | | 4.65 | | | 4.6 | |
| | | | | | | | | | | | | | | | |
Financial Condition data: | | | | | | | | | | | | | | | | |
Assets | | $ | 491,161,838 | | $ | 479,942,985 | | $ | 419,089,303 | | $ | 133,243,868 | | $ | 129,867,364 | |
Investment Securities | | | 34,925,398 | | | 36,665,607 | | | 36,586,669 | | | 9,716,626 | | | 14,674,092 | |
Loans (net of deferred fees and costs) | | | 393,240,567 | | | 393,051,192 | | | 320,680,332 | | | 101,736,172 | | | 97,020,049 | |
Allowance for loan losses | | | 1,773,009 | | | 1,294,976 | | | 851,000 | | | 655,942 | | | 824,653 | |
Deposits | | | 367,415,938 | | | 387,830,132 | | | 360,933,471 | | | 100,672,130 | | | 97,959,516 | |
Borrowings | | | 52,300,000 | | | 22,150,000 | | | — | | | — | | | — | |
Stockholders’ equity | | | 67,682,489 | | | 66,643,286 | | | 54,554,268 | | | 31,824,416 | | | 31,394,875 | |
| | | | | | | | | | | | | | | | |
Average Balances: | | | | | | | | | | | | | | | | |
Assets | | $ | 481,145,938 | | $ | 459,782,360 | | $ | 358,397,210 | | $ | 127,786,614 | | $ | 129,655,061 | |
Investment Securities | | | 36,649,655 | | | 36,561,271 | | | 24,427,877 | | | 11,486,249 | | | 16,667,155 | |
Loans | | | 389,684,221 | | | 364,511,290 | | | 259,698,504 | | | 97,871,329 | | | 91,976,636 | |
Interest-bearing Deposits | | | 290,969,449 | | | 292,056,338 | | | 231,245,789 | | | 73,365,709 | | | 78,770,578 | |
Borrowings | | | 23,188,219 | | | 9,269,231 | | | 92,328 | | | 18,306 | | | 19,178 | |
Stockholders' equity | | | 65,747,418 | | | 61,530,969 | | | 48,537,003 | | | 30,016,583 | | | 28,329,221 | |
| | | | | | | | | | | | | | | | |
Selected performance ratios: | | | | | | | | | | | | | | | | |
Return on average assets | | | 0.40 | % | | 0.66 | % | | 0.90 | % | | 0.05 | % | | 0.62 | % |
Return on average equity | | | 2.94 | % | | 4.93 | % | | 6.68 | % | | 0.19 | % | | 2.84 | % |
Yield on average interest-earning assets | | | 5.10 | % | | 5.60 | % | | 5.71 | % | | 7.89 | % | | 7.26 | % |
Rate on average interest-bearing liabilities | | | 0.58 | % | | 0.42 | % | | 0.55 | % | | 0.78 | % | | 0.89 | % |
Net interest spread | | | 4.51 | % | | 5.18 | % | | 5.16 | % | | 7.11 | % | | 6.37 | % |
Net interest margin | | | 4.70 | % | | 5.31 | % | | 5.33 | % | | 7.43 | % | | 6.70 | % |
| | | | | | | | | | | | | | | | |
Asset Quality ratios: | | | | | | | | | | | | | | | | |
Allowance for loan losses to loans | | | 0.45 | % | | 0.33 | % | | 0.27 | % | | 0.64 | % | | 0.85 | % |
Nonperforming loans to total loans | | | 2.26 | % | | 3.41 | % | | 2.59 | % | | 5.30 | % | | 7.31 | % |
Nonperforming assets to total assets | | | 2.10 | % | | 3.10 | % | | 2.29 | % | | 4.91 | % | | 6.62 | % |
Net charge-offs to average loans | | | 0.03 | % | | 0.10 | % | | 0.25 | % | | 0.92 | % | | 1.21 | % |
| | | | | | | | | | | | | | | | |
Capital ratios: | | | | | | | | | | | | | | | | |
Leverage ratio (2) | | | 13.75 | % | | 12.94 | % | | 11.41 | % | | 22.23 | % | | 22.36 | % |
Tier 1 risk-based capital ratio (2) | | | 16.14 | % | | 16.31 | % | | 14.42 | % | | 27.16 | % | | 27.85 | % |
Total risk-based capital ratio (2) | | | 16.58 | % | | 16.66 | % | | 14.68 | % | | 27.76 | % | | 28.59 | % |
Average equity to average assets | | | 13.66 | % | | 13.38 | % | | 13.54 | % | | 23.49 | % | | 21.85 | % |
| (1) | | On April 19, 2013, Jefferson completed its acquisition of Carrollton Bancorp. All transactions since the acquisition date are included in our consolidated financial statements. |
| (2) | | Capital ratios reported for Bay Bank, FSB. |
ITEM 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
OVERVIEW
The merger and acquisition completed over the last several years have strengthened our market position geographically and enhanced our delivery channels, allowing us to provide extraordinary customer service while delivering a fuller range of products and services and lessened our dependence on net interest income by adding fee-based sources of revenue including a mortgage origination division and electronic banking division. Amid the growth, our focus is on a high quality balance sheet, expense efficiency and improved profitability. Our team’s efforts increased the Company’s pre-tax profitability by 33% in 2015, when compared to 2014, which is also a $3.7 million increase in pre-tax earnings after adjusting for non-recurring items in 2014 (bargain purchase gain and exit of the Individual Retirement Account (“IRA”) product line). We accomplished this increase by growing our originated loan portfolio by 33%, while reducing our noninterest expense by $4.9 million, or 18%, when compared to 2014. While we did not grow total assets appreciably during 2015, our efforts to resolve acquired loans led to a reduction of our classified asset ratio to 26% at December 31, 2015 from 47% at December 31, 2014. Assuming that the pending Hopkins Merger closes as expected, management believes that we are poised to increase scale, profitability and leverage that will together lead to improved returns on our strong capital base.
The Bank’s relationship management activities resulted in net new loan growth in the Bank’s originated portfolio by a 32.5% annualized pace in 2015. Deposit mix changes were favorable, with planned declines in certificate of deposit balances offset by core interest bearing and noninterest-bearing deposit growth, leading to an attractive 0.40% cost of funds for the fourth quarter of 2015. The Bank has a very strong capital position and capacity for future growth with total regulatory capital to risk weighted assets of 16.6% as of December 31, 2015. The Bank has a proven record of success in acquisitions and acquired problem asset resolutions and, at December 31, 2015, had $9.4 million in remaining net purchase discounts on acquired loan portfolios.
On May 27, 2015, the Company elected two new members to its Board of Directors. Pierre Abushacra is a resident of Montgomery County, Maryland and the founder and CEO of Firehook Bakery, a retail and wholesale bakery with 10 locations in the broader Washington, D.C. market. Michael Chiaramonte is the founder and former President of the Southern Maryland Healthcare System based in Prince George’s County, Maryland before its sale to MedStar.
The Bank opened a new full service branch on April 27, 2015 in recognition of its desire to expand further south toward the Washington, D.C. corridor. This is the Bank’s first branch in Howard County, Maryland. On July 1, 2015, the Bank moved its corporate headquarters to Columbia, Maryland demonstrating that while the Bank’s primary geographic footprint has historically been the greater Baltimore metropolitan area, the Bank continues to expand in the growing Howard County market and is part of a strategic extension of the Bank’s presence towards the Washington D. C. corridor. The headquarters change resulted in 14 associates relocating to Columbia and 13 associates remaining in the Lutherville sales offices.
On July 30, 2015, the Company’s Board of Directors authorized the repurchase of up to 250,000 shares of its common stock over a 12-month period. The repurchase program does not obligate the Company to acquire any shares, but permits the Company to repurchase the shares in open market and/or privately negotiated transactions in amounts, at prices and at times determined by the Company’s President and the Chief Executive Officer. The repurchase program may be modified, suspended or discontinued at any time, at the Company’s discretion. During 2015, the Company purchased 170,492 shares of its common stock, at an average price of $5.03 per share, under this program. On February 24, 2016, the Board of Directors elected to continue the Company’s stock purchase efforts by authorizing the purchase of an additional 250,000 shares of common stock over a 12-month period.
On December 18, 2015, the Company and Hopkins announced the Hopkins Merger. At December 31, 2015, Hopkins had assets of approximately $239.8 million. The transaction is valued at approximately $23.8
million. The Hopkins Merger, which is subject to regulatory approval, is anticipated to close in the second quarter of 2016. Additional information regarding the Merger may be found in the Company’s Current Report on Form 8-K that was filed with the SEC on December 21, 2015.
Balance Sheet Review
Total assets were $491 million at December 31, 2015, an increase of $11 million, or 2%, when compared to December 31, 2014. The increase was due mainly to an $18 million increase in liquid assets during the year ended December 31, 2015. Investment securities decreased by $1.7 million, or 5%, for the year ended December 31, 2015, while loans held for sale decreased by $2.4 million, or 33%.
Total deposits were $367 million at December 31, 2015, a decrease of $20 million, or 5%, when compared to December 31, 2014. The decrease was due to managed declines in certificates of deposits, offset by a $10 million, or 11.1% increase, in noninterest bearing deposits. Certificates of deposits funding has been temporarily replaced with short term FHLB advances, improving the cost of funds, while the Bank prepares to integrate Hopkins Bank’s deposit funded balance sheet following the pending Hopkins Merger. Short term borrowings were $52 million at December 31, 2015, an increase of $30 million, or 136%, when compared to December 31, 2014.
Stockholders’ equity increased to $67.7 million at December 31, 2015, when compared to $66.6 million at December 31, 2014. The $1.1 million increase resulted primarily from the $1.9 million retention of corporate earnings and $0.9 million issuance of common stock under the Company’s stock option plans, offset by a $1.0 million increase in the Bank’s defined benefit pension plan liability due to changes in actuarial assumptions and $0.9 million repurchase of common stock pursuant to the stock purchase program that the Board of Directors approved on July 30, 2015. The book value of the Company’s common stock was $6.13 at December 31, 2015 and $6.05 at December 31, 2014.
Return on average assets and return on average equity are key measures of our performance. Return on average assets, the quotient of net income divided by average total assets, measures how effectively we utilize our assets to produce income. Our return on average assets for the years ended December 31, 2015 and 2014 was 0.40% and 0.66%, respectively. Return on average equity, the quotient of net income divided by average equity, measures how effectively we invest our capital to produce income. Return on average equity for the years ended December 31, 2015 and 2014 was 2.94% and 4.93%, respectively.
Nonperforming assets, which consist of nonaccrual loans, troubled debt restructurings, accruing loans past due 90 days or more, and real estate acquired through foreclosure, decreased to $10.3 million at December 31, 2015 from $14.9 million at December 31, 2014. The improvements were driven by decreases in nonaccrual loans excluding purchased credit impaired (“PCI”) loans, nonaccrual PCI loans, accruing loans past due 90 days or more excluding PCI loans and PCI loans 90 days or more past due of $0.4 million, $0.5 million, $0.5 million and $3.0 million, respectively. Nonperforming assets represented 2.10% of total assets at December 31, 2015, compared to 3.10% at December 31, 2014.
At December 31, 2015, the Bank maintained capital in excess of all “well-capitalized” regulatory requirements. The Bank’s tier 1 risk-based capital ratio was 16.14% at December 31, 2015 as compared to 16.31% at December 31, 2014. Liquidity remained strong due to managed cash and cash equivalents, borrowing lines with the FHLB of Atlanta, the Federal Reserve and correspondent banks, and the size and composition of the investment portfolio.
Review of Financial Results
Net income for the year ended December 31, 2015 was $1.93 million, compared to $3.03 million for the same period of 2014. With the changes to net income primarily the result of the 2014 bargain purchase gain attributable to the Slavie Acquisition of $0.52 million and the 2014 recognition of the remaining interest rate
mark-to-market adjustment of $2.38 million related to the exit from our IRA business, 2015 net income was less comparable to 2014 net income.
Net interest income decreased to $21.4 million for the year ended December 31, 2015, compared to $22.9 million for the same period of 2014. The decrease resulted from a $2.3 million decline in net discount accretion of purchased loan discounts recognized in interest income and a $1.1 million decrease in the fair value amortization on deposits, offset by a $1.4 million increase in interest income on interest earning assets primarily due to $24.4 million of net growth in average interest-earning assets driven by the Slavie Acquisition in 2014 and new loan portfolio originations, and a $0.5 million reduction in interest expense on deposit balances. Excluding the impact of the fair value accounting, net interest income increased by $1.90 million, when compared to the year ended December 31, 2014. The net interest margin for the year ended December 31, 2015 decreased to 4.70% compared to 5.31% for 2014 due to the decline in discount accretion on loans and deposits. As of December 31, 2015, the remaining net loan discounts on the Bank’s loan portfolio, including loans acquired in the Slavie Acquisition, totaled $9.4 million.
Noninterest income for the year ended December 31, 2015 was $5.4 million, compared to $7.7 million for the same period of 2014. This decrease was primarily the result of the $2.38 million remaining interest rate mark to market adjustment on IRA deposits recognized in 2014, the $0.52 million bargain purchase gain associated with the Slavie Acquisition recognized in 2014 and a $0.23 million decrease in electronic banking fees, offset by a $0.76 million increase in mortgage banking fees and gains and a $0.29 million gain from the sale of certain securities in 2015. Expectations are for mortgage fees and gains to increase during 2016 as the Bank moves to expand its mortgage banking operations
Noninterest expense reduction was a key focus for 2015 net income improvement. For the year ended December 31, 2015, noninterest expense was $22.5 million compared to $27.5 million for the same period of 2014, a decrease of $4.9 million. The primary contributors to the 2015 noninterest expense decrease when compared to 2014 were decreases of $1.68 million in salary and employee benefits, $0.33 million in occupancy expense, $0.22 million in furniture and equipment expense and $1.01 million in merger and acquisition related expenses.
In the fourth quarter of 2014, the Company filed amended 2011 and 2012 Federal and Maryland tax returns for the former Carrollton Bancorp, resulting in the accrual of $0.6 million in tax refunds. Combined with a reversal of a deferred tax valuation allowance, the Bank recognized $1.2 million in favorable tax benefits resulting in an overall reduction in tax expense of $1.77 million.
CRITICAL ACCOUNTING POLICIES
Our accounting and reporting policies conform to accounting principles generally accepted in the United States of America (“U.S. GAAP”). All intercompany transactions are eliminated in consolidation and certain reclassifications are made when necessary in order to conform the previous year’s financial statements to the current year’s presentation. In preparing the consolidated financial statements, management is required to make estimates and assumptions that affect the reported amount of assets and liabilities as of the dates of the balance sheets and revenues and expenditures for the periods presented. Therefore, actual results could differ from these estimates. Our financial condition and results of operations are sensitive to accounting measurements and estimates of matters that are inherently uncertain. When applying accounting policies in areas that are subjective in nature, management must use its best judgment to arrive at the carrying value of certain assets. The most critical accounting policies applied relate to treatment of the allowance for loan losses, accounting for acquired loans, valuation of the securities portfolio, and accounting for income taxes.
Allowance for Loan Losses
The allowance involves a higher degree of judgment and complexity than other significant accounting policies. The allowance is calculated with the objective of maintaining a reserve level believed by us to be sufficient to absorb estimated probable loan losses. Our determination of the adequacy of the allowance is based on periodic evaluations of the loan portfolio and other relevant factors. However, this evaluation is inherently subjective as it requires material
estimates, including, among others, expected default probabilities, expected loan commitment usage, the amounts and timing of expected future cash flows on impaired and PCI loans, value of collateral, estimated losses on consumer loans and residential mortgages and general amounts for historical loss experience. The process also considers economic conditions and inherent risks in the loan portfolio. All of these factors may be susceptible to significant change. To the extent actual outcomes differ from our estimates, an additional provision for loan losses may be required that would adversely impact earnings in future periods. See the section of this document titled, “Allowance for Loan Losses and Credit Risk Management.”
Accounting for Acquired Loans
Loans purchased with evidence of credit deterioration since origination and for which it is probable that all contractually required payments will not be collected are considered to be credit impaired. Evidence of credit quality deterioration as of the purchase date may include information such as past due and nonaccrual status, borrower credit scores and recent loan to value percentages. PCI loans are initially measured at fair value, which considers estimated future credit losses expected to be incurred over the life of the loan. Accordingly, an allowance related to these loans is not carried over and recorded at the acquisition date. We monitor actual loan cash flows to determine any improvement or deterioration from those forecasted as of the acquisition date. Our acquired loans with specific credit deterioration are accounted for in accordance with Financial Accounting Standards Board Accounting Standards Codification 310-30, Loans and Debt Securities Acquired with Deteriorated Credit Quality. Certain acquired loans, those for which specific credit related deterioration subsequent to origination is identified, are recorded at fair value reflecting the present value of the amounts expected to be collected. Income recognition on PCI loans is based on a reasonable expectation about the timing and amount of cash flows to be collected.
Valuation of the Securities Portfolio
Securities are evaluated periodically to determine whether a decline in their value is other than temporary. The term “other than temporary” is not intended to indicate a permanent decline in value. Rather, it means that the prospects for near term recovery of value are not necessarily favorable, or that there is a lack of evidence to support fair values equal to, or greater than, the carrying value of an investment. We review other criteria such as magnitude and duration of the decline, as well as the reasons for the decline, to predict whether the loss in value is other than temporary. Once a decline in value is determined to be other than temporary, the value of the security is reduced and a corresponding charge to earnings is recognized.
Accounting for Income Taxes
We use the liability method of accounting for income taxes. Under the liability method, deferred tax assets and liabilities are determined based on differences between the financial statement carrying amounts and the tax basis of existing assets and liabilities (i.e., temporary differences) and are measured at the enacted rates in effect when these differences reverse. Deferred tax assets are reduced by a valuation allowance when, in the opinion of management, it is more likely than not that some portion or all of the deferred tax assets will not be realized. We exercise significant judgment in the evaluation of the amount and timing of the recognition of the resulting tax assets and liabilities. The judgments and estimates required for the evaluation are updated based upon changes in business factors and the tax laws. If actual results differ from the assumptions and other considerations used in estimating the amount and timing of tax recognized, there can be no assurance that additional expenses will not be required in future periods. Realization of deferred tax assets is dependent on generating sufficient taxable income in the future.
Other significant accounting policies are presented in Note 1 to the consolidated financial statements that appear elsewhere in this Annual Report. We have not substantively changed any aspect of our overall approach in the application of the foregoing policies.
RESULTS OF OPERATIONS
Net Interest Income
The following table sets forth, for the periods indicated, information regarding the average balances of interest-earning assets and interest-bearing liabilities, the amount of interest income and interest expense and the resulting yields on average interest-earning assets and rates paid on average interest-bearing liabilities. No tax equivalent yield adjustments were made, as the effect thereof was not material.
| | | | | | | | | | | | | | | | | | | | | | | | | |
| | 2015 | | 2014 | | 2013 | |
| | Average | | | | | | | Average | | | | | | | Average | | | | | | |
| | Balance | | Interest | | Yield/Rate | | Balance | | Interest | | Yield/Rate | | Balance | | Interest | | Yield/Rate | |
ASSETS | | | | | | | | | | | | | | | | | | | | | | | | | |
Interest-earning assets: | | | | | | | | | | | | | | | | | | | | | | | | | |
| | | | | | | | | | | | | | | | | | | | | | | | | |
Interest bearing deposits with banks and federal funds sold | | $ | 18,200,042 | | $ | 37,297 | | 0.20 | % | $ | 21,901,452 | | $ | 49,811 | | 0.23 | % | $ | 27,998,706 | | $ | 73,294 | | 0.26 | % |
Investment securities available for sale | | | 35,370,228 | | | 821,969 | | 2.32 | % | | 36,050,260 | | | 928,974 | | 2.58 | % | | 24,427,877 | | | 615,764 | | 2.52 | % |
Investment securities held to maturity | | | 1,279,427 | | | 32,779 | | 2.56 | % | | 511,011 | | | 10,792 | | 2.11 | % | | — | | | — | | — | % |
Restricted equity securities | | | 1,453,728 | | | 58,763 | | 4.04 | % | | 979,969 | | | 30,611 | | 3.12 | % | | 684,316 | | | 22,774 | | 3.33 | % |
Total interest-bearing deposits with banks, fed funds sold, and investments | | | 56,303,425 | | | 950,808 | | 1.69 | % | | 59,442,692 | | | 1,020,188 | | 1.72 | % | | 53,110,899 | | | 711,832 | | 1.34 | % |
| | | | | | | | | | | | | | | | | | | | | | | | | |
Loans held for sale | | | 9,268,964 | | | 350,833 | | 3.79 | % | | 6,873,298 | | | 246,212 | | 3.58 | % | | 20,390,570 | | | 776,325 | | 3.81 | % |
Loans, net | | | | | | | | | | | | | | | | | | | | | | | | | |
Commercial & Industrial | | | 35,800,127 | | | 1,888,496 | | 5.28 | % | | 43,734,768 | | | 2,977,357 | | 6.81 | % | | 30,774,084 | | | 2,559,257 | | 8.32 | % |
Commercial Real Estate | | | 162,950,066 | | | 9,131,583 | | 5.60 | % | | 158,091,703 | | | 9,885,986 | | 6.25 | % | | 126,062,242 | | | 8,183,908 | | 6.49 | % |
Residential Real Estate | | | 131,931,315 | | | 7,756,119 | | 5.88 | % | | 107,485,763 | | | 6,467,857 | | 6.02 | % | | 53,593,865 | | | 3,635,914 | | 6.78 | % |
HELOC | | | 33,674,244 | | | 1,653,351 | | 4.91 | % | | 35,851,459 | | | 1,979,302 | | 5.52 | % | | 29,405,291 | | | 1,649,928 | | 5.61 | % |
Construction | | | 18,741,548 | | | 1,101,524 | | 5.88 | % | | 15,652,957 | | | 1,251,447 | | 7.99 | % | | 16,286,846 | | | 1,085,322 | | 6.66 | % |
Land | | | 5,439,531 | | | 263,058 | | 4.84 | % | | 2,482,128 | | | 186,754 | | 7.52 | % | | 1,887,070 | | | 319,018 | | 16.91 | % |
Consumer & Other | | | 1,147,390 | | | 113,734 | | 9.91 | % | | 1,212,512 | | | 99,897 | | 8.24 | % | | 1,689,106 | | | 98,039 | | 5.80 | % |
Total loans, net (1) | | | 389,684,221 | | | 21,907,865 | | 5.62 | % | | 364,511,290 | | | 22,848,600 | | 6.27 | % | | 259,698,504 | | | 17,531,386 | | 6.75 | % |
Total earning assets | | | 455,256,610 | | $ | 23,209,506 | | 5.10 | % | | 430,827,280 | | $ | 24,115,000 | | 5.60 | % | | 333,199,973 | | $ | 19,019,543 | | 5.71 | % |
Cash | | | 3,955,371 | | | | | | | | 4,082,953 | | | | | | | | 4,959,821 | | | | | | |
Allowance for loan losses | | | (1,291,307) | | | | | | | | (1,132,374) | | | | | | | | (738,783) | | | | | | |
Market valuation | | | 538,025 | | | | | | | | 231,775 | | | | | | | | 198,695 | | | | | | |
Other assets | | | 22,687,239 | | | | | | | | 25,772,726 | | | | | | | | 20,777,504 | | | | | | |
Total non-earning assets | | | 25,889,328 | | | | | | | | 28,955,080 | | | | | | | | 25,197,237 | | | | | | |
Total Assets | | $ | 481,145,938 | | | | | | | $ | 459,782,360 | | | | | | | $ | 358,397,210 | | | | | | |
| | | | | | | | | | | | | | | | | | | | | | | | | |
LIABILITIES AND STOCKHOLDERS' EQUITY | | | | | | | | | | | | | | | | | | | | | | | | | |
Interest-bearing liabilities: | | | | | | | | | | | | | | | | | | | | | | | | | |
Interest-bearing checking and savings | | $ | 84,326,839 | | $ | 94,597 | | 0.11 | % | $ | 80,030,537 | | $ | 90,741 | | 0.11 | % | $ | 49,428,952 | | $ | 65,098 | | 0.13 | % |
Money market | | | 91,545,248 | | | 263,821 | | 0.29 | % | | 83,404,571 | | | 305,217 | | 0.37 | % | | 64,100,619 | | | 236,988 | | 0.37 | % |
Time deposits | | | 115,097,362 | | | 1,403,481 | | 1.22 | % | | 128,621,230 | | | 835,685 | | 0.65 | % | | 117,716,218 | | | 957,815 | | 0.81 | % |
Total interest-bearing deposits | | | 290,969,449 | | | 1,761,899 | | 0.61 | % | | 292,056,338 | | | 1,231,643 | | 0.42 | % | | 231,245,789 | | | 1,259,901 | | 0.54 | % |
Borrowed funds: | | | | | | | | | | | | | | | | | | | | | | | | | |
Federal funds purchased | | | 65,753 | | | 604 | | 0.92 | % | | — | | | — | | — | % | | 56,164 | | | 486 | | 0.87 | % |
FHLB advances and other borrowed funds | | | 23,188,219 | | | 72,380 | | 0.31 | % | | 9,269,231 | | | 25,556 | | 0.28 | % | | 36,164 | | | 1,582 | | 4.37 | % |
Total borrowed funds | | | 23,253,972 | | | 72,984 | | 0.31 | % | | 9,269,231 | | | 25,556 | | 0.28 | % | | 92,328 | | | 2,068 | | 2.24 | % |
Total interest-bearing funds | | | 314,223,421 | | | 1,834,883 | | 0.58 | % | | 301,325,569 | | | 1,257,199 | | 0.42 | % | | 231,338,117 | | | 1,261,969 | | 0.55 | % |
Noninterest-bearing deposits | | | 97,275,956 | | | — | | | | | 93,643,953 | | | — | | | | | 74,794,928 | | | — | | | |
Total cost of funds | | | 411,499,377 | | $ | 1,834,883 | | 0.45 | % | | 394,969,522 | | $ | 1,257,199 | | 0.32 | % | | 306,133,045 | | $ | 1,261,969 | | 0.41 | % |
Other liabilities and accrued expenses | | | 3,899,143 | | | | | | | | 3,281,869 | | | | | | | | 3,727,162 | | | | | | |
Total Liabilities | | | 415,398,520 | | | | | | | | 398,251,391 | | | | | | | | 309,860,207 | | | | | | |
Stockholders' Equity | | | 65,747,418 | | | | | | | | 61,530,969 | | | | | | | | 48,537,003 | | | | | | |
Total Liabilities and Stockholders' Equity | | $ | 481,145,938 | | | | | | | $ | 459,782,360 | | | | | | | $ | 358,397,210 | | | | | | |
Net interest income and spread (2) | | | | | $ | 21,374,623 | | 4.51 | % | | | | $ | 22,857,801 | | 5.18 | % | | | | $ | 17,757,574 | | 5.16 | % |
Net interest margin (3) | | | | | | | | 4.70 | % | | | | | | | 5.31 | % | | | | | | | 5.33 | % |
| (1) | | Non-accrual loans are included in average loan balances. |
| (2) | | Interest rate spread represents the difference between the average yield on interest-earning assets and the average cost of interest-bearing liabilities. |
| (3) | | Net interest margin represents net interest income as a percentage of average interest-earning assets. |
Net interest income, the amount by which interest income on interest-earning assets exceeds interest expense on interest-bearing liabilities, is the most significant component of our earnings. Net interest income is a function of several factors, including the volume and mix of interest-earning assets and funding sources, as well as the relative level of market interest rates. While management’s policies influence some of these factors, external forces, including customer needs and demands, competition, the economic policies of the federal government and the monetary policies of the Federal Reserve also affect net interest income.
Net interest income decreased to $21.4 million for the year ended December 31, 2015, compared to $22.9 million for 2014. The decrease resulted from a $2.3 million decline in net discount accretion of purchased loan discounts recognized in interest income and a $1.1 million increase in the fair value amortization on deposits, offset by a $1.4 million increase in interest income on interest earning assets primarily due to $24.4 million of net growth in average interest-earning assets driven by the Slavie Acquisition in 2014 and new loan portfolio originations, and a $0.5 million reduction in interest expense on deposit balances. Excluding the impact of the fair value accounting, net interest income increased by $1.90 million when compared to the year ended December 31, 2014.
Total interest income decreased by $0.9 million, or 3.8%, for the year ended December 31, 2015, when compared to 2014. Interest income on loans decreased by $0.9 million, or 4.1%, for the year ended December 31, 2015 when compared to 2014. Interest income on loans held for sale, investment securities and interest-bearing deposits in banks and federal funds sold increased by an aggregate $0.04 million for the year ended December 31, 2015 when compared to 2014. The decrease in interest income for 2015 was due primarily to the decline in discount accretion of purchased loan discounts recognized in interest income. In 2015, average interest-earning assets increased by 5.7% while average interest-bearing liabilities increased by 4.3%.
Total interest expense increased by $0.6 million, or 46%, for the year ended December 31, 2015 when compared to 2014. The total cost of interest-bearing liabilities increased to 0.58% for the year ended December 31, 2015, as compared to 0.42% for 2014. The increase in interest expense related primarily to a $1.1 million decline in the amortization of mark to market adjustments on deposits, offset by a $0.5 million decline in interest on deposits. Average noninterest-bearing deposits increased $3.6 million in 2015 when compared to 2014, while the percentage of average noninterest-bearing deposits to total deposits was 24% for 2015 and 2014.
Effect of Volume and Rate Changes on Net Interest Income
The following table presents the effect of volume and rate changes on net interest income for the periods indicated:
| | | | | | | | | | | | | | | | | | | |
| | 2015 Versus 2014 | | 2014 Versus 2013 | |
| | Increase (Decrease) Due to Change In | | Increase (Decrease) Due to Change In | |
| | Average Volume | | Average Rate | | Total | | Average Volume | | Average Rate | | Total | |
Interest Income: | | | | | | | | | | | | | | | | | | | |
Loans | | $ | 1,510,232 | | $ | (2,450,967) | | $ | (940,735) | | $ | 6,599,110 | | $ | (1,281,895) | | $ | 5,317,215 | |
Total interest-bearing deposits with banks, fed funds sold, and investments | | | 11,623 | | | (81,004) | | | (69,381) | | | 304,651 | | | 3,705 | | | 308,356 | |
Loans held for sale | | | 89,997 | | | 14,624 | | | 104,621 | | | (486,702) | | | (43,412) | | | (530,114) | |
Total Interest Income | | | 1,611,852 | | | (2,517,347) | | | (905,495) | | | 6,417,059 | | | (1,321,602) | | | 5,095,457 | |
| | | | | | | | | | | | | | | | | | | |
Interest Expense: | | | | | | | | | | | | | | | | | | | |
Time deposits | | | (96,118) | | | 663,913 | | | 567,795 | | | 83,100 | | | (205,230) | | | (122,130) | |
Other interest-bearing deposits | | | 32,626 | | | (70,165) | | | (37,539) | | | 106,390 | | | (12,518) | | | 93,872 | |
Borrowings | | | 43,641 | | | 3,787 | | | 47,428 | | | 26,598 | | | (3,110) | | | 23,488 | |
Total Interest Expense | | | (19,851) | | | 597,535 | | | 577,684 | | | 216,088 | | | (220,858) | | | (4,770) | |
| | | | | | | | | | | | | | | | | | | |
(Decrease)/Increase in Net Interest Income | | $ | 1,631,703 | | $ | (3,114,882) | | $ | (1,483,179) | | $ | 6,200,971 | | $ | (1,100,744) | | $ | 5,100,227 | |
Variances that are the combined effect of volume and rate, but cannot be separately identified, are allocated to the volume and rate variances based on their respective relative amounts.
Provision for Loan Losses
The provision for loan losses is determined by management as the amount to be added to the allowance for loan losses after net charge-offs have been deducted to bring the allowance to a level which, in management's best estimate, is necessary to absorb probable losses within the existing loan portfolio. On a monthly basis, management reviews all loan portfolios to determine trends and monitor asset quality. For consumer loan portfolios, this review generally consists of reviewing delinquency levels on an aggregate basis with timely follow-up on accounts that become delinquent. In commercial loan portfolios, delinquency information is monitored and periodic reviews of business and property leasing operations are performed on an individual loan basis to determine potential collection and repayment problems. See the section captioned “Allowance for Loan Losses” elsewhere in this discussion for further analysis of the provision for loan losses.
We recorded a provision for loan losses of $1,142,522 and $801,688 for the years ended December 31, 2015 and 2014, respectively. The increase for 2015 was due primarily to $48.6 million of growth in the Bank’s originated portfolio and $0.2 million lower net charge-offs that was driven primarily by runoff and accelerated resolution of the acquired loan portfolio. As a result, the allowance for loan losses was $1.77 million at December 31, 2015, representing 0.45% of total loans, compared to $1.29 million, or 0.33% of total loans, at December 31, 2014. Management expects both the allowance for losses and the related provision for loan losses to increase in the future due to the continued runoff of the acquired loan portfolio and growth in new loan originations.
Noninterest Income
The following table reflects the amounts and changes in noninterest income for the years ended December 31, 2015 and December 31, 2014:
| | | | | | | | | | | | |
| | Year Ended December 31: | | 2015 vs 2014 | |
| | 2015 | | 2014 | | $ Change | | % Change | |
| | | | | | | | | | | | |
Electronic banking fees | | $ | 2,402,589 | | $ | 2,637,079 | | $ | (234,490) | | (9) | % |
Mortgage banking fees and gains | | | 1,708,779 | | | 950,299 | | | 758,480 | | 80 | % |
Service charges on deposit accounts | | | 313,697 | | | 393,128 | | | (79,431) | | (20) | % |
Bargain purchase gain | | | — | | | 524,432 | | | (524,432) | | (100) | % |
Gain on securities sold | | | 289,912 | | | — | | | 289,912 | | — | % |
Other income | | | 658,992 | | | 3,201,243 | | | (2,542,251) | | (79) | % |
Total Noninterest Income | | $ | 5,373,969 | | $ | 7,706,181 | | $ | (2,332,212) | | (30) | % |
Noninterest income for the year ended December 31, 2015 was $5.37 million, compared to $7.71 million for 2014. This decrease was primarily the result of the $2.38 million remaining interest rate mark-to-market adjustment on IRA deposits recognized in 2014, the $0.52 million bargain purchase gain recognized in 2014 and a $0.23 million decrease in electronic banking fees, offset by a $0.76 million increase in mortgage banking fees and gains and a $0.29 million gain from the sale of certain securities in 2015.
Noninterest Expenses
The following table reflects the amounts and changes in noninterest expense for the years ended December 31, 2015 and 2014:
| | | | | | | | | | | | |
| | Year Ended December 31: | | 2015 vs 2014 | |
| | 2015 | | 2014 | | $ Change | | % Change | |
| | | | | | | | | | | | |
Salary and employee benefits | | $ | 11,666,515 | | $ | 13,347,292 | | $ | (1,680,777) | | (13) | % |
Occupancy and equipment expenses | | | 3,559,576 | | | 4,110,791 | | | (551,215) | | (13) | % |
Legal, accounting and other professional fees | | | 1,361,907 | | | 1,416,505 | | | (54,598) | | (4) | % |
Data processing and item processing services | | | 1,372,688 | | | 1,197,231 | | | 175,457 | | 15 | % |
FDIC insurance costs | | | 403,502 | | | 383,031 | | | 20,471 | | 5 | % |
Advertising and marketing related expenses | | | 377,906 | | | 382,465 | | | (4,559) | | (1) | % |
Foreclosed property expenses | | | 463,949 | | | 632,943 | | | (168,994) | | (27) | % |
Loan collection costs | | | 343,521 | | | 332,843 | | | 10,678 | | 3 | % |
Core deposit intangible amortization | | | 854,098 | | | 992,960 | | | (138,862) | | (14) | % |
Merger related expenses | | | 22,097 | | | 1,028,239 | | | (1,006,142) | | (98) | % |
Other expenses | | | 2,114,881 | | | 3,632,071 | | | (1,517,190) | | (42) | % |
Total Noninterest Expenses | | $ | 22,540,640 | | $ | 27,456,371 | | $ | (4,915,731) | | (18) | % |
Noninterest expense for the year ended December 31, 2015 was $22.54 million compared to $27.46 million for 2014, a decrease of $4.92 million. The primary contributors to the decrease when compared to 2014 were decreases of $1.68 million in salary and employee benefits, $0.55 million in occupancy and equipment expense and $1.01 million merger and acquisition related expenses.
Income Taxes
For the year ended December 31, 2015, the provision for income taxes totaled $1.1 million, or an effective tax rate of 37.0%, compared to a benefit for income taxes of $0.7 million, or an effective tax rate of (31.5%), for 2014. The change in the effective tax rate for the year ended December 31, 2015 when compared to 2014 resulted from the Company filing amended 2011 and 2012 Federal and Maryland tax returns for the former Carrollton Bancorp, resulting in the accrual of $0.6 million in tax refunds. Combined with a reversal of a deferred tax valuation allowance, the Bank recognized $1.2 million in favorable tax benefits resulting in an overall reduction in tax expense of $1.77 million. Except for the impact of the amended tax returns and reversal of tax valuation allowance, the variance in the effective rate relates to the change in the mix of tax advantaged income relative to total book income as well as the tax effects of stock-based compensation. Unless there are any significant unusual transactions or changes in tax law, our effective tax rate should remain closer to the combined federal and state statutory rate of approximately 39.5%.
FINANCIAL CONDITION
Our total assets were $491 million at December 31, 2015, an increase of $11.2 million, or 2.3%, when compared to the $480 million recorded at December 31, 2014. Investment securities decreased by $1.7 million, or 4.7%, while loans held for sale decreased by $2.4 million, or 32.8%. These changes were partially offset by a $16.5 million increase in cash and cash equivalents resulting from the funding strategy implemented in anticipation of the Hopkins Merger. Total deposits were $367 million at December 31, 2015, a decrease of $20.4 million, or 5.3%, when compared to the $388 million recorded at December 31, 2014. The decrease was primarily due to managed declines in certificates of deposits, offset by a $10.2 million, or 11.1%, increase in non-interest bearing deposits. This funding source has been temporarily replaced with short term FHLB advances, improving the cost of funds, while the Company prepares to integrate Hopkins Bank’s deposit funded balance sheet following the pending Hopkins Merger. Short term borrowings were $52 million at December 31, 2015, an increase of $30 million, or 136%, when compared to December 31, 2014. Stockholders’ equity increased to $67.7 million at December 31, 2015, compared to $66.6 million at December 31, 2014. The increase includes increases related to corporate earnings and net market value adjustments on bank owned investment securities, offset by increases in the Bank’s retirement income plan liability due to changes in actuarial assumptions. The book value of the Company’s common stock was $6.13 and $6.05 at December 31, 2015 and 2014, respectively.
Investment Securities
Our investment policy authorizes management to invest in traditional securities instruments in order to provide ongoing liquidity, income and a ready source of collateral that can be pledged in order to access other sources of funds. The investment portfolio consists mainly of securities available for sale. Securities available for sale are those securities that we intend to hold for an indefinite period of time but not necessarily until maturity. These securities are carried at fair value and may be sold as part of an asset/liability management strategy, liquidity management, interest rate risk management, regulatory capital management or other similar factors.
The investment portfolio consists primarily of U.S. Government agency securities, U.S. Treasury securities, residential mortgage-backed securities, and state and municipal obligations. The income from state and municipal obligations is exempt from federal income tax. Certain agency securities are exempt from state income taxes. We use the investment portfolio as a source of both liquidity and earnings. Management continues to evaluate investment options that will produce income without assuming significant credit or interest rate risk and to look for opportunities to use liquidity from maturing investments to reduce our use of high cost time deposits and borrowed funds.
Investment securities decreased $1.8 million to $34.9 million at December 31, 2015 from $36.7 at December 31, 2014. New purchases totaled $14.2 million and included $0.3 million in securities designated as held to maturity. This increase was offset by principal pay downs totaling $5.9 million and sales/redemptions of $9.6 million. There was a decrease of $0.1 million in market value in 2015 compared to an increase of $0.7 million in 2014.
The composition of investment securities, at carrying value, at December 31, 2015, 2014 and 2013 are presented in the following table:
| | | | | | | | | | | | | | | | |
| | 2015 | | 2014 | | 2013 | |
| | Amount | | % | | Amount | | % | | Amount | | % | |
Available for sale securities | | | | | | | | | | | | | | | | |
U.S. government agency | | $ | 3,810,639 | | 11.4 | % | $ | 7,778,271 | | 21.9 | % | $ | 7,525,915 | | 20.6 | % |
U.S. treasury securities | | | 5,872,140 | | 17.6 | % | | — | | 0.0 | % | | — | | 0.0 | % |
Residential mortgage-backed securities | | | 15,023,225 | | 45.0 | % | | 20,870,927 | | 59.0 | % | | 23,801,003 | | 65.0 | % |
State and municipal bonds | | | 4,531,554 | | 13.6 | % | | 4,654,146 | | 13.2 | % | | 5,189,886 | | 14.2 | % |
Corporate bonds | | | 4,058,140 | | 12.2 | % | | 2,030,000 | | 5.7 | % | | — | | 0.0 | % |
Total debt securities | | | 33,295,698 | | 99.8 | % | | 35,333,344 | | 100.0 | % | | 36,516,804 | | 99.8 | % |
Equity securities | | | 56,535 | | 0.2 | % | | 16,545 | | 0.0 | % | | 69,865 | | 0.2 | % |
Total available for sale | | $ | 33,352,233 | | 100.0 | % | $ | 35,349,889 | | 100.0 | % | $ | 36,586,669 | | 100.0 | % |
| | | | | | | | | | | | | | | | |
| | 2015 | | 2014 | | 2013 | |
| | Amount | | % | | Amount | | % | | Amount | | % | |
Held to maturity securities | | | | | | | | | | | | | | | | |
U.S. government agency | | $ | 334,257 | | 21.2 | % | $ | — | | 0.0 | % | $ | — | | 0.0 | % |
Residential mortgage-backed securities | | | 1,238,908 | | 78.8 | % | | 1,315,718 | | 100.0 | % | | — | | 0.0 | % |
Total held to maturity | | $ | 1,573,165 | | 100.0 | % | $ | 1,315,718 | | 100.0 | % | $ | — | | 0.0 | % |
Maturities and weighted average yields for investment securities at December 31, 2015 are presented in the following table:
| | | | | | | | | |
| | 2015 | |
| | Amortized | | Fair | | Yield | |
| | Cost | | Value | | (1), (2) | |
Maturing - Available for sale | | | | | | | | | |
Within one year | | $ | 836,706 | | $ | 837,414 | | 0.86 | % |
Over one to five years | | | 9,542,262 | | | 9,609,537 | | 2.26 | % |
Over five to ten years | | | 7,778,830 | | | 7,825,522 | | 2.67 | % |
Over ten years | | | — | | | — | | 0.00 | % |
Residential mortgage-backed securities | | | 14,836,750 | | | 15,023,225 | | 3.23 | % |
Total debt securities | | $ | 32,994,548 | | $ | 33,295,698 | | | |
| | | | | | | | | |
| | 2015 | |
| | Amortized | | Fair | | Yield | |
| | Cost | | Value | | (1), (2) | |
Maturing - Held to maturity | | | | | | | | | |
Within one year | | $ | — | | $ | — | | 0 | % |
Over one to five years | | | — | | | — | | 0 | % |
Over five to ten years | | | — | | | — | | 0 | % |
Over ten years | | | 334,257 | | | 340,147 | | 3.43 | % |
Residential mortgage-backed securities | | | 1,238,908 | | | 1,256,115 | | 2.64 | % |
Total held to maturity | | $ | 1,573,165 | | $ | 1,596,262 | | | |
| (1) | | Yields are stated as book yields which are adjusted for amortization and accretion of purchase premiums and discounts, respectively. |
| (2) | | Yields on tax-exempt obligations have been computed on a tax-equivalent basis. |
Restricted Equity Securities
Restricted equity securities increased $1.1 million, or 59%, to $3.0 million at December 31, 2015, from $1.9 million at December 31, 2014. This increase was the result of required purchases of additional FHLB stock based on the increased level of FHLB borrowings at December 31, 2015.
Loans Held for Sale
Loans held for sale were $4.9 million at December 31, 2015, compared to $7.2 million at December 31, 2014. Loans originated for sale to third-party investors generally remain on our balance sheet for an average of 45 days.
Loans
A comparison of the loan portfolio for the years indicated is presented in the following table:
| | | | | | | | | | | | | | | | | | | | | | | | | | |
| | 2015 | | 2014 | | 2013 | | 2012 | | 2011 | |
| | Amount | | % | | Amount | | % | | Amount | | % | | Amount | | % | | Amount | | % | |
Commercial & Industrial | | $ | 46,464,340 | | 12 | % | $ | 33,454,280 | | 9 | % | $ | 34,278,539 | | 11 | % | $ | 20,601,207 | | 20 | % | $ | 26,351,942 | | 27 | % |
Commercial Real Estate | | | 168,569,159 | | 43 | % | | 158,714,554 | | 40 | % | | 157,450,876 | | 49 | % | | 39,906,055 | | 39 | % | | 28,561,983 | | 30 | % |
Residential Real Estate | | | 124,810,853 | | 32 | % | | 140,374,035 | | 36 | % | | 73,323,554 | | 23 | % | | 22,229,445 | | 22 | % | | 20,858,635 | | 21 | % |
Home Equity Line of Credit | | | 33,722,696 | | 9 | % | | 35,717,982 | | 9 | % | | 33,257,822 | | 10 | % | | 10,284,221 | | 10 | % | | 13,612,924 | | 14 | % |
Land | | | 5,229,645 | | 1 | % | | 5,856,875 | | 1 | % | | 1,716,747 | | 1 | % | | 3,098,973 | | 3 | % | | 5,172,942 | | 5 | % |
Construction | | | 13,277,353 | | 3 | % | | 18,052,287 | | 5 | % | | 19,343,013 | | 6 | % | | 4,704,581 | | 5 | % | | 1,959,353 | | 2 | % |
Consumer & Other | | | 1,166,521 | | — | % | | 881,179 | | — | % | | 1,309,781 | | — | % | | 911,690 | | 1 | % | | 502,270 | | 1 | % |
Total Loans | | | 393,240,567 | | 100 | % | | 393,051,192 | | 100 | % | | 320,680,332 | | 100 | % | | 101,736,172 | | 100 | % | | 97,020,049 | | 100 | % |
Less: Allowance for Loan Losses | | | (1,773,009) | | | | | (1,294,976) | | | | | (851,000) | | | | | (655,942) | | | | | (824,653) | | | |
Net Loans | | $ | 391,467,558 | | | | $ | 391,756,216 | | | | $ | 319,829,332 | | | | $ | 101,080,230 | | | | $ | 96,195,396 | | | |
Loans, net of deferred fees and costs, decreased by $0.3 million to $391.5 million at December 31, 2015 from $391.8 million at December 31, 2014, due to the additional allowance for loan losses required on the growth in newly originated loans.
The following table summarizes the scheduled repayments of our loan portfolio, both by loan category and by fixed and adjustable rates, at December 31, 2015:
| | | | | | | | | | | | | |
| | | | | After One Through | | | | | | | |
| | One Year or Less | | Five Years | | After Five Years | | Total | |
By Loan Category: | | | | | | | | | | | | | |
Commercial & Industrial | | $ | 27,790,294 | | $ | 10,939,764 | | $ | 7,734,282 | | $ | 46,464,340 | |
Commercial Real Estate | | | 16,200,479 | | | 77,991,281 | | | 74,377,399 | | | 168,569,159 | |
Residential Real Estate | | | 15,928,830 | | | 19,141,004 | | | 89,741,019 | | | 124,810,853 | |
Land | | | 28,507,002 | | | 336,278 | | | 4,879,417 | | | 33,722,697 | |
Home Equity Line of Credit | | | 3,828,431 | | | 1,401,214 | | | — | | | 5,229,645 | |
Construction | | | 11,478,669 | | | 537,783 | | | 1,260,901 | | | 13,277,353 | |
Consumer & Other | | | 296,814 | | | 492,919 | | | 376,788 | | | 1,166,521 | |
Total | | $ | 104,030,519 | | $ | 110,840,242 | | $ | 178,369,806 | | $ | 393,240,567 | |
| | | | | | | | | | | | | |
By Rate Terms: | | | | | | | | | | | | | |
Fixed rate | | | 18,163,685 | | | 97,822,061 | | | 148,096,362 | | | 264,082,108 | |
Adjustable rate | | | 85,866,834 | | | 13,018,181 | | | 30,273,444 | | | 129,158,459 | |
Total | | $ | 104,030,519 | | $ | 110,840,242 | | $ | 178,369,806 | | $ | 393,240,567 | |
Loans are placed on nonaccrual status when they are past due 90 days as to either principal or interest or when, in the opinion of management, the collection of all interest and/or principal is in doubt. Placing a loan on nonaccrual status means that we no longer accrue interest on such loan and reverse any interest previously accrued but not collected. Management may grant a waiver from nonaccrual status for a 90 day past due loan that is both well secured and in the process of collection. A loan remains on nonaccrual status until the loan is current as to payment of both principal and interest and the borrower demonstrates the ability to make payments in accordance with the terms of the loan and remains current.
A loan is considered to be impaired when, based on current information and events, it is probable that we will be unable to collect all amounts due according to the contractual terms of the loan agreement. Impaired loans are measured based on the fair value of the collateral for collateral dependent loans and at the present value of expected future cash flows using the loans’ effective interest rates for loans that are not collateral dependent.
At December 31, 2015, we had 114 impaired loans totaling $8.9 million. Of this amount, 88 impaired loans totaling $5.9 million were classified as nonaccrual loans. At December 31, 2015, troubled debt restructurings, or TDRs, included in impaired loans totaled $2.0 million, 14 loans of which were included in nonaccrual loans having a total balance of $1.4 million. Borrowers under all other restructured loans are paying in accordance with the terms of the modified loan agreement and have been placed on accrual status after a period of performance with the restructured terms. At December 31, 2015, the total valuation allowance for impaired loans was $0.06 million.
At December 31, 2014, we had 67 impaired loans totaling $6.4 million. Of this amount, 58 impaired loans totaling $5.2 million were classified as nonaccrual loans. At December 31, 2014, troubled debt restructurings, or TDRs, included in impaired loans totaled $2.4 million, eight loans of which were included in nonaccrual loans having a total balance of $1.2 million. Borrowers under all other restructured loans are paying in accordance with the terms of the modified loan agreement and have been placed on accrual status after a period of performance with the restructured terms. At December 31, 2014, the total valuation allowance for impaired loans was $0.
The following table presents details of our nonperforming loans and nonperforming assets, as these asset quality metrics are evaluated by management, for the years indicated:
| | | | | | | | | | | | | | | | |
| | As of December 31, | |
| | 2015 | | 2014 | | 2013 | | 2012 | | 2011 | |
| | | | | | | | | | | | | | | | |
Nonaccrual loans excluding PCI loans | | $ | 4,794,377 | | $ | 5,237,356 | | $ | 3,809,000 | | $ | 1,299,252 | | $ | 3,474,989 | |
Nonaccrual PCI loans | | | 1,089,461 | | | 1,620,710 | | | 179,114 | | | 656,624 | | | 20,000 | |
TDR loans excluding those in nonaccrual loans | | | 623,912 | | | 1,155,508 | | | 1,633,980 | | | 1,794,220 | | | 1,750,000 | |
Accruing loans past due 90+ days excluding PCI loans | | | — | | | — | | | — | | | 460,354 | | | — | |
Accruing PCI loans past due 90+ days | | | 2,354,891 | | | 5,380,847 | | | 2,692,572 | | | 1,186,437 | | | 1,848,482 | |
| | | | | | | | | | | | | | | | |
Total nonperforming loans | | | 8,862,641 | | | 13,394,421 | | | 8,314,666 | | | 5,396,887 | | | 7,093,471 | |
| | | | | | | | | | | | | | | | |
Real estate acquired through foreclosure | | | 1,459,732 | | | 1,480,472 | | | 1,290,120 | | | 1,151,256 | | | 1,504,101 | |
| | | | | | | | | | | | | | | | |
Total nonperforming assets | | $ | 10,322,373 | | $ | 14,874,893 | | $ | 9,604,786 | | $ | 6,548,143 | | $ | 8,597,572 | |
Nonperforming assets, which consist of nonaccrual loans, troubled debt restructurings, accruing loans past due 90 days or more, and real estate acquired through foreclosure, decreased to $10.3 million at December 31, 2015 from $14.9 million at December 31, 2014. Nonperforming assets represented 2.10% of total assets at December 31, 2015, compared to 3.10% at December 31, 2014. The level of nonperforming assets decreased primarily due to the resolution of accruing PCI loans past due 90+ days. Management has worked diligently to identify borrowers that may be facing difficulties in order to restructure terms where appropriate, secure additional collateral or pursue foreclosure and other secondary sources of repayment. The continued success in reducing nonperforming assets will ultimately be dependent on continued management diligence and improvement in the economy and the real estate market.
Potential problem loans consist of loans that are performing under contract but for which credit problems have caused us to place them on our list of criticized loans. These loans have a risk rating of 6 (Special Mention) or higher, and exclude all nonaccrual loans and accruing loans past due 90+ days. As of December 31, 2015, these loans totaled $17.0 million and consisted primarily of Commercial Real Estate and Residential Real Estate loans which had balances of $7.8 million and $6.3 million, respectively. As of December 31, 2014, these loans totaled $33.6 million and consisted primarily of Commercial Real Estate and Residential Real Estate loans which had balances of $19.2 million and $11.1 million, respectively. Difficulties in the economy and the accompanying impact on these borrowers, as well as future events, such as regulatory examination assessments, may result in these loans and others being classified as nonperforming assets in the future.
Allowance for Loan Losses and Credit Risk Management
The allowance for loan losses is established to estimate losses that may occur on loans by recording a provision for loan losses that is charged to earnings in the current period. The allowance is evaluated on a quarterly basis by management and is based upon management’s periodic review of the collectability of the loans in light of historic experience, the nature and volume of the loan portfolio, adverse situations that may affect the borrower’s ability to repay, estimated value of any underlying collateral and prevailing economic conditions. This evaluation is inherently subjective as it requires estimates that are susceptible to significant revision as more information becomes available. Measured impairment and credit losses are charged against the allowance when management believes the loan or a portion of the loan’s balance is not collectable. Subsequent recoveries, if any, are credited to the allowance.
The allowance consists of specific and general components. The specific component relates to individual loans that are classified as impaired. A loan is impaired when, based on current information and events, it is probable that the Bank will be unable to collect all amounts due (principal and interest) according to the contractual terms of the loan agreement and primarily includes nonaccrual, TDRs, and PCI loans where cash flows have deteriorated from those forecasted as of the acquisition date. For those loans that are classified as impaired, an allowance is established when the discounted cash flows, collateral value, or observable market price, whichever is appropriate, of the impaired loan is lower than the carrying value of the loan. For collateral-dependent impaired loans, any measured impairment is properly
charged off against the loan and allowance in the applicable reporting period. The specific component may fluctuate from period to period if changes occur in the nature and volume of impaired loans.
The general component covers pools of similar loans, including purchased loans that did not have deteriorated credit quality and new loan originations, and is based upon historical loss experience of the Bank or peer bank group if the Bank’s loss experience is deemed by management to be insufficient and several qualitative factors. These qualitative factors address various risk characteristics in the Bank’s loan portfolio after an assessment of internal or external influences on credit quality that are not fully reflected in the historical loss data. Management will continue to evaluate the appropriateness of the peer group data used with each quarterly allowance analysis until such time as the Bank has sufficient loss experience to provide a foundation for the general reserve requirement. The general component may fluctuate from period to period if changes occur in the mix of the Bank’s loan portfolio, economic conditions, or specific industry conditions.
A test of the adequacy of the allowance, using the methodology outlined above, is performed by management and reported to the Board of Directors on at least a quarterly basis. The complex evaluations involved in such testing require significant estimates. Management uses available data to establish the allowance at a prudent level, recognizing that the determination is inherently subjective, and that future adjustments may be necessary, depending upon many items including a change in economic conditions affecting specific borrowers, or in general economic conditions, and new information that becomes available. However, there are no assurances that the allowance will be sufficient to absorb losses on nonperforming loans, or that the allowance will be sufficient to cover losses on nonperforming loans in the future.
The allowance was $1,773,009 at December 31, 2015, compared to $1,294,976 at December 31, 2014. The allowance as a percentage of total portfolio loans was 0.45% at December 31, 2015 and 0.33% at December 31, 2014. Management expects continued gradual increases in our allowance for loan losses due to the gradual runoff of the discount on the acquired loan portfolio and an increase in new loan originations.
For non-impaired loans acquired by the Bank from Bay National Bank on July 10, 2010 without evidence of deteriorated credit quality, there was net unamortized discount of $0.5 million and $0.7 million at December 31, 2015 and December 31, 2014, respectively, which represented 3.1% and 3.3%, respectively, of the related loan balance. For non-impaired acquired legacy Carrollton Bank portfolio loans without evidence of deteriorated credit quality, there was net unamortized discount of $1.1 million and $1.3 million at December 31, 2015 and December 31, 2014, respectively, which represented 1.1% and 1.0%, respectively, of the related loan balance. For non-impaired acquired legacy Slavie portfolio loans without evidence of deteriorated credit quality, there was net unamortized discount of $1.8 million and $2.2 million at December 31, 2015 and December 31, 2014, respectively, which represented 4.0% and 2.2%, respectively, of the related loan balance. As the total combined remaining net discount exceeded the indicated total required reserve for these loan pools, no additional reserves were recorded.
During the year ended December 31, 2015, we recorded net charge offs of $664,489, compared to net charge offs of $357,712 during the year ended December 31, 2014.
The following table reflects activity in the allowance for loan losses for the periods indicated:
| | | | | | | | | | | | | | | | |
| | Year Ended December 31, | |
| | 2015 | | 2014 | | 2013 | | 2012 | | 2011 | |
Balance at beginning of year | | $ | 1,294,976 | | $ | 851,000 | | $ | 655,942 | | $ | 824,653 | | $ | 684,289 | |
Charge offs: | | | | | | | | | | | | | | | | |
Commercial & Industrial | | | 80,869 | | | — | | | 82,860 | | | 101,128 | | | 39,778 | |
Commercial Real Estate | | | 45,573 | | | 300,214 | | | 187,419 | | | 1,796 | | | — | |
Residential Real Estate | | | 454,356 | | | 274,382 | | | 441,421 | | | 183,765 | | | 424,579 | |
Home Equity Line of Credit | | | 64,918 | | | 79,492 | | | 10,919 | | | 647,063 | | | 383,187 | |
Land | | | — | | | — | | | — | | | 36,177 | | | 231,362 | |
Construction | | | 76,347 | | | — | | | — | | | — | | | 37,386 | |
Consumer & Other | | | 2,495 | | | 934 | | | 1,000 | | | — | | | — | |
Total charge offs | | | 724,558 | | | 655,022 | | | 723,619 | | | 969,929 | | | 1,116,292 | |
| | | | | | | | | | | | | | | | |
Recoveries: | | | | | | | | | | | | | | | | |
Commercial & Industrial | | | — | | | 30,000 | | | — | | | 30,000 | | | — | |
Commercial Real Estate | | | — | | | 137,072 | | | — | | | 1,796 | | | — | |
Residential Real Estate | | | 46,569 | | | 109,827 | | | 39,135 | | | 7,000 | | | — | |
Home Equity Line of Credit | | | 13,000 | | | 9,844 | | | 13,578 | | | 28,605 | | | — | |
Land | | | — | | | — | | | 23,026 | | | — | | | — | |
Construction | | | — | | | — | | | — | | | — | | | — | |
Consumer & Other | | | 500 | | | 10,567 | | | 731 | | | — | | | — | |
Total recoveries | | | 60,069 | | | 297,310 | | | 76,470 | | | 67,401 | | | — | |
| | | | | | | | | | | | | | | | |
Net charge offs | | | 664,489 | | | 357,712 | | | 647,149 | | | 902,528 | | | 1,116,292 | |
Provision for loan loss | | | 1,142,522 | | | 801,688 | | | 842,207 | | | 733,817 | | | 1,256,656 | |
| | | | | | | | | | | | | | | | |
Balance at end of year | | $ | 1,773,009 | | $ | 1,294,976 | | $ | 851,000 | | $ | 655,942 | | $ | 824,653 | |
| | | | | | | | | | | | | | | | |
Allowance as a percentage of total loans at the end of the year | | | 0.45 | % | | 0.33 | % | | 0.27 | % | | 0.64 | % | | 0.85 | % |
Net charge offs as a percentage of average loans during the year | | | 0.17 | % | | 0.10 | % | | 0.25 | % | | 0.92 | % | | 1.21 | % |
The following table presents the allowance for loan losses by loan category at the dates indicated below:
| | | | | | | | | | | | | | | | | | | | | | | | | | |
| | 2015 | | 2014 | | 2013 | | 2012 | | 2011 | |
| | | | | Percent | | | | | Percent | | | | | Percent | | | | | Percent | | | | | Percent | |
| | | | | of Loans | | | | | of Loans | | | | | of Loans | | | | | of Loans | | | | | of Loans | |
| | | | | in Each | | | | | in Each | | | | | in Each | | | | | in Each | | | | | in Each | |
| | | | | Category | | | | | Category | | | | | Category | | | | | Category | | | | | Category | |
| | | | | to Total | | | | | to Total | | | | | to Total | | | | | to Total | | | | | to Total | |
| | Amount | | Loans | | Amount | | Loans | | Amount | | Loans | | Amount | | Loans | | Amount | | Loans | |
Commercial & Industrial | | $ | 210,798 | | 12 | % | $ | 200,510 | | 9 | % | $ | 167,400 | | 11 | % | $ | 121,759 | | 20 | % | $ | 151,395 | | 27 | % |
Commercial Real Estate | | | 727,869 | | 43 | % | | 554,585 | | 40 | % | | 324,080 | | 49 | % | | 131,350 | | 39 | % | | 88,361 | | 30 | % |
Residential Real Estate | | | 593,084 | | 32 | % | | 203,413 | | 36 | % | | 80,239 | | 23 | % | | 199,306 | | 22 | % | | 49,490 | | 21 | % |
Home Equity Line of Credit | | | 157,043 | | 9 | % | | 166,733 | | 9 | % | | 129,203 | | 10 | % | | 81,955 | | 10 | % | | 446,911 | | 14 | % |
Land | | | 15,713 | | 1 | % | | 8,687 | | 1 | % | | 6,918 | | 1 | % | | 6,400 | | 3 | % | | 8,256 | | 5 | % |
Construction | | | 62,967 | | 3 | % | | 153,089 | | 5 | % | | 135,416 | | 6 | % | | 109,335 | | 5 | % | | 75,473 | | 2 | % |
Consumer & Other | | | 5,535 | | — | % | | 7,959 | | — | % | | 7,744 | | — | % | | 5,837 | | 1 | % | | 4,767 | | 1 | % |
Total Loans | | $ | 1,773,009 | | 100 | % | $ | 1,294,976 | | 100 | % | $ | 851,000 | | 100 | % | $ | 655,942 | | 100 | % | $ | 824,653 | | 100 | % |
Deposits
The following deposit table presents the composition of deposits at December 31, 2015 and 2014:
| | | | | | | | | | | | | | | | |
| | 2015 | | 2014 | | 2015 vs 2014 | |
| | Amount | | % of Total | | Amount | | % of Total | | $ Change | | % Change | |
Noninterest-bearing deposits | | $ | 101,838,210 | | 28 | % | $ | 91,676,534 | | 24 | % | $ | 10,161,676 | | 11 | % |
| | | | | | | | | | | | | | | | |
Interest-bearing deposits: | | | | | | | | | | | | | | | | |
Checking | | | 53,992,300 | | 15 | % | | 54,844,855 | | 14 | % | | (852,555) | | (2) | % |
Savings | | | 38,086,749 | | 10 | % | | 36,233,369 | | 9 | % | | 1,853,380 | | 5 | % |
Money market | | | 88,946,436 | | 24 | % | | 82,651,992 | | 21 | % | | 6,294,444 | | 8 | % |
Total interest-bearing checking, savings and money market deposits | | | 181,025,485 | | 49 | % | | 173,730,216 | | 44 | % | | 7,295,269 | | 4 | % |
| | | | | | | | | | | | | | | | |
Time deposits under $100,000 | | | 41,150,349 | | 11 | % | | 50,313,096 | | 13 | % | | (9,162,747) | | (18) | % |
Time deposits of $100,000 or more | | | 43,401,894 | | 12 | % | | 72,110,286 | | 19 | % | | (28,708,392) | | (40) | % |
Total time deposits | | | 84,552,243 | | 23 | % | | 122,423,382 | | 32 | % | | (37,871,139) | | (31) | % |
| | | | | | | | | | | | | | | | |
Total interest bearing deposits | | | 265,577,728 | | 72 | % | | 296,153,598 | | 76 | % | | (30,575,870) | | (10) | % |
| | | | | | | | | | | | | | | | |
Total Deposits | | $ | 367,415,938 | | 100 | % | $ | 387,830,132 | | 100 | % | $ | (20,414,194) | | (5) | % |
The $20.4 million decrease in total deposits was primarily attributable to maturing time deposits. Time deposit balances have decreased by $37.9 million for the year, as our strong liquidity position has allowed for a reduced dependence on large denomination and non-relationship balances.
The ratio of noninterest-bearing deposits to total deposits increased to 28% at December 31, 2015, from 24% at December 31, 2014. Included in our deposit portfolio are brokered deposits through the Promontory Interfinancial Network. Through this deposit matching network, which includes CDARS and insured cash sweep service (“ICS”), 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 CDARS and ICS on behalf of a customer, we typically receive matching deposits through the network’s reciprocal deposit program. At December 31, 2015, we had $9.3 million in CDARS and ICS deposits through the reciprocal deposit program, compared to $8.9 at December 31, 2014. We can also choose to place deposits through this network without receiving matching deposits. At December 31, 2015, we had placed $0.1 million of deposits through this network for which we received no matching deposits, compared to $0.3 million at December 31, 2014.
Average balances by deposit category and the related average rate paid for the periods indicated are presented in the following table:
| | | | | | | | | | | | | | | | |
| | Years Ended December 31, | |
| | 2015 | | 2014 | | 2013 | |
| | Average | | Average | | Average | | Average | | Average | | Average |
| | Balance | | Rate Paid | | Balance | | Rate Paid | | Balance | | Rate Paid | |
Noninterest-bearing deposits | | $ | 97,275,956 | | 0.00 | % | $ | 93,643,953 | | 0.00 | % | $ | 74,794,928 | | 0.00 | % |
Interest-bearing deposits: | | | | | | | | | | | | | | | | |
Checking | | | 46,872,288 | | 0.11 | % | | 45,700,865 | | 0.10 | % | | 29,363,622 | | 0.20 | % |
Savings | | | 37,454,550 | | 0.12 | % | | 34,329,672 | | 0.12 | % | | 20,065,330 | | 0.03 | % |
Money market | | | 91,545,248 | | 0.28 | % | | 83,404,571 | | 0.37 | % | | 64,100,619 | | 0.37 | % |
Total interest-bearing checking, savings and money market deposits | | | 175,872,087 | | 0.20 | % | | 163,435,108 | | 0.24 | % | | 113,529,571 | | 0.27 | % |
| | | | | | | | | | | | | | | | |
Total time deposits | | | 115,097,364 | | 1.22 | % | | 128,621,230 | | 0.65 | % | | 117,716,218 | | 0.81 | % |
| | | | | | | | | | | | | | | | |
Total interest-bearing deposits | | | 290,969,451 | | 0.60 | % | | 292,056,338 | | 0.42 | % | | 231,245,789 | | 0.54 | % |
| | | | | | | | | | | | | | | | |
Total Deposits | | $ | 388,245,408 | | 0.45 | % | $ | 385,700,291 | | 0.32 | % | $ | 306,040,717 | | 0.41 | % |
The following table presents the maturity distribution for time deposits of $100 thousand or more at December 31, 2015:
| | | | |
| | Amount | |
Three months or less | | $ | 4,893,736 | |
Over three months through six months | | | 3,585,808 | |
Over six months through twelve months | | | 15,468,874 | |
Over twelve months | | | 19,453,476 | |
Total Time Deposits | | $ | 43,401,894 | |
Borrowings
Borrowings at December 31, 2015 consist of FHLB advances of $52.0 million and Atlantic Community Bankers Bank (“ACBB”) advances of $0.3 million, compared to borrowings of $22.0 million and $0.2 million respectively as of December 31, 2014.
CAPITAL RESOURCES
Ample capital is necessary to sustain growth, provide a measure of protection against unanticipated declines in asset values and safeguard the funds of depositors. Capital also provides a source of funds to meet loan demand and enables us to manage its assets and liabilities effectively.
At December 31, 2015, our total stockholders’ equity increased to $67.7 million from $66.6 million at December 31, 2014, primarily as a result of $1.9 million of retained corporate earnings offset $1.2 million in net unrealized loss on the defined benefit pension plan.
The Bank is subject to various regulatory capital requirements administered by federal banking agencies. Failure to meet minimum capital requirements can initiate certain mandatory and possibly additional discretionary actions by regulators that, if undertaken, could have a direct material effect on our financial statements. Under capital adequacy guidelines and the regulatory framework for prompt corrective action, the Bank must meet specific capital guidelines that involve quantitative measures of its assets, liabilities and certain off-balance sheet items as calculated under regulatory accounting practices. The capital amounts and classification are also subject to qualitative judgments by the regulators about components, risk weightings and other factors.
In July 2013, federal bank regulatory agencies issued a final rule that revises their risk based capital requirements and the method for calculating risk weighted assets to make them consistent with agreements that were reached by the Basel Committee on Banking Supervision and certain provisions of the Dodd-Frank Act. These Basel III
Capital Rules were applicable to the Bank effective January 1, 2015, but they do not apply to the Company since it is a small bank holding company with less than $500 million in total consolidated assets.
The rule imposes higher risk based capital and leverage requirements than those in place at the time the rule was issued. Specifically, the rule imposes the following minimum capital requirements to be considered adequately capitalized:
| · | | A new common equity Tier 1 risk based capital ratio of 4.5%; |
| · | | A Tier 1 risk-based capital ratio of 6% (increased from the previous 4% requirement); |
| · | | A total risk-based capital ratio of 8% (unchanged from previous requirements); and |
The rule also includes changes in what constitutes regulatory capital, some of which are subject to a transition period. These changes include the phasing out of certain instruments as qualifying capital. In addition, Tier 2 capital is no longer limited to the amount of Tier 1 capital included in total capital. Certain deferred tax assets over designated percentages of common stock are required to be deducted from capital, subject to a transition period. Finally, common equity Tier 1 capital includes accumulated other comprehensive income (which includes all unrealized net gains and losses on available for sale debt and equity securities and all unrealized net gain or loss on defined benefit pension plan), subject to a transition period and a one-time opt-out election. The Bank elected to opt-out of this provision. As such, accumulated comprehensive income is not included in determining the Bank’s regulatory capital ratios.
The rule also includes changes in the risk weights of assets to better reflect credit risk and other risk exposures. These include a 150% risk weight (up from 100%) for certain high volatility commercial real estate acquisitions, development and construction loans and non-residential mortgage loans that are 90 days past due or otherwise on nonaccrual status, a 20% (up from 0%) credit conversion factor for the unused portion of a commitment with an original maturity of one year or less that is not unconditionally cancellable, a 250% risk weight (up from 100%) for deferred tax assets that are not deducted from capital and increased risk weights (from 0% to up to 600%) for certain equity exposures.
Finally, the rule limits capital distributions and certain discretionary bonus payments if the banking organization does not hold a “capital conservation buffer” consisting of 2.5% (once fully phased in) of common equity Tier 1 capital to risk weighted assets in addition to the amount necessary to meet its minimum risk based capital requirements.
The final rule became effective on January 1, 2015, and the requirements in the rule will be fully phased-in by January 1, 2019. While the ultimate impact of the fully phased-in capital standards on the Company and the Bank is currently being reviewed, we currently do not believe that compliance with the Basel III Capital Rules will have a material impact once fully implemented.
For regulatory capital purposes as of March 31, 2015, deferred tax assets that arise from net operating loss and tax credit carryforwards (net of any related valuations allowances and net of deferred tax liabilities) are excluded from regulatory capital, in addition to certain overall limits on net deferred tax assets as a percentage of common equity Tier 1 capital. At December 31, 2015, $0.9 million of the Bank’s net deferred tax asset was excluded from common equity Tier 1, Tier 1 and total regulatory capital. We will continue to evaluate the realizability of our net deferred tax asset on a quarterly basis for both financial reporting and regulatory capital purposes. This evaluation may result in the inclusion of a deferred tax asset in regulatory capital in an amount that is different from the amount determined under GAAP.
In addition, the OCC requires that FSBs, like the Bank, maintain a minimum level of Tier 1 capital to average total assets excluding intangibles. This measure is known as the leverage ratio. The current regulatory minimum for the leverage ratio for institutions to be considered adequately capitalized is 4%, but an individual institution could be required to maintain a higher level. In connection with the Merger, the Bank entered into an Operating Agreement with the OCC pursuant to which the Bank agreed, among other things, to maintain a leverage ratio of at least 10% for the term of the Operating Agreement. The Operating Agreement will remain in effect until it is terminated by the OCC or the Bank ceases to be an FSB.
Quantitative measures established by regulation to ensure capital adequacy require the Bank to maintain amounts and ratios (set forth in the table below) of total, common equity Tier 1 and Tier 1 capital (as defined in the regulations) to risk-weighted assets (as defined), and a leverage ratio of Tier 1 capital (as defined) to average tangible assets (as defined). At December 31, 2015 and 2014, the Bank had regulatory capital in excess of that required under each requirement and was classified as “well capitalized”.
Actual capital amounts and ratios for the Bank are presented in the following table (dollars in thousands):
| | | | | | | | | | | | | | | | | | |
| | | | | | | | | | | | | | To Be Well | |
| | | | | | | | | | | | | | Capitalized Under | |
| | | | | | | | To Be Considered | | | Prompt Corrective | |
| | Actual | | | Adequately Capitalized | | | Action Provisions | |
| | Amount | | Ratio | | | Amount | | Ratio | | | Amount | | Ratio | |
As of December 31, 2015: | | | | | | | | | | | | | | | | | | |
| | | | | | | | | | | | | | | | | | |
Common Equity Tier 1 Capital | | $ | 65,465 | | 16.14 | % | | $ | 18,249 | | 4.50 | % | | $ | 26,360 | | 6.50 | % |
| | | | | | | | | | | | | | | | | | |
Tier I Risk-Based Capital Ratio | | $ | 65,465 | | 16.14 | % | | $ | 24,332 | | 6.00 | % | | $ | 32,443 | | 8.00 | % |
| | | | | | | | | | | | | | | | | | |
Total Risk-Based Capital Ratio | | $ | 67,238 | | 16.58 | % | | $ | 32,443 | | 8.00 | % | | $ | 40,553 | | 10.00 | % |
| | | | | | | | | | | | | | | | | | |
Tier 1 Leverage Ratio | | $ | 65,465 | | 13.75 | % | | $ | 19,041 | | 4.00 | % | | $ | 23,801 | | 5.00 | % |
| | | | | | | | | | | | | | | | | | |
As of December 31, 2014: | | | | | | | | | | | | | | | | | | |
| | | | | | | | | | | | | | | | | | |
Common Equity Tier 1 Capital | | | N/A | | N/A | | | | N/A | | N/A | | | | N/A | | N/A | |
| | | | | | | | | | | | | | | | | | |
Tier I Risk-Based Capital Ratio | | $ | 61,448 | | 16.31 | % | | $ | 15,066 | | 4.00 | % | | $ | 22,599 | | 6.00 | % |
| | | | | | | | | | | | | | | | | | |
Total Risk-Based Capital Ratio | | $ | 62,743 | | 16.66 | % | | $ | 30,132 | | 8.00 | % | | $ | 37,665 | | 10.00 | % |
| | | | | | | | | | | | | | | | | | |
Tier 1 Leverage Ratio | | $ | 61,448 | | 12.94 | % | | $ | 18,988 | | 4.00 | % | | $ | 23,735 | | 5.00 | % |
The OCC is required to take certain supervisory actions against an undercapitalized FSB, the severity of which depends upon the FSB’s degree of capitalization. Failure to maintain an appropriate level of capital could cause the OCC to take any one or more of a number of discretionary supervisory actions, including the issuance of a capital directive and the replacement of senior executive officers and directors.
Banking regulations also limit the amount of dividends that may be paid without prior approval by an FSB's regulatory agencies. In addition to these regulations, the Bank agreed in the Operating Agreement that it would not declare or pay any dividends or otherwise reduce its capital unless it is in compliance with the Operating Agreement, including the minimum capital requirements. The Bank has applied for regulatory approval to pay a $23.27 million one-time cash dividend to the Company to be used to purchase all of the outstanding shares of Hopkins common stock in the pending Hopkins Merger. Due to the Bank’s desire to preserve capital to fund its growth, the Company currently does not anticipate paying dividends beyond the foregoing described need for the foreseeable future. In addition to these regulatory restrictions, it should be noted that the declaration of dividends is at the discretion of our Board of Directors and will depend, in part, on our earnings and future capital needs.
LIQUIDITY
Liquidity describes our ability to meet financial obligations, including lending commitments and contingencies, which arise during the normal course of business. Liquidity is primarily needed to meet the borrowing and deposit withdrawal requirements of the Company’s customers, as well as to meet current and planned expenditures. Management monitors the liquidity position daily.
Our liquidity is derived primarily from our deposit base, scheduled amortization and prepayments of loans and investment securities, funds provided by operations and capital. Additionally, liquidity is provided through our
portfolios of cash and interest-bearing deposits in other banks, federal funds sold, loans held for sale, and securities available for sale. While scheduled principal repayments on loans are a relatively predictable source of funds, deposit flows and loan prepayments are greatly influenced by market interest rates, economic conditions, and rates offered by the Bank’s competition.
The borrowing requirements of customers include commitments to extend credit and the unused portion of lines of credit, which totaled $84.2 million at December 31, 2015. Management notes that, historically, a small percentage of unused lines of credit are actually drawn down by customers within a 12-month period.
Our most liquid assets are cash and assets that can be readily converted into cash, including interest-bearing deposits with banks and federal funds sold, and investment securities. At December 31, 2015, we had $8.1 million in cash and due from banks, $26.4 million in interest-bearing deposits with banks and federal funds sold, and $33.4 million in investment securities available for sale.
The Bank also has external sources of funds through the Federal Reserve Bank of Richmond (the “Reserve Bank”) and FHLB, which can be drawn upon when required. The Bank has a line of credit totaling approximately $94.8 million with the FHLB of which $30.5 million was available to be drawn on December 31, 2015 based on qualifying loans pledged as collateral. In addition, the Bank can pledge securities at the Reserve Bank and FHLB and, depending on the type of security, may borrow approximately 50% to 97% of the fair market value of the securities. The Bank had $12.5 million of securities pledged at the FHLB, $0.1 million of securities pledged at the Reserve Bank, and an additional $22.0 million of unpledged securities. Using these securities as collateral, the Bank could borrow approximately $25.9 million as of December 31, 2015.
Additionally, the Bank has unsecured federal funds lines of credit totaling $8.0 million with two institutions and a $4.0 million secured federal funds line of credit with another institution. The secured federal funds line of credit with another institution would require the Bank to transfer securities currently pledged at the FHLB or the Reserve Bank or to pledge unpledged securities to this institution before it could borrow against this line. In November of 2014, the Company obtained a $1.0 million unsecured revolving line of credit with an institution that was renewed in full in November 2015. The proceeds of the Company’s line of credit may be used for general corporate purposes. At December 31, 2015, there were outstanding balances of $52.0 million under the Bank’s FHLB line and of $0.3 million under the Company’s other line of credit. There were outstanding balances under these lines of $22 million and $0.2 million, respectively, at December 31, 2014.
To further aid in managing liquidity, the Bank’s Board of Directors has approved and formed an Asset/Liability Management Committee (“ALCO”) to review and discuss recommendations for the use of available cash and to maintain an investment portfolio. By limiting the maturity of securities and maintaining a conservative investment posture, management can rely on the investment portfolio to help meet any short-term funding needs.
We believe the Bank has adequate cash on hand and available through liquidation of investment securities and available borrowing capacity to meet our liquidity needs. Although we believe sufficient liquidity exists, if economic conditions and consumer confidence deteriorate, this liquidity could be depleted, which would then materially affect our ability to meet operating needs and to raise additional capital.
MARKET RISK AND INTEREST RATE SENSITIVITY
Our primary market risk is interest rate fluctuation. Interest rate risk results primarily from the traditional banking activities in which the Bank engages, such as gathering deposits and extending loans. Many factors, including economic and financial conditions, movements in interest rates and consumer preferences affect the difference between the interest earned on our assets and the interest paid on liabilities. Our interest rate risk represents the level of exposure we have to fluctuations in interest rates and is primarily measured as the change in earnings and the theoretical market value of equity that results from changes in interest rates. The ALCO oversees our management of interest rate risk. The objective of the management of interest rate risk is to maximize stockholder value, enhance profitability and increase capital, serve customer and community needs, and protect us from any material financial consequences associated with changes in interest rate risk.
Interest rate risk is that risk to earnings or capital arising from movement of interest rates. It arises from differences between the timing of rate changes and the timing of cash flows (repricing risk); from changing rate relationships across yield curves that affect bank activities (basis risk); from changing rate relationships across the spectrum of maturities (yield curve risk); and from interest rate related options embedded in certain bank products (option risk). Changes in interest rates may also affect a bank’s underlying economic value. The value of a bank’s assets, liabilities, and interest-rate related, off-balance sheet contracts is affected by a change in rates because the present value of future cash flows, and in some cases the cash flows themselves, is changed.
We believe that accepting some level of interest rate risk is necessary in order to achieve realistic profit goals. Management and the Board have chosen an interest rate risk profile that is consistent with our strategic business plan.
The Company’s board of directors has established a comprehensive interest rate risk management policy, which is administered by our ALCO. The policy establishes limits on risk, which are quantitative measures of the percentage change in net interest income (a measure of net interest income at risk) and the fair value of equity capital (a measure of economic value of equity or “EVE” at risk) resulting from a hypothetical change in U.S. Treasury interest rates. We measure the potential adverse impacts that changing interest rates may have on our short-term earnings, long-term value, and liquidity by employing simulation analysis through the use of computer modeling. The simulation model captures optionality factors such as call features and interest rate caps and floors imbedded in investment and loan portfolio contracts. As with any method of gauging interest rate risk, there are certain shortcomings inherent in the interest rate modeling methodology we employ. When interest rates change, actual movements in different categories of interest-earning assets and interest-bearing liabilities, loan prepayments, and withdrawals of time and other deposits, may deviate significantly from assumptions used in the model. Finally, the methodology does not measure or reflect the impact that higher rates may have on adjustable-rate loan customers’ ability to service their debts, or the impact of rate changes on demand for loan and deposit products.
We prepare a current base case and up to eight alternative simulations at least once a quarter and report the analysis to the board of directors. In addition, more frequent forecasts are produced when interest rates are particularly uncertain or when other business conditions so dictate.
The statement of condition is subject to quarterly testing for up to eight alternative interest rate shock possibilities to indicate the inherent interest rate risk. Average interest rates are shocked by +/ - 100, 200, 300, and 400 basis points (“bp”), although we may elect not to use particular scenarios that we determine are impractical in the current rate environment. It is our goal to structure the balance sheet so that net interest-earnings at risk over a twelve-month period and the economic value of equity at risk do not exceed policy guidelines at the various interest rate shock levels.
At December 31, 2015, we were in a liability sensitive position. Management continuously strives to reduce higher costing fixed rate funding instruments, while increasing assets that are more fluid in their repricing. An asset sensitive position, theoretically, is favorable in a rising rate environment since more assets than liabilities will reprice in a given time frame as interest rates rise. Similarly, a liability sensitive position, theoretically, is favorable in a declining interest rate environment since more liabilities than assets will reprice in a given time frame as interest rates decline. Management works to maintain a consistent spread between yields on assets and costs of deposits and borrowings, regardless of the direction of interest rates.
| | | | | | | | | | | | | | | | | |
Estimated Changes in Net Interest Income | | | | | | | | | | | | | | | | | |
Change in Interest Rates: | | +400 | bp | +300 | bp | +200 | bp | +100 | bp | (100) | bp | (200) | bp | (300) | bp | (400) | bp |
Policy Limit | | (20.0) | % | (15) | % | (10.0) | % | (5.0) | % | (5.0) | % | (10.0) | % | (15) | % | (20.0) | % |
December 31, 2015 | | (2.2) | % | (1.6) | % | (1.0) | % | (0.4) | % | (3.9) | % | N/A | | N/A | | N/A | |
December 31, 2014 | | 1.8 | % | 1.4 | % | 0.9 | % | 0.4 | % | (2.4) | % | N/A | | N/A | | N/A | |
As shown above, measures of net interest income at risk were less favorable at December 31, 2015 than at December 31, 2014 at all interest rate shock levels. All measures remained within prescribed policy limits. The primary contributors to the less favorable position was the less asset sensitive balance sheet.
The measures of equity value at risk indicate the ongoing economic value of the Company by considering the effects of changes in interest rates on all of the Company’s cash flows, and by discounting the cash flows to estimate the
present value of assets and liabilities. The difference between these discounted values of the assets and liabilities is the economic value of equity, which, in theory, approximates the fair value of the Company’s net assets.
| | | | | | | | | | | | | | | | | |
Estimated Changes in Economic Value of Equity (EVE) | | | | | | | | | | | | | | | | | |
Change in Interest Rates: | | +400 | bp | +300 | bp | +200 | bp | +100 | bp | (100) | bp | (200) | bp | (300) | bp | (400) | bp |
Policy Limit | | (25.0) | % | (20.0) | % | (15.0) | % | (10.0) | % | (10.0) | % | (15.0) | % | (20.0) | % | (25.0) | % |
December 31, 2015 | | 8.9 | % | 7.7 | % | 5.9 | % | 4.0 | % | (12.4) | % | N/A | | N/A | | N/A | |
December 31, 2014 | | 12.1 | % | 10.2 | % | 7.7 | % | 4.9 | % | (3.2) | % | N/A | | N/A | | N/A | |
The EVE at risk declined at December 31, 2015 when compared to December 31, 2014 in all interest rate shock levels. We evaluated the slightly below policy decrease in the declining rate scenario shown in the table above. Although we believe the likelihood of this scenario is extremely remote, we will continue to adjust our strategy and monitor the impact of our adjustments to ensure they do not exacerbate or create new out-of-policy limit results.
CONTRACTUAL OBLIGATIONS AND OFF-BALANCE SHEET ARRANGEMENTS
We have various contractual obligations that may require future cash payments. The following table presents our significant contractual obligations as of December 31, 2015:
| | | | | | | | | | | | | | | | |
| | Projected Maturity Date or Payment Period | |
| | Total | | Less than 1 year | | 1 - 3 years | | 3 - 5 years | | More than 5 years | |
Time Deposits (1) | | $ | 84,552,243 | | $ | 45,067,147 | | $ | 19,936,770 | | $ | 19,516,755 | | $ | 31,571 | |
Operating lease obligations (2) | | | 8,341,401 | | | 1,340,065 | | | 2,144,838 | | | 1,486,758 | | | 3,369,740 | |
Purchase obligations (3) | | | 2,160,000 | | | 909,000 | | | 1,251,000 | | | — | | | — | |
Total | | $ | 95,053,644 | | $ | 47,316,212 | | $ | 23,332,608 | | $ | 21,003,513 | | $ | 3,401,311 | |
| (1) | | In the normal course of business, a substantial portion of these balances rollover into new time deposits. |
| (2) | | The total obligation is estimated based on our normal monthly charges. |
| (3) | | Represents payments required under a contract with our data processing services provider which expires in April 2018. |
We also enter into off-balance sheet arrangements in the normal course of business. These arrangements consist primarily of commitments to extend credit, lines of credit, letters of credit and mortgage loan repurchase obligations. Credit commitments are agreements to lend to a customer as long as there is no violation of any condition to the contract. Loan commitments generally have interest rates fixed at current market amounts, fixed expiration dates, and may require payment of a fee. Lines of credit generally have variable interest rates. Such lines generally do not represent future cash requirements because it is unlikely that all customers will draw upon their lines in full at any time. Letters of credit are commitments issued to guarantee the performance of a customer to a third party. Mortgage loan repurchase obligations arise when loans previously sold by the Bank are required to be repurchased.
The following table presents our outstanding loan commitments, lines and letters of credit and mortgage loan repurchase obligations as of December 31, 2015:
| | | | |
| | December 31, 2015 | |
Loan commitments | | $ | 6,054,409 | |
Unused lines of credit | | | 78,100,042 | |
Standby letters of credit | | | 2,925,984 | |
Mortgage loan repurchase obligation | | | 2,790,836 | |
Our exposure to credit loss in the event of nonperformance by the borrower is the contract amount of the commitment. Loan commitments, lines of credit, and letters of credit are made on the same terms, including collateral, as outstanding loans. Management is not aware of any accounting loss that we would incur by funding these commitments. The Company’s contractual obligation for mortgage loan repurchase arises only when the breach of representations and warranties are discovered and repurchase is demanded. The maximum potential future payment related to these guarantees is not readily determinable because the Company’s obligation under these agreements depends on the occurrence of future events. The loan balances subject to repurchase were $ 2.8 million and $10.1 million at December 31, 2015 and 2014, respectively. Management does not expect losses resulting from repurchase requests to be material to reported financial results.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
This disclosure is not required, since we are a “smaller reporting company”, but information regarding our market risk is discussed in Item 7 of this Part II under the heading, “Market Risk and Interest Rate Sensitivity”.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
To the Board of Directors and Stockholders
Bay Bancorp, Inc.
Columbia, Maryland
We have audited the accompanying consolidated balance sheet of Bay Bancorp, Inc. and subsidiary (the “Company”) as of December 31, 2015, and the related consolidated statement of income and comprehensive income, change in stockholders’ equity, and cash flows for the year ended December 31, 2015. These consolidated financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these consolidated financial statements based on our audit.
We conducted our audit in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. The company is not required to have, nor were we engaged to perform, an audit of its internal control over financial reporting. Our audit included consideration of internal control over financial reporting as a basis for designing audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the company’s internal control over financial reporting. Accordingly, we express no such opinion. An audit also includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audit provides a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of Bay Bancorp, Inc. and subsidiary as of December 31, 2015, and the results of their operations and their cash flows for the year ended December 31, 2015, in conformity with accounting principles generally accepted in the United States of America.
/s/ Dixon Hughes Goodman LLP
Rockville, Maryland
March 30, 2016
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
To the Board of Directors and Stockholders
Bay Bancorp, Inc.
Columbia, Maryland
We have audited the accompanying consolidated balance sheet of Bay Bancorp, Inc. and Subsidiary (the “Company”) as of December 31, 2014, and the related consolidated statements of income, comprehensive income, stockholders’ equity and cash flows for the year then ended. These consolidated financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audit.
We conducted our audit in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. The Company is not required to have, nor were we engaged to perform, an audit of its internal control over financial reporting. Our audits 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 includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audit provides a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of Bay Bancorp, Inc. and Subsidiary as of December 31, 2014, and the results of their operations and their cash flows for the year then ended, in conformity with U.S. generally accepted accounting principles.
/s/RSM US, LLP
Frederick, Maryland
March 31, 2015
BAY BANCORP, INC. AND SUBSIDIARY
CONSOLIDATED BALANCE SHEETS
| | | | | | | |
| | December 31, | |
| | 2015 | | 2014 | |
ASSETS | | | | | | | |
| | | | | | | |
Cash and due from banks | | $ | 8,059,888 | | $ | 7,062,943 | |
Interest bearing deposits with banks and federal funds sold | | | 26,353,334 | | | 9,829,231 | |
Total Cash and Cash Equivalents | | | 34,413,222 | | | 16,892,174 | |
| | | | | | | |
Investment securities available for sale, at fair value | | | 33,352,233 | | | 35,349,889 | |
Investment securities held to maturity, at amortized cost | | | 1,573,165 | | | 1,315,718 | |
Restricted equity securities, at cost | | | 2,969,595 | | | 1,862,995 | |
Loans held for sale | | | 4,864,344 | | | 7,233,306 | |
| | | | | | | |
Loans, net of deferred fees and costs | | | 393,240,567 | | | 393,051,192 | |
Less: Allowance for loan losses | | | (1,773,009) | | | (1,294,976) | |
Loans, net | | | 391,467,558 | | | 391,756,216 | |
| | | | | | | |
Real estate acquired through foreclosure | | | 1,459,732 | | | 1,480,472 | |
Premises and equipment, net | | | 5,060,802 | | | 5,553,957 | |
Bank owned life insurance | | | 5,611,352 | | | 5,485,377 | |
Core deposit intangibles | | | 2,624,184 | | | 3,478,282 | |
Deferred tax assets, net | | | 2,723,557 | | | 3,214,100 | |
Accrued interest receivable | | | 1,271,871 | | | 1,306,111 | |
Accrued taxes receivable | | | 2,775,237 | | | 3,122,885 | |
Defined benefit pension asset | | | — | | | 680,668 | |
Prepaid expenses | | | 691,372 | | | 925,288 | |
Other assets | | | 303,614 | | | 285,547 | |
Total Assets | | $ | 491,161,838 | | $ | 479,942,985 | |
| | | | | | | |
LIABILITIES | | | | | | | |
| | | | | | | |
Noninterest-bearing deposits | | $ | 101,838,210 | | $ | 91,676,534 | |
Interest-bearing deposits | | | 265,577,728 | | | 296,153,598 | |
Total Deposits | | | 367,415,938 | | | 387,830,132 | |
| | | | | | | |
Short-term borrowings | | | 52,300,000 | | | 22,150,000 | |
Defined benefit pension liability | | | 829,237 | | | — | |
Accrued expenses and other liabilities | | | 2,934,174 | | | 3,319,567 | |
Total Liabilities | | | 423,479,349 | | | 413,299,699 | |
| | | | | | | |
STOCKHOLDERS’ EQUITY | | | | | | | |
Common stock - par $1.00 per shares, authorized 20,000,000 shares, issued and outstanding 11,062,932 shares as of December 31, 2015; authorized 20,000,000 shares, issued and outstanding 11,014,517 shares as December 31, 2014. | | | 11,062,932 | | | 11,014,517 | |
| | | | | | | |
Additional paid-in capital | | | 43,378,927 | | | 43,228,950 | |
Retained earnings | | | 12,667,070 | | | 10,736,305 | |
Accumulated other comprehensive income | | | 573,560 | | | 1,663,514 | |
Total Stockholders' Equity | | | 67,682,489 | | | 66,643,286 | |
Total Liabilities and Stockholders' Equity | | $ | 491,161,838 | | $ | 479,942,985 | |
See accompanying notes to audited consolidated financial statements
BAY BANCORP, INC. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF INCOME
| | | | | | | |
| | Year Ended December 31, | |
| | 2015 | | 2014 | |
INTEREST INCOME | | | | | | | |
Interest and fees on loans | | $ | 21,907,865 | | $ | 22,848,600 | |
Interest on loans held for sale | | | 350,833 | | | 246,212 | |
Interest and dividends on securities | | | 913,511 | | | 970,377 | |
Interest on deposits with banks and federal funds sold | | | 37,297 | | | 49,811 | |
Total Interest Income | | | 23,209,506 | | | 24,115,000 | |
| | | | | | | |
INTEREST EXPENSE | | | | | | | |
Interest on deposits | | | 1,761,899 | | | 1,231,643 | |
Interest on fed funds purchased | | | 604 | | | — | |
Interest on short-term borrowings | | | 72,380 | | | 25,556 | |
Total Interest Expense | | | 1,834,883 | | | 1,257,199 | |
Net Interest Income | | | 21,374,623 | | | 22,857,801 | |
| | | | | | | |
Provision for loan losses | | | 1,142,522 | | | 801,688 | |
Net interest income after provision for loan losses | | | 20,232,101 | | | 22,056,113 | |
| | | | | | | |
NONINTEREST INCOME | | | | | | | |
Electronic banking fees | | | 2,402,589 | | | 2,637,079 | |
Mortgage banking fees and gains | | | 1,708,779 | | | 950,299 | |
Service charges on deposit accounts | | | 313,697 | | | 393,128 | |
Bargain purchase gain | | | — | | | 524,432 | |
Gain on securities sold | | | 289,912 | | | — | |
Other income | | | 658,992 | | | 3,201,243 | |
Total Noninterest Income | | | 5,373,969 | | | 7,706,181 | |
| | | | | | | |
NONINTEREST EXPENSES | | | | | | | |
Salary and employee benefits | | | 11,666,515 | | | 13,347,292 | |
Occupancy and equipment expenses | | | 3,559,576 | | | 4,110,791 | |
Legal, accounting and other professional fees | | | 1,361,907 | | | 1,416,505 | |
Data processing and item processing services | | | 1,372,688 | | | 1,197,231 | |
FDIC insurance costs | | | 403,502 | | | 383,031 | |
Advertising and marketing related expenses | | | 377,906 | | | 382,465 | |
Foreclosed property expenses and OREO sales, net | | | 463,949 | | | 632,943 | |
Loan collection costs | | | 343,521 | | | 332,843 | |
Core deposit intangible amortization | | | 854,098 | | | 992,960 | |
Merger related expenses | | | 22,097 | | | 1,028,239 | |
Other expenses | | | 2,114,881 | | | 3,632,071 | |
Total Noninterest Expenses | | | 22,540,640 | | | 27,456,371 | |
Income before income taxes | | | 3,065,430 | | | 2,305,923 | |
| | | | | | | |
Income tax expense (benefit) | | | 1,134,665 | | | (726,785) | |
NET INCOME | | $ | 1,930,765 | | $ | 3,032,708 | |
| | | | | | | |
Basic net income per common share | | $ | 0.17 | | $ | 0.29 | |
| | | | | | | |
Diluted net income per common share | | $ | 0.17 | | $ | 0.29 | |
See accompanying notes to audited consolidated financial statements
BAY BANCORP, INC. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
| | | | | | | |
| | Year Ended December 31, | |
| | 2015 | | 2014 | |
Net income | | $ | 1,930,765 | | $ | 3,032,708 | |
| | | | | | | |
Other Comprehensive Income: | | | | | | | |
| | | | | | | |
Unrealized (loss) gain on investment securities available for sale | | | (69,917) | | | 664,241 | |
Income tax benefit (expense) relating to item above | | | 27,437 | | | (261,976) | |
Net effect on other comprehensive income | | | (42,480) | | | 402,265 | |
| | | | | | | |
Unrealized (loss) gain on defined benefit pension plan | | | (1,729,790) | | | 243,303 | |
Income tax benefit (expense) relating to item above | | | 682,316 | | | (95,971) | |
Net effect on other comprehensive income | | | (1,047,474) | | | 147,332 | |
| | | | | | | |
Other comprehensive (loss) income | | | (1,089,954) | | | 549,597 | |
| | | | | | | |
Total Comprehensive Income | | $ | 840,811 | | $ | 3,582,305 | |
See accompanying notes to audited consolidated financial statements
BAY BANCORP, INC. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY
| | | | | | | | | | | | | | | | |
| | | | | | | | | | | Accumulated | | | | |
| | | | | Additional | | | | | Other | | | | |
| | Common | | Paid-in | | Retained | | Comprehensive | | | | |
| | Stock | | Capital | | Earnings | | Income (Loss) | | Total | |
Balance December 31, 2013 | | $ | 9,362,308 | | $ | 36,374,446 | | $ | 7,703,597 | | $ | 1,113,917 | | $ | 54,554,268 | |
| | | | | | | | | | | | | | | | |
Net income | | | — | | | — | | | 3,032,708 | | | — | | | 3,032,708 | |
Other comprehensive income | | | — | | | — | | | — | | | 549,597 | | | 549,597 | |
Issuance of restricted common stock | | | 17,445 | | | (17,445) | | | — | | | — | | | — | |
Stock-based compensation | | | 212,000 | | | 1,294,713 | | | — | | | — | | | 1,506,713 | |
Issuance of common stock under Securities Purchase Agreement | | | 1,422,764 | | | 5,577,236 | | | — | | | — | | | 7,000,000 | |
Balance December 31, 2014 | | | 11,014,517 | | | 43,228,950 | | | 10,736,305 | | | 1,663,514 | | | 66,643,286 | |
| | | | | | | | | | | | | | | | |
Net income | | | — | | | — | | | 1,930,765 | | | — | | | 1,930,765 | |
Other comprehensive loss | | | — | | | — | | | — | | | (1,089,954) | | | (1,089,954) | |
Issuance of restricted common stock | | | 16,256 | | | (16,256) | | | — | | | — | | | — | |
Stock-based compensation | | | — | | | 143,712 | | | — | | | — | | | 143,712 | |
Issuance of common stock under
stock option plan | | | 202,651 | | | 709,603 | | | — | | | — | | | 912,254 | |
Repurchase of common stock | | | (170,492) | | | (687,082) | | | — | | | — | | | (857,574) | |
Balance December 31, 2015 | | $ | 11,062,932 | | $ | 43,378,927 | | $ | 12,667,070 | | $ | 573,560 | | $ | 67,682,489 | |
See accompanying notes to audited consolidated financial statements
BAY BANCORP, INC. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF CASH FLOWS
| | | | | | | |
| | Years Ended December 31, | |
| | 2015 | | 2014 | |
| | | | | | | |
Cash flows from operating activities: | | | | | | | |
Net income | | $ | 1,930,765 | | $ | 3,032,708 | |
Adjustments to reconcile net income to net cash provided by operating activities: | | | | | | | |
Depreciation and amortization of premises and equipment | | | 732,618 | | | 880,644 | |
Stock-based compensation | | | 143,712 | | | 1,506,713 | |
Amortization of investment premiums and discounts, net | | | 326,047 | | | 239,612 | |
Accretion of net discounts on loans | | | (3,346,032) | | | (5,666,090) | |
Amortization of core deposit intangibles | | | 854,098 | | | 992,960 | |
Reversal of remaining interest rate mark to market adjustment on IRA deposit | | | — | | | (2,379,662) | |
Amortization of deposit premiums | | | 53,398 | | | (1,018,176) | |
Provision for loan losses | | | 1,142,522 | | | 801,688 | |
Increase in cash surrender value of bank owned life insurance | | | (125,975) | | | (128,802) | |
Bargain purchase gain | | | — | | | (524,432) | |
Gain on sale and redemption of securities | | | (289,912) | | | — | |
Loss on disposal of premises and equipment | | | 60,041 | | | 4,431 | |
Write down of real estate acquired through foreclosure | | | 270,685 | | | 412,343 | |
Gain on sale of real estate acquired through foreclosure | | | (45,285) | | | (58,046) | |
Origination of loans held for sale | | | (113,989,930) | | | (74,709,000) | |
Proceeds from sales of loans held for sale | | | 119,273,960 | | | 81,333,823 | |
Gains on sales of loans held for sale | | | (3,143,667) | | | (2,123,595) | |
Deferred income taxes | | | 1,200,294 | | | 2,992,074 | |
Net increase (decrease) in accrued taxes receivable | | | 347,648 | | | (3,122,885) | |
Net decrease in accrued pension plan asset | | | (219,885) | | | (479,857) | |
Net increase (decrease) in prepaid expenses and other assets | | | 250,089 | | | 182,112 | |
Net decrease in accrued expenses and other liabilities | | | (385,393) | | | (182,773) | |
Net cash provided by operating activities | | | 5,039,798 | | | 1,985,790 | |
| | | | | | | |
Cash flows from investing activities: | | | | | | | |
Acquisition, net of cash acquired | | | — | | | 24,623,173 | |
Net decrease in time deposits with banks | | | — | | | 1,546,718 | |
Purchases of investment securities available for sale | | | (13,816,533) | | | (2,042,500) | |
Purchases of investment securities held to maturity | | | (333,939) | | | (1,340,499) | |
Redemptions and maturities of investment securities available for sale | | | 15,701,802 | | | 3,926,003 | |
Redemption and maturities of investment securities held to maturity | | | 82,829 | | | — | |
Net (purchase) redemption of Federal Home Loan Bank Stock | | | (1,106,600) | | | 400,300 | |
Net decrease in loans | | | 793,838 | | | 15,646,634 | |
Proceeds from sale of real estate acquired through foreclosure | | | 1,722,269 | | | 762,542 | |
Purchases of premises and equipment | | | (306,829) | | | (479,250) | |
Proceeds from sale of premises and equipment | | | 7,325 | | | 38,750 | |
Net cash provided by investing activities | | | 2,744,162 | | | 43,081,871 | |
| | | | | | | |
Cash flows from financing activities: | | | | | | | |
Net decrease in deposits | | | (20,467,592) | | | (80,598,547) | |
Net increase in short-term borrowings | | | 30,150,000 | | | 22,150,000 | |
Repurchase of common stock | | | (857,574) | | | — | |
Proceeds from issuance of common stock | | | — | | | 7,000,000 | |
Issuance of common stock on stock option exercise | | | 912,254 | | | — | |
Net cash used in financing activities | | | 9,737,088 | | | (51,448,547) | |
| | | | | | | |
Net (decrease) increase in cash and cash equivalents | | | 17,521,048 | | | (6,380,886) | |
Cash and cash equivalents at beginning of period | | | 16,892,174 | | | 23,273,060 | |
Cash and cash equivalents at end of period | | $ | 34,413,222 | | $ | 16,892,174 | |
| | | | | | | |
Supplemental Disclosures of Cash Flow information: | | | | | | | |
Interest paid on deposits and borrowings | | $ | 1,785,674 | | $ | 2,289,856 | |
Net income tax refunds | | | (408,618) | | | (256,007) | |
| | | | | | | |
Non Cash activities: | | | | | | | |
Transfer of loans to real estate acquired through foreclosure | | $ | 1,926,929 | | $ | 1,307,191 | |
Transfer of loans held for sale to loan portfolio | | | 228,599 | | | 1,101,700 | |
| | | | | | | |
See accompanying notes to audited consolidated financial statements
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Nature of Business
Bay Bancorp, Inc. is a savings and loan holding company. Through its subsidiary, Bay Bank, FSB, (the “Bank”), a federal savings bank (an “FSB”), Bay Bancorp, Inc. serves the community with a network of 11 branches strategically located throughout the Baltimore Metropolitan Statistical Area, particularly Baltimore City and the Maryland counties of Baltimore, Anne Arundel, Howard, and Harford, as well as south along the Baltimore-Washington corridor with an expanded focus on Prince George’s and Montgomery counties. The Bank serves local consumers, small and medium size businesses, professionals and other valued customers by offering a broad suite of financial products and services, including on-line and mobile banking, commercial banking, cash management, mortgage lending and retail banking. The Bank funds a variety of loan types including commercial and residential real estate loans, commercial term loans and lines of credit, consumer loans and letters of credit.
As used in these notes, the term “the Company” refers to Bay Bancorp, Inc. and, unless the context clearly requires otherwise, its consolidated subsidiaries.
Basis of Presentation
The consolidated financial statements include the accounts of Bay Bancorp, Inc., the Bank and the Bank’s consolidated subsidiaries. All significant intercompany balances and transactions have been eliminated in consolidation. The investment in subsidiary is recorded on Bay’s books on the basis of its equity in the net assets.
On April 19, 2013, Bay Bancorp, Inc. acquired all the outstanding common stock of Jefferson Bancorp, Inc. (“Jefferson”) in a merger (the “Jefferson Merger”) that was accounted for as a reverse acquisition and recapitalization in accordance with accounting principles generally accepted in the United States of America (“U.S. GAAP”). For accounting and financial reporting purposes, Jefferson is deemed to have acquired Bay Bancorp, Inc. in the Jefferson Merger even though Bay Bancorp, Inc. was the legal successor in the Jefferson Merger, and the historical financial statements of Jefferson have become the Company’s historical financial statements.
Reclassifications
Certain prior year amounts have been reclassified to conform to current period classifications.
In September 2015, the Financial Accounting Standards Board (the “FASB”) issued Accounting Standards Update (“ASU”) 2015-16, Simplifying the Accounting for Measurement-Period Adjustments, which rescinds the recognition and presentation of changes to the provisional amounts recognized in a business combination. Effective for fiscal years beginning after December 15, 2015, measurement-period adjustments will no longer be accounted for retrospectively.
Time deposits with banks totaling $34,849 at December 31, 2014 were reclassified to interest bearing deposits with banks and federal funds sold at December 31, 2015 due to the maturity of the time deposit in June 2014.
Common stock totaling $17,445 was reclassified to additional paid in capital at December 31, 2013, and from additional paid in capital to common stock at December 31, 2014 to reflect restricted stock as outstanding at the vesting date as opposed to the grant date.
Net gain on sale of real estate acquired through foreclosure is offset against foreclosed property expenses in noninterest expense as required by SEC reporting regulations.
Occupancy expenses and furniture and equipment expense are combined and reported in noninterest expenses in the Occupancy and equipment line item.
Use of Estimates
The preparation of financial statements requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ materially from those estimates.
Material estimates that are particularly susceptible to significant change in the near term include the determination of the allowance for loan losses (the “allowance”); the fair value of financial instruments, such as loans, investment securities, and derivatives; measurement and assessment of intangible assets and other purchase accounting related adjustments; benefit plan obligations and expenses; the valuation of deferred tax assets, real estate acquired through foreclosure, and net assets acquired in the Slavie Acquisition; and the estimate of expected cash flows for loans acquired with deteriorated credit quality.
Segment Information
The Company has one reportable segment, “Community Banking.” All of the Company’s activities are interrelated, and each activity is dependent and assessed based on how each of the activities of the Company supports the others. For example, lending is dependent upon the ability of the Bank to fund itself with deposits and other borrowings and manage interest rate and credit risk. Accordingly, all significant operating decisions are based upon analysis of the Company as one segment or unit.
Cash and Cash Equivalents
The Company has included cash and due from banks, interest bearing deposits with banks with an original maturity of 90 days or less, and federal funds sold as cash and cash equivalents for the purpose of reporting cash flows.
The Bank is required under regulations promulgated by the Board of Governors of the Federal Reserve System (the “Federal Reserve”) to maintain reserves against its transaction accounts. These reserves are generally held in the form of cash or noninterest-earning accounts at the Bank. Based on the nature of our transaction account deposits and the amount of vault cash on hand, the Bank is not required to maintain a reserve balance with the Federal Reserve at December 31, 2015 and 2014.
Investment Securities
Investment securities are accounted for according to their purpose and holding period. Trading securities are those that are bought and held principally for the purpose of selling them in the near future. The Company held no trading securities as of December 31, 2015 and 2014. Available for sale securities are those that may be sold before maturity due to changes in the Company’s interest rate risk profile or funding needs, and are reported at fair value with unrealized gains and losses, net of taxes, reported as a component of other comprehensive income. Held to maturity investment securities are those that management has the positive intent and ability to hold to maturity and are reported at amortized cost.
Net realized gains and losses on securities available for sale are included in noninterest income (expense) and, when applicable, are reported as a reclassification adjustment, net of tax, in other comprehensive income (loss). Gains and losses on sales of securities are determined on a trade date basis using the specific-identification method. Interest and dividends on investment securities are recognized in interest income on an accrual basis. Premiums and discounts are amortized or accreted into interest income using the interest method over the expected lives of the individual securities.
Management evaluates securities for other-than-temporary impairment on at least a quarterly basis, and more frequently when economic or market concern warrants such evaluation. Debt securities with a decline in fair value below their cost that are deemed to be other-than-temporarily impaired are reflected in earnings as realized losses to the extent impairment is related to credit losses. The amount of the impairment for debt securities related to other factors is recognized in other comprehensive income (loss). In evaluating other-than-temporary impairment losses, management considers: (1) the length of time and the extent to which the fair value has been less than cost, (2) the reasons for the decline in value, (3) the financial position and access to capital of the issuer, including the current and future impact of
any specific events, and (4) for fixed maturity securities, whether the Company intends to sell the security, or it is more likely than not that the Company will be required to sell the security before recovery of the cost basis, which may be at maturity.
Restricted Equity Securities, At Cost
The Bank is required to maintain a minimum investment in capital stock of other financial institutions in order to conduct business with these institutions. Since no ready market exists for these stocks and they have no quoted market value, the Bank’s investments in these stocks are carried at cost. Management reviews these securities for impairment based on the ultimate recoverability of the cost basis. The stocks’ values are determined by the ultimate recoverability of the par values rather than by recognizing temporary declines. Management considers such criteria as the significance of a decline in net assets, if any, the length of time the situation has persisted, commitments by the institutions to make payments required by law or regulation, the impact of legislative or regulatory changes on the customer base and the Bank’s liquidity position.
The Company’s holdings of restricted stock investments consist of the following at December 31, 2015 and 2014:
| | | | | | | |
| | 2015 | | 2014 | |
Federal Home Loan Bank | | $ | 2,650,600 | | $ | 1,544,000 | |
Visa Inc., Class B | | | 204,195 | | | 204,195 | |
Maryland Financial Bank | | | 49,800 | | | 49,800 | |
Atlantic Central Bankers Bank | | | 65,000 | | | 65,000 | |
Total restricted equity securities | | $ | 2,969,595 | | $ | 1,862,995 | |
Loans Held for Sale
The Company engages in sales of residential mortgage loans originated by the Bank. Loans originated and intended for sale in the secondary market are carried at the lower of cost or estimated fair value on an aggregate basis. Loans held for sale include fixed rate single-family residential mortgage loans under contract to be sold in the secondary market. These loans are sold with the mortgage servicing rights released. Under limited circumstances, buyers have recourse to return a purchased loan to the Company. Recourse conditions may include early payment default, breach of representation or warranties, or documentation deficiencies. Fair value is based on outstanding investor commitments or, in absent of such commitments, based on current investor yield requirements based on third party models. Declines in fair value below cost (and subsequent recoveries) are recognized in noninterest income in the Consolidated Statements of Income. Deferred fees and costs related to these loans are not amortized but are recognized as part of the cost basis of the loan at the time it is sold. Gains and losses on sales of these loans are recorded as a component of noninterest income in the Consolidated Statements of Income.
Loans
The accounting methods for loans differ depending on whether the loans are originated or purchased, and if purchased, whether or not the purchased loans reflected credit deterioration since the date of origination such that it is probable on the purchase date that the Company will be unable to collect all contractually required payments.
Originated Loans
Loans are generally stated at the principal amount outstanding net of any deferred fees and costs. Interest income on loans is accrued at the contractual rate on the principal amount outstanding. It is the Company’s policy to discontinue the accrual of interest when circumstances indicate that collection is doubtful. The accrual of interest is discontinued at the time the loan is 90 days past due unless the credit is well-secured and in the process of collection. Past due status is based on contractual terms of the loan. Generally, loans are placed on nonaccrual status once they are determined to be impaired or when principal or interest payments are 90 or more days past due. Previously accrued but uncollected interest income on these loans is reversed against interest income. Loans are returned to accrual status when all principal and interest amounts contractually due are brought current and future payments are reasonably assured. Fees charged and costs capitalized for originating certain loans are amortized or accreted by the interest method over the term of the loan.
Loans are considered impaired when, based on current information, it is probable that the Company will not collect all principal and interest payments according to contractual terms. Impaired loans do not include large groups of smaller balance homogeneous credits such as residential real estate and consumer installment loans, which management evaluates collectively for impairment. Factors considered by management in determining impairment include payment status, collateral value, and the probability of collecting scheduled principal and interest payments when due. Loans that experience insignificant payment delays and payment shortfalls generally are not classified as impaired. Management determines the significance of payment delays and payment shortfalls on a case-by-case basis, taking into consideration all of the circumstances surrounding the loan and the borrower, including the length of the delay, the reason for the delay, the borrower’s prior payment record, and the amount of the shortfall in relation to the principal and interest owed. Impaired loans are measured based on the present value of expected future cash flows discounted at the loan’s effective interest rate. However, as a practical expedient, management may measure impairment based on a loan’s observable market price or the fair value of the collateral if repayment of the loan is collateral-dependent. For collateral-dependent loans, any measured impairment is charged off in the applicable reporting period.
Loans Acquired in a Transfer
The loans acquired in the Slavie Acquisition (see Note 2) were recorded at fair value at the acquisition date and no separate valuation allowance was established. The initial fair values were determined by management, with the assistance of an independent valuation specialist, based on estimated expected cash flows discounted at appropriate rates. The discount rates were based on market rates for new originations of comparable loans and did not include a factor for loan losses as that was included in the estimated cash flows.
The FASB ASC Topic 310-30, Loans and Debt Securities Acquired with Deteriorated Credit Quality, applies to loans acquired in a transfer with evidence of deterioration of credit quality for which it is probable, at acquisition, that the investor will be unable to collect all contractually required payments receivable. If both conditions exist, the Company determines whether to account for each loan individually or whether such loans will be assembled into pools based on common risk characteristics such as credit score, loan type, and origination date. Based on this evaluation, the Company determined that the loans acquired from Bay National Bank, Slavie and in the Jefferson Merger were subject to ASC Topic 310-30 and would be accounted for individually.
The Company considered expected prepayments and estimated the total expected cash flows, which included undiscounted expected principal and interest. The excess of that amount over the fair value of the loan is referred to as accretable yield. Accretable yield is recognized as interest income on a constant yield basis over the expected life of the loan. The excess of the contractual cash flows over expected cash flows is referred to as nonaccretable difference and is not accreted into income. Over the life of the loan, the Company continues to estimate expected cash flows. Subsequent decreases in expected cash flows are recognized as impairments in the current period through the allowance for loan losses. Subsequent increases in cash flows to be collected are first used to reverse any existing valuation allowance and any remaining increase are recognized prospectively through an adjustment of the loan’s yield over its remaining life.
ASC Topic 310-20, Nonrefundable Fees and Other Costs, was applied to loans not considered to have deteriorated credit quality at acquisition. Under ASC Topic 310-20, the difference between the loan’s principal balance at the time of purchase and the fair value is recognized as an adjustment of yield over the life of the loan.
Allowance for Loan Losses
The allowance for loan losses is established to estimate losses that may occur on loans by recording a provision for loan losses that is charged to earnings in the current period. Loans are charged off when management believes a loan or any portion thereof is not collectable. Subsequent recoveries, if any, are credited to the allowance.
The allowance is evaluated on a regular basis by management and is based upon management’s periodic review of the collectability of loans in light of historical experience, the nature and volume of the loan portfolio, adverse situations that may affect the borrower’s ability to repay, estimated value of any underlying collateral and prevailing economic conditions. This evaluation is inherently subjective as it requires estimates that are susceptible to significant revision as more information becomes available.
The allowance consists of specific and general components. The specific component relates to loans that are classified as impaired. For those loans that are classified as impaired, an allowance is established when the discounted cash flows, collateral value, or observable market price, whichever is appropriate, of the impaired loan is lower than the carrying value of that loan. For impaired loans that are collateral dependent, any measured impairment is charged off against the loan and the allowance in the applicable reporting period. The general component covers loans that are not classified as impaired and primarily include purchased loans not deemed impaired and new loan originations. The general reserve is based on historical loss experience of the Bank or peer bank group if the Bank’s loss experience is deemed by management to be insufficient and several qualitative factors. These qualitative factors address various risk characteristics in the Company’s loan portfolio after an assessment of internal or external influences on credit quality that are not fully reflected in the historical loss data.
While management believes it has established the allowance in accordance with U.S. GAAP and has taken into account both the views of the Company’s regulators and the current economic environment, there can be no assurance that the Company’s regulators and/or the economic environment will not require future increases in the allowance.
Real Estate Acquired Through Foreclosure
The Company records foreclosed real estate assets at fair value less estimated costs to sell at the time of acquisition. Estimated fair value is based upon many subjective factors, including location and condition of the property and current economic conditions. Since the calculation of fair value relies on estimates and judgments relating to inherently uncertain events, actual results may differ materially from the Company’s estimates.
Fair value adjustments at the time of acquisition are made through the allowance. Write-downs for subsequent declines in value and net operating expenses are included in foreclosed property expenses. Gains or losses realized upon disposition are included in noninterest income.
Premises and Equipment
Land is carried at cost. Buildings, land improvements, leasehold improvements, furniture and equipment, and software are stated at cost less accumulated depreciation and amortization. The cost basis of premises and equipment acquired through the Slavie Acquisition is the acquisition date fair value. Depreciation is computed by the straight-line method over the estimated useful lives of the assets. Leasehold improvements are amortized over the shorter of the lease term or over the estimated useful lives of the assets. Maintenance and normal repairs are charged to operations as incurred, while additions and improvements to buildings, leasehold improvements, and furniture and equipment are capitalized. Gains or losses on disposition of assets are reflected in earnings.
Long-lived assets are evaluated for impairment by management on an on-going basis. Impairment may occur whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable.
Bank Owned Life Insurance
The Company has purchased bank owned life insurance policies on certain current and former employees as a means to generate tax-exempt income which is used to offset a portion of current and future employee benefit costs. Bank owned life insurance is recorded at the cash surrender value of the policies. Changes in the cash surrender value are included in noninterest income.
Core Deposit Intangibles
Core deposit intangibles (the portion of an acquisition purchase price which represents value assigned to the existing deposit base) have finite lives and are amortized by the declining balance method over periods ranging from six to nine years; amortization is recorded in noninterest expenses.
Other Comprehensive Income (Loss)
The Company records unrealized gains and losses on available for sale securities and unrecognized actuarial gains and losses, transition obligations and prior service costs on its pension plan in accumulated other comprehensive income, net of taxes. Unrealized gains and losses on available for sale securities are reclassified into earnings as the gains or losses are realized upon sale of the securities. The credit component of unrealized losses on available for sale
securities that are determined to be other-than-temporary impaired are reclassified into earnings at the time the determination is made.
Mortgage Banking Derivatives
In connection with the origination of residential mortgage loans, the Company enters into commitments to originate loans whereby the interest rate on the loan is determined prior to funding (i.e., rate lock commitment). The period of time between issuance of a loan commitment and closing and sale of the loan generally ranges from 15 to 60 days. To protect itself against exposure to various factors and to reduce sensitivity to interest rate movement, the Company hedges these assets with best efforts forward mortgage loan commitments to sell to various investors. Both the mortgage loan commitments and the related sales contracts are considered derivatives and are recorded at fair value with changes in fair value recorded in noninterest income in the Consolidated Statements of Income. The Company determines the fair value of rate lock commitments using the investor’s prices for the underlying loans less cost to originate the loans adjusted for the anticipated funding probability (closing ratio) based on historical experience. Closing ratios derived using the Company’s recent historical data are utilized to estimate the quantity of mortgage loans that will be funded within the terms of the rate lock commitment. Forward mortgage loan sales commitments are valued based on the gain or loss that would occur if the Company were to pair-off the sales transaction with the investor. The cash flows from forward sales agreements are classified as operating activities in the Statements of Cash Flows.
Transfer of Financial Assets
Transfers of financial assets are accounted for as sales when control over the assets has been relinquished. Control over transferred assets is deemed to be surrendered when the assets have been isolated from the Company, the transferee obtains the right (free of conditions that constrain it from taking advantage of that right) to pledge or exchange the transferred assets and the Company does not maintain effective control over the transferred assets through an agreement to repurchase them before their maturity. In certain instances, the recourse to the Bank to repurchase assets may exist but is deemed immaterial based on the specific facts and circumstances.
Advertising Costs
Advertising costs are expensed as incurred and included in noninterest expense.
Income Taxes
The Company uses the liability method of accounting for income taxes. Under the liability method, deferred tax assets and liabilities are determined based on differences between the financial statement carrying amounts and the tax bases of existing assets and liabilities (i.e., temporary differences) and are measured at the enacted rates in effect when these differences reverse.
Deferred tax assets are reduced by a valuation allowance when, in the opinion of management, it is more likely than not that some portion or all of the deferred tax assets will not be realized. Deferred tax assets and liabilities are adjusted for the effects of changes in tax laws and rates on the date of enactment. Realization of deferred tax assets is dependent on generating sufficient taxable income in the future.
When tax returns are filed, management is highly certain that some positions taken would be sustained upon examination by the taxing authorities, while there may be other positions that are subject to uncertainty about their merits or the amounts of the positions that ultimately would be sustained if examined. The benefit of a tax position is recognized in the financial statements in the period during which, based on all available evidence, management believes it is more likely than not that the position will be sustained upon examination, including the resolution of appeals or litigation processes, if any. The evaluation of a position taken is considered by itself and not offset or aggregated with other positions. Tax positions that meet the more likely than not recognition threshold are measured as the largest amount of tax benefit that is more than 50% likely of being realized upon settlement with the applicable taxing authority. The portion of benefits associated with tax positions taken that exceeds the amount measured as described above is reflected as a liability for unrecognized tax benefits in the accompanying balance sheet along with any associated interest and penalties that would be payable to the taxing authorities upon examination. Management evaluated the Company's tax positions and concluded that the Company had taken no uncertain tax positions that require adjustment to the consolidated financial statements.
It is the Company’s policy to recognize interest and penalties related to unrecognized tax liabilities within income tax expense in the statement of operations.
Stock Based Compensation
Stock based compensation expense is recognized over the employee or director’s service period, which is generally defined as the vesting period, of the stock based grant based on the estimated grant date fair value. A Black-Scholes option pricing model is used to estimate the fair value of stock options granted.
Earnings per share
Basic earnings per share represents net income available to common stockholders divided by the weighted average number of common shares outstanding during the period. Diluted earnings per share reflects additional common shares that would have been outstanding if dilutive potential common shares had been issued. Potential common shares that may be issued by the Company relate solely to outstanding stock options and unvested restricted stock awards, and are determined using the treasury stock method.
Recent Accounting Pronouncements and Developments
In January 2014, the FASB issued ASU 2014-04, Receivables-Troubled Debt Restructuring by Creditors (Subtopic 310-40). The objective of this guidance is to clarify when an in substance repossession or foreclosure occurs, that is when a creditor should be considered to have received physical possession of residential real estate property collateralizing a consumer mortgage loan such that the loan receivable should be derecognized and the real estate property recognized. ASU No. 2014-04 states that an in substance repossession or foreclosure occurs, and a creditor is considered to have received physical possession of residential real estate property collateralizing a consumer mortgage loan, upon either: (1) the creditor obtaining legal title to the residential real estate property upon completion of a foreclosure; or (2) the borrower conveying all interest in the residential real estate property to the creditor to satisfy that loan through completion of a deed in lieu of foreclosure or through a similar legal agreement. Additionally, ASU No. 2014-04 requires interim and annual disclosure of both: (1) the amount of foreclosed residential real estate property held by the creditor; and (2) the recorded investment in consumer mortgage loans collateralized by residential real estate property that are in the process of foreclosure according to local requirements of the applicable jurisdiction. The Company adopted ASU No. 2014-04 effective January 1, 2015. The adoption of ASU No. 2014-04 did not have a material impact on the Company's Consolidated Financial Statements.
In May 2014, the FASB issued ASU 2014-09, Revenue from Contracts with Customers (Topic 606), which will supersede the revenue recognition requirements in ASC Topic 605, Revenue Recognition, and most industry-specific revenue recognition guidance throughout the ASC. The amendments in this update affect any entity that either enters into contracts with customers to transfer goods or services or enters into contracts for the transfer of non-financial assets unless those contracts, including leases and insurance contracts, are within the scope of other standards. The amendments establish a core principle requiring the recognition of revenue to depict the transfer of goods or services to customers in an amount reflecting the consideration to which the entity expects to be entitled in exchange for such goods or services. The amendments also require expanded disclosures concerning the nature, amount, timing and uncertainty of revenues and cash flows arising from contracts with customers. In August 2015, the FASB deferred the effective date one year from the date in the original guidance. The guidance is effective for fiscal years and interim periods beginning after December 15, 2018, which will be the first quarter of 2019 for the Company. The Company’s adoption of this item is not expected to have a material impact on its results of operations or financial condition.
In June 2014, the FASB issued ASU No. 2014-11, Repurchase-to-Maturity Transactions, Repurchase Financings, and Disclosures. The new guidance aligns the accounting for repurchase-to-maturity transactions and repurchase agreements executed as repurchase financings with the accounting for other typical repurchase agreements. Going forward, these transactions would all be accounted for as secured borrowings. The guidance eliminates sale accounting for repurchase-to-maturity transactions and supersedes the guidance under which a transfer of a financial asset and a contemporaneous repurchase financing could be accounted for on a combined basis as a forward agreement, which has resulted in outcomes referred to as off-balance-sheet accounting. The amendments in the ASU require a new disclosure for transactions economically similar to repurchase agreements in which the transferor retains substantially all of the exposure to the economic return on the transferred financial assets throughout the term of the transaction. The
amendments in the ASU also require expanded disclosures about the nature of collateral pledged in repurchase agreements and similar transactions accounted for as secured borrowings. The amendments in this ASU are effective for public companies for the first interim or annual period beginning after December 15, 2014. In addition, for public companies, the disclosure for certain transactions accounted for as a sale is effective for the first interim or annual reporting periods beginning on or after December 15, 2014, and the disclosure for transactions accounted for as secured borrowings is required to be presented for annual reporting periods beginning after December 15, 2014, and interim periods beginning after March 15, 2015. As of December 31, 2014 and December 31, 2015, all of the Company's repurchase agreements were typical in nature (i.e., not repurchase-to-maturity transactions or repurchase agreements executed as a repurchase financing) and are accounted for as secured borrowings. As such, the amendments in this update did not have an impact on the consolidated financial statements and no change to the current disclosure was required.
In June 2014, the FASB issued ASU No. 2014-12, Accounting for Share-Based Payments When the Terms of an Award Provide That a Performance Target Could Be Achieved after the Requisite Service Period. The amendments in the ASU require that a performance target that affects vesting and that could be achieved after the requisite service period be treated as a performance condition. A reporting entity should apply existing guidance in ASC Topic 718, Compensation - Stock Compensation, as it relates to awards with performance conditions that affect vesting to account for such awards. The performance target should not be reflected in estimating the grant-date fair value of the award. However, compensation cost should be recognized in the period in which it becomes probable that the performance target will be achieved and should represent the compensation cost attributable to the period(s) for which the requisite service has already been rendered. If the performance target becomes probable of being achieved before the end of the requisite service period, the remaining unrecognized compensation cost should be recognized prospectively over the remaining requisite service period. The total amount of compensation cost recognized during and after the requisite service period should reflect the number of awards that are expected to vest and should be adjusted to reflect those awards that ultimately vest. The requisite service period ends when the employee can cease rendering service and still be eligible to vest in the award if the performance target is achieved. The amendments in this ASU are effective for interim or annual reporting periods beginning after December 15, 2015; early adoption is permitted. Entities may apply the amendments in this ASU either: (1) prospectively to all awards granted or modified after the effective date; or (2) retrospectively to all awards with performance targets that are outstanding as of the beginning of the earliest annual period presented in the financial statements and to all new or modified awards thereafter. As of December 31, 2015, the Company did not have any share-based payment awards that included performance targets that could be achieved after the requisite service period. As such, the adoption of ASU No. 2014-12 is not expected to have a material impact on the Company's consolidated financial statements.
In August 2014, the FASB issued ASU No. 2014-14, Classification of Certain Government-Guaranteed Mortgage Loans upon Foreclosure. The objective of this guidance is to reduce diversity in practice related to how creditors classify government-guaranteed mortgage loans, including FHA or VA guaranteed loans, upon foreclosure. Some creditors reclassify those loans to real estate consistent with other foreclosed loans that do not have guarantees; others reclassify the loans to other receivables. The amendments in this guidance require that a mortgage loan be derecognized and that a separate other receivable be recognized upon foreclosure if the following conditions are met: (1) the loan has a government guarantee that is not separable from the loan before foreclosure; (2) at the time of foreclosure, the creditor has the intent to convey the real estate property to the guarantor and make a claim on the guarantee, and the creditor has the ability to recover under that claim; and (3) at the time of foreclosure, any amount of the claim that is determined on the basis of the fair value of the real estate is fixed. Upon foreclosure, the separate other receivable should be measured based on the amount of the loan balance (principal and interest) expected to be recovered from the guarantor. ASU No. 2014-14 is effective for interim and annual reporting periods beginning after December 15, 2014. The adoption of ASU No. 2014-14 in the first quarter of 2015 did not have an impact on the Company's consolidated financial statements.
In April 2015, the FASB issued ASU 2015-03, Interest-Imputation of Interest (Subtopic 835-30): Simplifying the Presentation of Debt Issuance Costs. Under the new guidance, the debt issuance costs related to a recognized debt liability will be presented on the balance sheet as a direct deduction from the carrying amount of that debt liability, consistent with debt discounts. The guidance is effective on a retrospective basis beginning on January 1, 2016, with early adoption permitted. The adoption of ASU No. 2015-03 is not expected to have a material impact on the Company's consolidated financial statements.
In September 2015, the FASB issued ASU 2015-16, “Business Combinations (Topic 805), Simplifying the Accounting for Measurement-Period Adjustments.” This Update simplifies the accounting for adjustments made to provisional amounts recognized in a business combination, and eliminates the requirement to retrospectively account for those adjustments. The amendments to this Update require that an acquirer recognize adjustments to provisional amounts that are identified during the measurement period in the reporting period in which the adjustment amounts are determined. The Updates require that the acquirer record, in the same period’s financial statements, the effect on earnings of changes in depreciation, amortization, or other income effects, if any, as a result of the change to the provisional amounts, calculated as if the accounting had been completed at the acquisition date. The amendments in this Update require an entity to present separately on the face of the income statement or disclose in the notes the portion of the amount recorded in current-period earnings by line item that would have been recorded in previous reporting periods if the adjustment to the provisional amounts had been recognized as of the acquisition date. For public business entities, the amendments to this Update are effective for fiscal years beginning after December 15, 2015, including interim periods within those fiscal years. This Update should be applied prospectively to adjustments to provisional amounts that occur after the effective date of this Update with earlier application permitted for financial statements that have not been issued. The adoption of ASU No. 2015-16 did not have a material impact on the Company's consolidated financial statements.
In January 2016, the FASB issued ASU 2016-01, Recognition and Measurement of Financial Assets and Financial Liabilities, which amended guidance related to recognition and measurement of financial assets and liabilities. The amended guidance requires that equity investments (excluding those accounted for under the equity method of accounting or those that result in consolidation of the investee) to be measured at fair value with changes in fair value recognized in net income. An entity can elect to measure equity investments that do not have readily determinable fair values at cost less impairment, plus or minus changes resulting from observable price changes in orderly transactions for the identical or similar investment of the same issuer. The impairment assessment of equity investments without readily determinable fair values is simplified by requiring a qualitative assessment to identify impairment. When a qualitative assessment indicates impairment exists, an entity is required to measure the investment at fair value. The guidance eliminates the requirement for public business entities to disclose the method and significant assumptions used to estimate the fair value that is required to be disclosed for financial instruments measured at amortized cost on the balance sheet. Further, the guidance requires public entities to use the exit price when measuring the fair value of financial instruments for disclosure purposes. The guidance also requires an entity to present separately in other comprehensive income, a change in the instrument-specific credit risk when the entity has elected to measure a liability at fair value in accordance with the fair value option. Separate presentation of financial assets and financial liabilities by measurement category and type of instrument on the balance sheet or accompanying notes to the financial statements is required. The guidance also clarifies that an entity should evaluate the need for a valuation allowance on a deferred tax asset related to available-for-sale securities in combination with the entity’s other deferred tax assets. This guidance is effective for annual periods and interim periods within those annual periods beginning after December 15, 2017. The Company is evaluating the impact the guidance could have on its consolidated financial statements.
In February 2016, the FASB issued ASU 2016-02, Leases. From the lessee’s perspective, the new standard establishes a right-of-use (ROU) model that requires a lessee to record a ROU asset and a lease liability on the balance sheet for all leases with terms longer than 12 months. Leases will be classified as either finance or operating, with classification affecting the pattern of expense recognition in the income statement for a lessees. From the lessor’s perspective, the new standard requires a lessor to classify leases as either sales-type, finance or operating. A lease will be treated as a sale if it transfers all of the risks and rewards, as well as control of the underlying asset, to the lessee. If risks and rewards are conveyed without the transfer of control, the lease is treated as a financing lease. If the lessor doesn’t convey risks and rewards or control, an operating lease results. The new standard is effective for fiscal years beginning after December 15, 2018, including interim periods within those fiscal years. A modified retrospective transition approach is required for lessees for capital and operating leases existing at, or entered into after, the beginning of the earliest comparative period presented in the financial statements, with certain practical expedients available. A modified retrospective transition approach is required for lessors for sales-type, direct financing, and operating leases existing at, or entered into after, the beginning of the earliest comparative period presented in the financial statements, with certain practical expedients available. The Company is currently evaluating the impact of the adoption of this guidance on its consolidated financial statements.
NOTE 2 – BUSINESS COMBINATIONS
The Company has accounted for the Slavie Acquisition (defined below) under the acquisition method of accounting in accordance with ASC Topic 805, Business Combinations, whereby the acquired net assets and assumed liabilities were recorded by the Company at their estimated fair values as of their acquisition date. Fair value estimates were based on management’s assessment of the best information available as of the acquisition date.
In accordance with the framework established by ASC Topic 820,” Fair Value Measurements and Disclosure,” the Company used a fair value hierarchy to prioritize the information used to develop assumptions to calculate estimates in determining fair values. These fair value hierarchies are discussed in Note 18.
Slavie Acquisition
On May 30, 2014, the Bank acquired certain assets and assumed substantially all deposits and certain other liabilities (the “Slavie Acquisition”) of Slavie Federal Savings Bank (“Slavie”), which was closed on May 30, 2014 by the Office of the Comptroller of the Currency (the “OCC”). The Slavie Acquisition was completed in accordance with the terms of the Purchase and Assumption Agreement All Deposits, with the Federal Deposit Insurance Corporation (the “FDIC”). The Bank did not acquire any of Slavie’s other real estate owned. Additionally, the Bank did not at closing commit to purchase any owned or leased bank premises of Slavie; however, the Bank was granted an option to elect following closing to purchase any or all of the banking premises owned by Slavie, or, in the case of leased banking premises, to assume the lease. The Bank terminated the lease for Slavie’s Bel Air location in October 2014 and extended its current lease at the Overlea branch.
The following table presents the allocation of the consideration received to acquire assets and assume liabilities in the Slavie Acquisition as of the acquisition date. The allocation results in an after-tax bargain purchase gain of $317,544.
| | | | |
Assets acquired at fair value: | | | | |
| | | | |
Cash and cash equivalents | | $ | 30,341,150 | |
Time deposits with banks | | | 1,546,718 | |
Investment securities available for sale, at fair value | | | 197,311 | |
Restriced equity securities, at cost | | | 1,253,600 | |
Loans, net of deferred fees and costs | | | 82,914,607 | |
Accrued interest receivable | | | 347,772 | |
Core deposit intangible | | | 477,563 | |
Total assets acquired | | $ | 117,078,721 | |
| | | | |
Liabilities assumed at fair value: | | | | |
Deposits | | $ | 110,833,046 | |
Accrued expenses and other liabilities | | | 3,266 | |
Total liabilities assumed | | $ | 110,836,312 | |
| | | | |
| | | | |
| | | | |
Net assets acquired at fair value: | | $ | 6,242,409 | |
| | | | |
Transaction cash consideration paid | | | 5,717,977 | |
| | | | |
Total estimated bargain purchase gain, before tax | | | 524,432 | |
Tax expense | | | (206,888) | |
Total estimated bargain purchase gain, after tax | | $ | 317,544 | |
In many cases, determining the fair value of the acquired assets and assumed liabilities requires the Company to estimate cash flows expected to result from those assets and liabilities and to discount those cash flows at appropriate rates of interest. The most significant of these determinations related to the valuation of acquired loans.
The following is a summary of the loans acquired in the Slavie Acquisition:
| | | | | | | | | | |
| | Purchased | | | | | | | |
| | Credit | | Purchased | | Total | |
| | Impaired | | Non-Impaired | | Purchased | |
| | Loans | | Loans | | Loans | |
| | | | | | | | | | |
Contractually required principal and interest at acquisition | | $ | 26,970,809 | | $ | 68,701,805 | | $ | 95,672,614 | |
Contractual cash flows not expected to be collected | | | (7,018,601) | | | (3,983,263) | | | (11,001,864) | |
Expected cash flows at acquisition | | | 19,952,208 | | | 64,718,542 | | | 84,670,750 | |
Interest component of expected cash flows | | | (1,114,951) | | | (641,192) | | | (1,756,143) | |
Basis in purchased loans at acquisition - estimated fair value | | $ | 18,837,257 | | $ | 64,077,350 | | $ | 82,914,607 | |
The fair value of checking, savings and money market deposit accounts acquired was assumed to be the carrying value as these accounts have no stated maturity and are payable on demand. Certificate of deposit accounts were valued at the present value of the certificates’ expected contractual payments discounted at market rates for similar certificates.
In connection with the Slavie Acquisition, the Company incurred acquisition related expenses. These expenses were primarily related to professional services, system conversions and integration of operations, termination of existing contractual arrangements to purchase various services, initial marketing and promotion expenses designed to introduce the Bank to the former Slavie Bank customers, and other costs of completing the transaction. For the year ended December 31, 2015 and 2014, the Company incurred acquisition related costs of $0 and $909,471, respectively.
Pro Forma Condensed Combined Financial Information
The following pro forma information combines the historical results of Slavie and pre-Slavie Acquisition Bay Bancorp, Inc. The pro forma financial information does not include the potential impacts of possible business model changes, current market conditions, revenue enhancements, expense efficiencies, or other factors. The pro forma results exclude the impact of the bargain purchase gain of $524,432 and Slavie Acquisition-related expenses of $909,471. While adjustments were made for the estimated impact of certain fair value adjustments, the following results are not indicative of what would have occurred had the Slavie Acquisition taken place on indicated dates.
If the Slavie Acquisition had been completed on January 1, 2014, total revenue would have been approximately $33.0 million for the year ended December 31, 2014. Net income would have been approximately $3.1 million for the same period. Basic and diluted earnings per share would have been $0.30 for the year ended December 31, 2014.
The disclosure of Slavie’s post-Slavie Acquisition total revenue, net of interest expense, and net income is not practicable due to the integration of operations shortly after the Slavie Acquisition.
The Jefferson Merger
On April 19, 2013, Bay Bancorp, Inc. (then known as Carrollton Bancorp) completed its merger with Jefferson. Pursuant to the terms and conditions of the Agreement and Plan of Merger, dated as of April 8, 2012 (as amended, the “Merger Agreement”), by and among Jefferson, Bay Bancorp, Inc., and FSPF, Jefferson merged with and into Bay Bancorp, Inc., with Bay Bancorp, Inc. continuing as the surviving corporation. In addition, Bay Bancorp’s bank subsidiary, Carrollton Bank, merged with and into the Bank, which was then a subsidiary of Jefferson with the Bank continuing as the surviving bank. Prior to the Jefferson Merger, Carrollton Bank had five subsidiaries: Bay Financial Services, Inc. f/k/a Carrollton Financial Services, Inc. (“BFS”); Carrollton Community Development Corporation (“CCDC”); Mulberry Street, LLC (“MSLLC”); 13 Beaver Run LLC (“BRLLC”); and Mulberry Street A LLC (“MSALLC” and, together with BFS, CCDC, MSLLC and BRLLC, the “Carrollton Subsidiaries”). Carrollton Bank’s interests in the Carrollton Subsidiaries were transferred to Bay Bank, FSB as a result of the Bank Merger.
The Merger is accounted for using the acquisition method of accounting, and accordingly, the assets acquired and liabilities assumed were recognized at fair value on the date the transaction was completed. There was no goodwill recorded as a result of the Merger; however, a non-taxable bargain purchase gain of $2,860,199 was recognized and
included as a separate line item within noninterest income on the consolidated statements of income. The bargain purchase gain represented the excess of the fair value of net assets acquired over consideration paid. The consideration paid represented a substantial discount to the book value of pre-Jefferson Merger Bay Bancorp, Inc.’s net assets at the acquisition date. The net impact of the fair value adjustments resulted in a $5,282,481 reduction in pre-Jefferson Merger net assets of Bay Bancorp, Inc. The more significant fair value adjustments were the net discount on loans of $7,927,608 and the core deposit intangible of $4,611,362 which is being amortized over an estimated useful life of approximately nine years.
NOTE 3 – INVESTMENT SECURITIES
At December 31, 2015 and December 31, 2014, the amortized cost and estimated fair value of the Company’s investment securities portfolio are summarized as follows:
| | | | | | | | | | | | | |
Available for Sale | | Amortized | | Gross Unrealized | | Estimated | |
December 31, 2015 | | cost | | Gains | | Losses | | Fair Value | |
U.S. government agency | | $ | 3,714,681 | | $ | 95,958 | | $ | — | | $ | 3,810,639 | |
U.S. treasury securities | | | 5,907,341 | | | — | | | (35,201) | | | 5,872,140 | |
Residential mortgage-backed securities | | | 14,836,750 | | | 287,365 | | | (100,890) | | | 15,023,225 | |
State and municipal | | | 4,510,883 | | | 21,096 | | | (425) | | | 4,531,554 | |
Corporate bonds | | | 4,024,894 | | | 33,246 | | | — | | | 4,058,140 | |
Total debt securities | | | 32,994,549 | | | 437,665 | | | (136,516) | | | 33,295,698 | |
Equity securities | | | 78,752 | | | — | | | (22,217) | | | 56,535 | |
Totals | | $ | 33,073,301 | | $ | 437,665 | | $ | (158,733) | | $ | 33,352,233 | |
| | | | | | | | | | | | | |
Held-to-Maturity | | Amortized | | Gross Unrealized | | Estimated | |
December 31, 2015 | | cost | | Gains | | Losses | | Fair Value | |
U.S. government agency | | $ | 334,257 | | $ | 5,891 | | $ | — | | $ | 340,148 | |
Residential mortgage-backed securities | | | 1,238,908 | | | 17,206 | | | — | | | 1,256,114 | |
Total debt securities | | | 1,573,165 | | | 23,097 | | | — | | | 1,596,262 | |
Totals | | $ | 1,573,165 | | $ | 23,097 | | $ | — | | $ | 1,596,262 | |
| | | | | | | | | | | | | |
Available for Sale | | Amortized | | Gross Unrealized | | Estimated | |
December 31, 2014 | | cost | | Gains | | Losses | | Fair Value | |
U.S. government agency | | $ | 7,561,238 | | $ | 217,033 | | $ | — | | $ | 7,778,271 | |
Residential mortgage-backed securities | | | 20,679,345 | | | 399,198 | | | (207,616) | | | 20,870,927 | |
State and municipal | | | 4,639,988 | | | 17,779 | | | (3,621) | | | 4,654,146 | |
Corporate bonds | | | 2,041,718 | | | — | | | (11,718) | | | 2,030,000 | |
Total debt securities | | | 34,922,289 | | | 634,010 | | | (222,955) | | | 35,333,344 | |
Equity securities | | | 78,754 | | | — | | | (62,209) | | | 16,545 | |
Totals | | $ | 35,001,043 | | $ | 634,010 | | $ | (285,164) | | $ | 35,349,889 | |
| | | | | | | | | | | | | |
Held-to-Maturity | | Amortized | | Gross Unrealized | | Estimated | |
December 31, 2014 | | cost | | Gains | | Losses | | Fair Value | |
Residential mortgage-backed securities | | $ | 1,315,718 | | $ | 9,079 | | $ | — | | $ | 1,324,797 | |
Total debt securities | | | 1,315,718 | | | 9,079 | | | — | | | 1,324,797 | |
Totals | | $ | 1,315,718 | | $ | 9,079 | | $ | — | | $ | 1,324,797 | |
Unrealized losses segregated by length of impairment as of December 31, 2015 and December 31, 2014 were as follows:
| | | | | | | | | | | | | | | | | | | |
| | Less than 12 months | | 12 months or longer | | Total | |
Available for Sale | | Fair | | Unrealized | | Fair | | Unrealized | | Fair | | Unrealized | |
December 31, 2015 | | Value | | Losses | | Value | | Losses | | Value | | Losses | |
U.S. government agency | | $ | — | | $ | — | | $ | — | | $ | — | | $ | — | | $ | — | |
U.S. treasury securities | | | 5,872,140 | | | (35,201) | | | — | | | — | | | 5,872,140 | | | (35,201) | |
Residential mortgage-backed securities | | | 1,862,893 | | | (26,479) | | | 1,761,669 | | | (74,411) | | | 3,624,562 | | | (100,890) | |
State and municipals | | | 1,150,915 | | | (425) | | | — | | | — | | | 1,150,915 | | | (425) | |
Corporate bonds | | | — | | | — | | | — | | | — | | | — | | | — | |
Total debt securities | | | 8,885,947 | | | (62,105) | | | 1,761,669 | | | (74,411) | | | 10,647,616 | | | (136,516) | |
Equity securities | | | — | | | — | | | 44,435 | | | (22,217) | | | 44,435 | | | (22,217) | |
Totals | | $ | 8,885,947 | | $ | (62,105) | | $ | 1,806,104 | | $ | (96,628) | | $ | 10,692,051 | | $ | (158,733) | |
| | | | | | | | | | | | | | | | | | | |
| | | | | | | | | | | | | | | | | | | |
| | Less than 12 months | | 12 months or longer | | Total | |
Available for Sale | | Fair | | Unrealized | | Fair | | Unrealized | | Fair | | Unrealized | |
December 31, 2014 | | Value | | Losses | | Value | | Losses | | Value | | Losses | |
U.S. government agency | | $ | — | | $ | — | | $ | — | | $ | — | | $ | — | | $ | — | |
U.S. treasury securities | | | — | | | — | | | — | | | — | | | — | | | — | |
Residential mortgage-backed securities | | | 791 | | | (3) | | | 6,901,324 | | | (207,613) | | | 6,902,115 | | | (207,616) | |
State and municipals | | | 757,939 | | | (3,621) | | | — | | | — | | | 757,939 | | | (3,621) | |
Corporate bonds | | | 2,030,000 | | | (11,718) | | | — | | | — | | | 2,030,000 | | | (11,718) | |
Total debt securities | | | 2,788,730 | | | (15,342) | | | 6,901,324 | | | (207,613) | | | 9,690,054 | | | (222,955) | |
Equity securities | | | — | | | — | | | 16,545 | | | (62,209) | | | 16,545 | | | (62,209) | |
Totals | | $ | 2,788,730 | | $ | (15,342) | | $ | 6,917,869 | | $ | (269,822) | | $ | 9,706,599 | | $ | (285,164) | |
At December 31, 2015, unrealized losses in the Company’s portfolio of debt securities of $136,516 in the aggregate were related to 15 securities and caused by increases in market interest rates, spread volatility, or other factors that management deems to be temporary. Since management believes that it is more likely than not that the Company will not be required to sell these securities prior to maturity or a full recovery of the amortized cost, the Company does not consider these securities to be other-than-temporarily impaired.
At December 31, 2015, unrealized losses in the Company’s portfolio of equity securities of $22,217 were related to one security and considered temporary. Since management believes that it is more likely than not the Company will not be required to sell these equity positions for a reasonable period of time sufficient for recovery of fair value, the Company does not consider these equity securities to be other-than-temporarily impaired.
At December 31, 2014, unrealized losses in the Company’s portfolio of debt securities of $222,955 in the aggregate were related to 11 securities and caused by increases in market interest rates, spread volatility, or other factors that management deems to be temporary. Since management believes that it is more likely than not that the Company will not be required to sell these securities prior to maturity or a full recovery of the amortized cost, the Company does not consider these securities to be other-than-temporarily impaired.
At December 31, 2014, unrealized losses in the Company’s portfolio of equity securities of $62,209 were related to one security and considered temporary. Since management believes that it is more likely than not the Company will not be required to sell these equity positions for a reasonable period of time sufficient for recovery of fair value, the Company does not consider these equity securities to be other-than-temporarily impaired.
The outstanding balance of no single issuer, except for U.S. Agency securities, exceeded 10% of stockholders’ equity at December 31, 2015 or 2014.
No investment securities held by the Company as of December 31, 2015 and December 31, 2014 were subject to a write-down due to credit related other-than-temporary impairment.
Contractual maturities of debt securities at December 31, 2015 and 2014 are shown below. Actual maturities may differ from contractual maturities because borrowers have the right to call or prepay obligations with or without call or prepayment penalties.
| | | | | | | | | | | | | |
| | 2015 | | 2014 | |
| | Amortized | | Fair | | Amortized | | Fair | |
| | Cost | | Value | | Cost | | Value | |
Available for sale | | | | | | | | | | | | | |
Within one year | | $ | 836,706 | | $ | 837,413 | | $ | 237,687 | | $ | 240,942 | |
Over one to five years | | | 9,542,262 | | | 9,609,537 | | | 4,794,585 | | | 4,787,945 | |
Over five to ten years | | | 7,778,830 | | | 7,825,523 | | | 9,210,672 | | | 9,433,530 | |
Over ten years | | | — | | | — | | | — | | | — | |
Residential mortgage-backed securities | | | 14,836,750 | | | 15,023,225 | | | 20,679,345 | | | 20,870,927 | |
Totals | | $ | 32,994,549 | | $ | 33,295,698 | | $ | 34,922,289 | | $ | 35,333,344 | |
| | | | | | | | | | | | | |
| | 2015 | | 2014 | |
| | Amortized | | Fair | | Amortized | | Fair | |
| | Cost | | Value | | Cost | | Value | |
Held to maturity | | | | | | | | | | | | | |
Over ten years | | $ | 334,257 | | $ | 340,147 | | $ | — | | $ | — | |
Residential mortgage-backed securities | | | 1,238,908 | | | 1,256,115 | | | 1,315,718 | | | 1,324,797 | |
Totals | | $ | 1,573,165 | | $ | 1,596,262 | | $ | 1,315,718 | | $ | 1,324,797 | |
The Company’s residential mortgage-backed securities portfolio is presented as a separate line within the maturity table, since borrowers have the right to prepay obligations without prepayment penalties.
During the year ended December 31, 2015, there were two sales of investment securities available for sale for a gain of $119,476. There were no sales of investment securities available for sale during the year ended December 31, 2014.
At December 31, 2015, securities with an amortized cost of $12,391,059 (fair value of $12,654,624) were pledged as collateral for potential borrowings from the Federal Home Loan Bank of Atlanta (the “FHLB”) and the Federal Reserve Bank of Richmond (the “Reserve Bank”). At December 31, 2014, securities with an amortized cost of $20,035,812 (fair value of $20,358,237) were pledged as collateral for potential borrowings from the FHLB and the Reserve Bank.
NOTE 4 – LOANS AND ALLOWANCE FOR LOAN LOSSES
The fundamental lending business of the Company is based on understanding, measuring, and controlling the credit risk inherent in the loan portfolio. The Company's loan portfolio is subject to varying degrees of credit risk. These risks entail both general risks, which are inherent in the lending process, and risks specific to individual
borrowers. The Company's credit risk is mitigated through portfolio diversification, which limits exposure to any single customer, industry or collateral type. The loan portfolio segment balances are presented in the following table:
| | | | | | | |
| | December 31, | |
| | 2015 | | 2014 | |
Commercial & Industrial | | $ | 46,464,340 | | $ | 33,454,280 | |
Commercial Real Estate | | | 168,569,159 | | | 158,714,554 | |
Residential Real Estate | | | 124,810,853 | | | 140,374,035 | |
Home Equity Line of Credit | | | 33,722,696 | | | 35,717,982 | |
Land | | | 5,229,645 | | | 5,856,875 | |
Construction | | | 13,277,353 | | | 18,052,287 | |
Consumer & Other | | | 1,166,521 | | | 881,179 | |
Total Loans | | | 393,240,567 | | | 393,051,192 | |
Less: Allowance for Loan Losses | | | (1,773,009) | | | (1,294,976) | |
Net Loans | | $ | 391,467,558 | | $ | 391,756,216 | |
At December 31, 2015 and December 31, 2014, loans not considered to have deteriorated credit quality at acquisition had a total remaining unamortized discount of $3,949,215 and $5,281,192, respectively.
Portfolio Segments:
The Company currently manages its credit products and the respective exposure to loan losses by the following specific portfolio segments, which are levels at which the Company develops and documents its systematic methodology to determine the allowance for loan losses. The Company considers each loan type to be a portfolio segment having unique risk characteristics.
Commercial & Industrial
Commercial & Industrial (“C&I”) loans are made to provide funds for equipment and general corporate needs. Repayment of these loans primarily uses the funds obtained from the operation of the borrower's business. C&I loans also include lines of credit that are utilized to finance a borrower's short-term credit needs and/or to finance a percentage of eligible receivables or inventory. Of primary concern in C&I lending is the borrower's creditworthiness and ability to successfully generate sufficient cash flow from their business to service the debt.
Commercial Real Estate
Commercial Real Estate loans are bifurcated into Investor and Owner Occupied types (classes). Commercial Real Estate - Investor loans consist of loans secured by non-owner occupied properties and involve investment properties for warehouse, retail, apartment, and office space with a history of occupancy and cash flow. This commercial real estate class includes mortgage loans to the developers and owners of commercial real estate where the borrower intends to operate or sell the property at a profit and use the income stream or proceeds from the sale(s) to repay the loan. Commercial Real Estate - Owner Occupied loans consist of commercial mortgage loans secured by owner occupied properties and involves a variety of property types to conduct the borrower's operations. The primary source of repayment for this type of loan is the cash flow from the business and is based upon the borrower's financial health and the ability of the borrower and the business to repay. At December 31, 2015 and 2014, Commercial Real Estate – Investor loans had a total balance of $111,871,251 and $101,947,596, respectively. At December 31, 2015 and December 31, 2014, Commercial Real Estate – Owner Occupied loans had a total balance of $56,697,908 and $56,766,958, respectively.
Residential Real Estate
Residential Real Estate loans are bifurcated into Investor and Owner Occupied types (classes). Residential Real Estate - Investor loans consist of loans secured by non-owner occupied residential properties and usually carry higher credit risk than Residential Real Estate – Owner Occupied loans due to their reliance on stable rental income and due to lower incentive for the borrower to avoid foreclosure. Payments on loans secured by rental properties often depend on the successful operation and management of the properties and the payment of rent by tenants. At December 31, 2015 and 2014, Residential Real Estate – Investor loans had a total balance of $39,410,230 and $50,708,153, respectively. At
December 31, 2015 and 2014, Residential Real Estate – Owner Occupied loans had a total balance of $85,400,623 and $89,665,882, respectively.
Home Equity Line of Credit
Home Equity Lines of Credit (“HELOCs”) are a form of revolving credit in which a borrower's primary residence serves as collateral. Borrowers use HELOCs primarily for education, home improvements, and other significant personal expenditures. The borrower will be approved for a specific credit limit set at a percentage of their home's appraised value less the balance owed on the existing first mortgage. Major risks in HELOC lending include the borrower's ability to service the existing first mortgage plus the HELOC, the Company's ability to pursue collection in a second lien position upon default, and overall risks in fluctuation in the value of the underlying collateral property.
Land
Land loans are secured by underlying properties that usually consist of tracts of undeveloped land that do not produce income. These loans carry the risk that there will be inadequate demand to ensure the sale of the property within an acceptable time. As a result, land loans carry the risk that the builder will have to pay the property taxes and other carrying costs of the property until a buyer is identified.
Construction
Construction loans, which include land development loans, are generally considered to involve a higher degree of credit risk than long term financing on improved, occupied real estate. Risk of loss on a construction loan depends largely upon the accuracy of the initial estimate of the property's value at completion of construction and estimated costs of construction, as well as the property’s ability to attract and retain tenants. Loan funds are disbursed periodically as pre-specified stages of completion are attained based upon site inspections. If the Company is forced to foreclose on a building before or at completion due to a default, it may be unable to recover all of the unpaid balance of and accrued interest on the loan as well as related foreclosure and holding costs.
Consumer & Other
Consumer & Other loans include installment loans, personal lines of credit, and automobile loans. Payment on these loans often depends on the borrower's creditworthiness and ability to generate sufficient cash flow to service the debt.
Allowance for Loan Losses
To control and monitor credit risk, management has an internal credit process in place to determine whether credit standards are maintained along with in-house loan administration accompanied by oversight and review procedures. The primary purpose of loan underwriting is the evaluation of specific lending risks that involves the analysis of the borrower's ability to service the debt as well as the assessment of the underlying collateral. Oversight and review procedures include the monitoring of the portfolio credit quality, early identification of potential problem credits and the management of problem credits. As part of the oversight and review process, the Company maintains an allowance for loan losses to absorb estimated and probable losses inherent in the loan portfolio.
For purposes of calculating the allowance, the Company segregates its loan portfolio into portfolio segments based primarily on the type of supporting collateral. The Commercial Real Estate and Residential Real Estate segments, which both exclude any collateral property currently under construction, are further disaggregated into Owner Occupied and Investor classes for each. Further, all segments are also segregated as either PCI loans, purchased loans not deemed impaired, troubled debt restructurings, or new originations.
The analysis for determining the allowance is consistent with guidance set forth in U.S. GAAP and the Interagency Policy Statement on the Allowance for Loan and Lease Losses. Pursuant to Bank policy, the allowance is evaluated quarterly by management and is based upon management's review of the collectability of loans in light of historical experience, the nature and volume of the loan portfolio, adverse situations that may affect the borrowers' ability to repay, estimated value of any underlying collateral and prevailing economic conditions. The allowance consists of specific and general reserves. The specific reserves relate to loans classified as impaired, primarily including
nonaccrual, TDR, and PCI loans where cash flows have deteriorated from those forecasted as of the acquisition date. The reserve for these loans is established when the discounted cash flows, collateral value, or observable market price, whichever is appropriate, of the impaired loan is lower than the carrying value. For impaired loans, any measured impairment is charged off against the loan and allowance for those loans that are collateral dependent in the applicable reporting period.
The general reserve covers loans that are not classified as impaired and primarily includes purchased loans not deemed impaired and new loan originations. The general reserve requirement is based on historical loss experience and several qualitative factors derived from economic and market conditions that have been determined to have an effect on the probability and magnitude of a loss. Since the Bank does not have its own sufficient loss experience, management also references the historical net charge off experience of peer groups to determine a reasonable range of reserve values, which is permissible per Bank policy. The peer groups consist of competing Maryland-based financial institutions with established ranges in total asset size. Management will continue to evaluate the appropriateness of the peer group data used with each quarterly allowance analysis until such time that the Bank has sufficient loss experience to provide a foundation for the general reserve requirement. The qualitative analysis incorporates global economic factors in the following trends: national and local economic metrics; portfolio risk ratings and composition; and concentrations in credit.
The following table provides information on the activity in the allowance for loan losses by the respective loan portfolio segment for the year ended December 31, 2015:
| | | | | | | | | | | | | | | | | | | | | | | | | |
| | Commercial | | Commercial | | Residential | | Home Equity | | | | | | | | Consumer | | | | |
| | & Industrial | | Real Estate | | Real Estate | | Line of Credit | | Land | | Construction | | & Other | | Total | |
Allowance for loan losses: | | | | | | | | | | | | | | | | | | | | | | | | | |
Beginning balance | | $ | 200,510 | | $ | 554,585 | | $ | 203,413 | | $ | 166,733 | | $ | 8,687 | | $ | 153,089 | | $ | 7,959 | | $ | 1,294,976 | |
Charge-offs | | | (80,869) | | | (45,573) | | | (454,356) | | | (64,918) | | | — | | | (76,347) | | | (2,495) | | | (724,558) | |
Recoveries(1) | | | — | | | — | | | 46,569 | | | 13,000 | | | — | | | — | | | 500 | | | 60,069 | |
Provision | | | 91,157 | | | 218,857 | | | 797,458 | | | 42,228 | | | 7,026 | | | (13,775) | | | (429) | | | 1,142,522 | |
Ending balance | | $ | 210,798 | | $ | 727,869 | | $ | 593,084 | | $ | 157,043 | | $ | 15,713 | | $ | 62,967 | | $ | 5,535 | | $ | 1,773,009 | |
The following table presents loans and the related allowance for loan losses, by loan portfolio segment, as of December 31, 2015:
| | | | | | | | | | | | | | | | | | | | | | | | | |
| | Commercial | | Commercial | | Residential | | Home Equity | | | | | | | | Consumer | | | | |
| | & Industrial | | Real Estate | | Real Estate | | Line of Credit | | Land | | Construction | | & Other | | Total | |
Allowance for loan losses: | | | | | | | | | | | | | | | | | | | | | | | | | |
Ending balance: individually evaluated for impairment | | $ | — | | $ | — | | $ | 60,000 | | $ | — | | $ | — | | $ | — | | $ | — | | $ | 60,000 | |
Ending balance: collectively evaluated for impairment | | | 210,798 | | | 727,869 | | | 533,084 | | | 157,043 | | | 15,713 | | | 62,967 | | | 5,535 | | | 1,713,009 | |
Totals | | $ | 210,798 | | $ | 727,869 | | $ | 593,084 | | $ | 157,043 | | $ | 15,713 | | $ | 62,967 | | $ | 5,535 | | $ | 1,773,009 | |
| | | | | | | | | | | | | | | | | | | | | | | | | |
Loans: | | | | | | | | | | | | | | | | | | | | | | | | | |
Ending balance: individually evaluated for impairment | | $ | 813,678 | | $ | 612,315 | | $ | 3,839,857 | | $ | 73,341 | | $ | — | | $ | 73,300 | | $ | 5,798 | | $ | 5,418,289 | |
Ending balance: collectively evaluated for impairment | | | 44,204,047 | | | 152,632,809 | | | 111,786,914 | | | 32,931,643 | | | 3,295,080 | | | 13,204,053 | | | 1,160,723 | | | 359,215,269 | |
Ending balance: loans acquired with deteriorated credit quality(2) | | | 1,446,616 | | | 15,324,034 | | | 9,184,082 | | | 717,712 | | | 1,934,565 | | | — | | | — | | | 28,607,009 | |
Totals | | $ | 46,464,341 | | $ | 168,569,158 | | $ | 124,810,853 | | $ | 33,722,696 | | $ | 5,229,645 | | $ | 13,277,353 | | $ | 1,166,521 | | $ | 393,240,567 | |
| (1) | | Excludes cash payments received on loans acquired with deteriorated credit quality with a carrying value of $0. |
| (2) | | Includes loans acquired with deteriorated credit quality of $198,482 that have current period charge offs. |
The following table provides information on the activity in the allowance for loan losses by the respective loan portfolio segment for the year ended December 31, 2014:
| | | | | | | | | | | | | | | | | | | | | | | | | |
| | Commercial | | Commercial | | Residential | | Home Equity | | | | | | | | Consumer | | | | |
| | & Industrial | | Real Estate | | Real Estate | | Line of Credit | | Land | | Construction | | & Other | | Total | |
Allowance for loan losses: | | | | | | | | | | | | | | | | | | | | | | | | | |
Beginning balance | | $ | 167,400 | | $ | 324,080 | | $ | 80,239 | | $ | 129,203 | | $ | 6,918 | | $ | 135,416 | | $ | 7,744 | | $ | 851,000 | |
Charge-offs | | | — | | | (300,214) | | | (274,382) | | | (79,492) | | | — | | | — | | | (934) | | | (655,022) | |
Recoveries(1) | | | 30,000 | | | 137,072 | | | 109,827 | | | 9,844 | | | — | | | — | | | 10,567 | | | 297,310 | |
Provision | | | 3,110 | | | 393,647 | | | 287,729 | | | 107,178 | | | 1,769 | | | 17,673 | | | (9,418) | | | 801,688 | |
Ending balance | | $ | 200,510 | | $ | 554,585 | | $ | 203,413 | | $ | 166,733 | | $ | 8,687 | | $ | 153,089 | | $ | 7,959 | | $ | 1,294,976 | |
The following table presents loans and the related allowance for loan losses, by loan portfolio segment, as of December 31, 2014:
| | | | | | | | | | | | | | | | | | | | | | | | | |
| | Commercial | | Commercial | | Residential | | Home Equity | | | | | | | | Consumer | | | | |
| | & Industrial | | Real Estate | | Real Estate | | Line of Credit | | Land | | Construction | | & Other | | Total | |
Allowance for loan losses: | | | | | | | | | | | | | | | | | | | | | | | | | |
Ending balance: individually evaluated for impairment | | $ | — | | $ | — | | $ | — | | $ | — | | $ | — | | $ | — | | $ | — | | $ | — | |
Ending balance: collectively evaluated for impairment | | | 200,510 | | | 554,585 | | | 203,413 | | | 166,733 | | | 8,687 | | | 153,089 | | | 7,959 | | | 1,294,976 | |
Totals | | $ | 200,510 | | $ | 554,585 | | $ | 203,413 | | $ | 166,733 | | $ | 8,687 | | $ | 153,089 | | $ | 7,959 | | $ | 1,294,976 | |
| | | | | | | | | | | | | | | | | | | | | | | | | |
Loans: | | | | | | | | | | | | | | | | | | | | | | | | | |
Ending balance: individually evaluated for impairment | | $ | 957,080 | | $ | 828,264 | | $ | 4,314,191 | | $ | 320,329 | | $ | — | | $ | — | | $ | — | | $ | 6,419,864 | |
Ending balance: collectively evaluated for impairment | | | 30,474,533 | | | 137,781,830 | | | 124,042,412 | | | 34,686,415 | | | 2,448,388 | | | 17,380,581 | | | 881,179 | | | 347,695,338 | |
Ending balance: loans acquired with deteriorated credit quality(2) | | | 2,022,667 | | | 20,104,460 | | | 12,017,432 | | | 711,238 | | | 3,408,487 | | | 671,706 | | | — | | | 38,935,990 | |
Totals | | $ | 33,454,280 | | $ | 158,714,554 | | $ | 140,374,035 | | $ | 35,717,982 | | $ | 5,856,875 | | $ | 18,052,287 | | $ | 881,179 | | $ | 393,051,192 | |
| (1) | | Excludes cash payments received on loans acquired with deteriorated credit quality with a carrying value of $0. |
| (2) | | Includes loans acquired with deteriorated credit quality of $104,460 that have current period charge-offs. |
The following table presents information with respect to impaired loans, which includes loans acquired with deteriorated credit quality that have current period charge-offs, as of December 31, 2015:
| | | | | | | | | | | | | | | | |
| | | | | | | | | | | For the Year Ended | |
| | As of December 31, 2015 | | December 31, 2015 | |
| | | | | Unpaid | | | | | Average | | Interest | |
| | Recorded | | Principal | | Related | | Recorded | | Income | |
| | Investment | | Balance | | Allowance | | Investment | | Recognized(1) | |
With no related allowance recorded: | | | | | | | | | | | | | | | | |
Commercial & Industrial | | $ | 813,678 | | $ | 980,154 | | $ | — | | $ | 995,042 | | $ | 59,275 | |
Commercial Real Estate - Investor | | | 612,315 | | | 612,315 | | | — | | | 641,498 | | | 2,232 | |
Commercial Real Estate - Owner Occupied | | | — | | | — | | | — | | | — | | | — | |
Residential Real Estate - Investor | | | 1,524,751 | | | 1,773,567 | | | — | | | 1,998,815 | | | 130,426 | |
Residential Real Estate - Owner Occupied | | | 2,218,453 | | | 2,444,350 | | | — | | | 2,650,649 | | | 228,761 | |
Home Equity Line of Credit | | | 73,341 | | | 103,896 | | | — | | | 108,138 | | | 2,248 | |
Land | | | — | | | — | | | — | | | — | | | — | |
Construction | | | 73,300 | | | 73,242 | | | — | | | 77,194 | | | (31) | |
Consumer & Other | | | 5,798 | | | 189,204 | | | — | | | 104,118 | | | — | |
| | | | | | | | | | | | | | | | |
With an allowance recorded: | | | | | | | | | | | | | | | | |
Commercial & Industrial | | | — | | | — | | | — | | | — | | | — | |
Commercial Real Estate - Investor | | | — | | | — | | | — | | | — | | | — | |
Commercial Real Estate - Owner Occupied | | | — | | | — | | | — | | | — | | | — | |
Residential Real Estate - Investor | | | 125,453 | | | 130,408 | | | 60,000 | | | 134,541 | | | 5,132 | |
Residential Real Estate - Owner Occupied | | | — | | | — | | | — | | | — | | | — | |
Home Equity Line of Credit | | | — | | | — | | | — | | | — | | | — | |
Land | | | — | | | — | | | — | | | — | | | — | |
Construction | | | — | | | — | | | — | | | — | | | — | |
Consumer & Other | | | — | | | — | | | — | | | — | | | — | |
Total: | | | 5,447,089 | | | 6,307,136 | | | 60,000 | | | 6,709,995 | | | 428,043 | |
| | | | | | | | | | | | | | | | |
Commercial & Industrial | | $ | 813,678 | | $ | 980,154 | | $ | — | | $ | 995,042 | | $ | 59,275 | |
Commercial Real Estate | | | 612,315 | | | 612,315 | | | — | | | 641,498 | | | 2,232 | |
Residential Real Estate | | | 3,868,657 | | | 4,348,325 | | | 60,000 | | | 4,784,005 | | | 364,319 | |
Home Equity Line of Credit | | | 73,341 | | | 103,896 | | | — | | | 108,138 | | | 2,248 | |
Land | | | — | | | — | | | — | | | — | | | — | |
Construction | | | 73,300 | | | 73,242 | | | — | | | 77,194 | | | (31) | |
Consumer & Other | | | 5,798 | | | 189,204 | | | — | | | 104,118 | | | — | |
| | $ | 5,447,089 | | $ | 6,307,136 | | $ | 60,000 | | $ | 6,709,995 | | $ | 428,043 | |
| (1) | | Consists primarily of accretion income on loans acquired with deteriorated credit quality that were reclassified as troubled debt restructurings subsequent to acquisition. |
The following table presents information with respect to impaired loans, which includes loans acquired with deteriorated credit quality that have current period charge-offs, as of December 31, 2014:
| | | | | | | | | | | | | | | | |
| | | | | | | | | | | For the Year Ended | |
| | December 31, 2014 | | December 31, 2014 | |
| | | | | Unpaid | | Average | | Interest | | | | |
| | Recorded | | Principal | | Related | | Recorded | | Income | |
| | Investment | | Balance | | Allowance | | Investment | | Recognized(1) | |
With no related allowance recorded: | | | | | | | | | | | | | | | | |
Commercial & Industrial | | $ | 957,080 | | $ | 1,155,553 | | $ | — | | $ | 1,136,545 | | $ | 92,978 | |
Commercial Real Estate - Investor | | | 662,280 | | | 668,287 | | | — | | | 731,634 | | | 2,371 | |
Commercial Real Estate - Owner Occupied | | | 165,984 | | | 165,984 | | | — | | | 170,360 | | | — | |
Residential Real Estate - Investor | | | 1,168,103 | | | 1,959,337 | | | — | | | 1,728,843 | | | 6,508 | |
Residential Real Estate - Owner Occupied | | | 3,250,548 | | | 3,853,959 | | | — | | | 3,752,953 | | | 201,428 | |
Home Equity Line of Credit | | | 320,329 | | | 404,347 | | | — | | | 368,477 | | | — | |
Land | | | — | | | — | | | — | | | — | | | — | |
Construction | | | — | | | — | | | — | | | — | | | — | |
Consumer & Other | | | — | | | 19,034 | | | — | | | 10,245 | | | 615 | |
| | | | | | | | | | | | | | | | |
With an allowance recorded: | | | | | | | | | | | | | | | | |
Commercial & Industrial | | | — | | | — | | | — | | | — | | | — | |
Commercial Real Estate - Investor | | | — | | | — | | | — | | | — | | | — | |
Commercial Real Estate - Owner Occupied | | | — | | | — | | | — | | | — | | | — | |
Residential Real Estate - Investor | | | — | | | — | | | — | | | — | | | — | |
Residential Real Estate - Owner Occupied | | | — | | | — | | | — | | | — | | | — | |
Home Equity Line of Credit | | | — | | | — | | | — | | | — | | | — | |
Land | | | — | | | — | | | — | | | — | | | — | |
Construction | | | — | | | — | | | — | | | — | | | — | |
Consumer & Other | | | — | | | — | | | — | | | — | | | — | |
Total: | | | 6,524,324 | | | 8,226,501 | | | — | | | 7,899,057 | | | 303,900 | |
| | | | | | | | | | | | | | | | |
Commercial & Industrial | | $ | 957,080 | | $ | 1,155,553 | | $ | — | | $ | 1,136,545 | | $ | 92,978 | |
Commercial Real Estate | | | 828,264 | | | 834,271 | | | — | | | 901,994 | | | 2,371 | |
Residential Real Estate | | | 4,418,651 | | | 5,813,296 | | | — | | | 5,481,796 | | | 207,936 | |
Home Equity Line of Credit | | | 320,329 | | | 404,347 | | | — | | | 368,477 | | | — | |
Land | | | — | | | — | | | — | | | — | | | — | |
Construction | | | — | | | — | | | — | | | — | | | — | |
Consumer & Other | | | — | | | 19,034 | | | — | | | 10,245 | | | 615 | |
| | $ | 6,524,324 | | $ | 8,226,501 | | $ | — | | $ | 7,899,057 | | $ | 303,900 | |
| (1) | | Consists primarily of accretion income on loans acquired with deteriorated credit quality that were reclassified as troubled debt restructurings subsequent to acquisition. |
In addition to monitoring the performance status of the loan portfolio, the Company utilizes a risk rating scale (1-8) to evaluate loan asset quality for all loans. Loans that are rated 1-4 are classified as pass credits. Loans rated a 5 (Watch) are pass credits, but are loans that have been identified that warrant additional attention and monitoring. Loans that are risk rated 5 or higher are placed on the Company's monthly watch list. For the pass rated loans, management believes there is a low risk of loss related to these loans and as necessary, credit may be strengthened through improved borrower performance and/or additional collateral. Loans rated a 6 (Special Mention) or higher are considered criticized loans and represent an increased level of credit risk and are placed into these three categories:
6 (Special Mention) - Borrowers exhibit potential credit weaknesses or downward trends that may weaken the credit position if uncorrected. The borrowers are considered marginally acceptable without potential for loss of principal or interest.
7 (Substandard) - Borrowers have well defined weaknesses or characteristics that present the possibility that the Company will sustain some loss if the deficiencies are not corrected.
8 (Doubtful) - Borrowers classified as doubtful have the same weaknesses found in substandard borrowers; however, these weaknesses indicate that the collection of debt in full (principal and interest), based on current conditions, is highly questionable and improbable.
In the normal course of loan portfolio management, relationship managers are responsible for continuous assessment of credit risk arising from the individual borrowers within their portfolio and assigning appropriate risk ratings. Credit Administration is responsible for ensuring the integrity and operation of the risk rating system and maintenance of the watch list. The Officer's Loan Committee meets monthly to discuss and monitor problem credits and internal risk rating downgrades that result in updates to the watch list.
The following table provides information with respect to the Company's credit quality indicators by class of the loan portfolio as of December 31, 2015:
| | | | | | | | | | | | | | | | |
| | Risk Rating | |
| | Pass | | Special Mention | | Substandard | | Doubtful | | Total | |
Commercial & Industrial | | $ | 43,506,060 | | $ | 943,675 | | $ | 2,014,605 | | $ | — | | $ | 46,464,340 | |
Commercial Real Estate - Investor | | | 107,594,899 | | | 3,428,403 | | | 847,949 | | | — | | | 111,871,251 | |
Commercial Real Estate - Owner Occupied | | | 52,366,555 | | | 3,486,013 | | | 845,340 | | | — | | | 56,697,908 | |
Residential Real Estate - Investor | | | 30,782,962 | | | 1,615,816 | | | 7,011,451 | | | — | | | 39,410,229 | |
Residential Real Estate - Owner Occupied | | | 82,557,939 | | | — | | | 2,842,685 | | | — | | | 85,400,624 | |
Home Equity Line of Credit | | | 33,339,596 | | | — | | | 383,100 | | | — | | | 33,722,696 | |
Land | | | 3,460,808 | | | — | | | 1,768,837 | | | — | | | 5,229,645 | |
Construction | | | 13,204,053 | | | — | | | 73,300 | | | — | | | 13,277,353 | |
Consumer & Other | | | 1,160,723 | | | — | | | 5,798 | | | — | | | 1,166,521 | |
Total | | $ | 367,973,595 | | $ | 9,473,907 | | $ | 15,793,065 | | $ | — | | $ | 393,240,567 | |
The following table provides information with respect to the Company's credit quality indicators by class of the loan portfolio as of December 31, 2014:
| | | | | | | | | | | | | | | | |
| | Risk Rating | |
| | Pass | | Special Mention | | Substandard | | Doubtful | | Total | |
Commercial & Industrial | | $ | 30,150,745 | | $ | 1,530,547 | | $ | 1,772,988 | | $ | — | | $ | 33,454,280 | |
Commercial Real Estate - Investor | | | 93,113,185 | | | 5,837,107 | | | 2,997,304 | | | — | | | 101,947,596 | |
Commercial Real Estate - Owner Occupied | | | 42,898,246 | | | 6,864,098 | | | 7,004,614 | | | — | | | 56,766,958 | |
Residential Real Estate - Investor | | | 39,109,937 | | | 2,804,857 | | | 8,793,359 | | | — | | | 50,708,153 | |
Residential Real Estate - Owner Occupied | | | 84,796,122 | | | — | | | 4,869,760 | | | — | | | 89,665,882 | |
Home Equity Line of Credit | | | 35,088,028 | | | — | | | 629,954 | | | — | | | 35,717,982 | |
Land | | | 3,850,748 | | | — | | | 2,006,127 | | | — | | | 5,856,875 | |
Construction | | | 17,848,675 | | | 81,234 | | | 122,378 | | | — | | | 18,052,287 | |
Consumer & Other | | | 881,179 | | | — | | | — | | | — | | | 881,179 | |
Total | | $ | 347,736,865 | | $ | 17,117,843 | | $ | 28,196,484 | | $ | — | | $ | 393,051,192 | |
Management further monitors the performance and credit quality of the loan portfolio by analyzing the age of the portfolio as determined by the length of time a recorded payment is past due.
The following table presents the classes of the loan portfolio summarized by the aging categories of performing loans and nonaccrual loans as of December 31, 2015. PCI loans are excluded from this aging and nonaccrual loans schedule.
| | | | | | | | | | | | | | | | | | | | | | |
| | Accrual Loans | | | | | | | |
| | 30-59 | | 60-89 | | 90 or More | | | | | | | | | | | | | |
| | Days | | Days | | Days | | Total | | | | | Nonaccrual | | Total | |
| | Past Due | | Past Due | | Past Due | | Past Due | | Current | | Loans | | Loans | |
Commercial & Industrial | | $ | — | | $ | — | | $ | — | | $ | — | | $ | 44,530,267 | | $ | 487,457 | | $ | 45,017,724 | |
Commercial Real Estate - Investor | | | — | | | — | | | — | | | — | | | 101,282,012 | | | 561,460 | | | 101,843,472 | |
Commercial Real Estate - Owner Occupied | | | — | | | — | | | — | | | — | | | 51,401,653 | | | — | | | 51,401,653 | |
Residential Real Estate - Investor | | | — | | | — | | | — | | | — | | | 30,176,907 | | | 1,574,473 | | | 31,751,380 | |
Residential Real Estate - Owner Occupied | | | 923,060 | | | 59,656 | | | ��� | | | 982,716 | | | 80,874,127 | | | 2,018,548 | | | 83,875,391 | |
Home Equity Line of Credit | | | 308,058 | | | — | | | — | | | 308,058 | | | 32,623,585 | | | 73,341 | | | 33,004,984 | |
Land | | | — | | | — | | | — | | | — | | | 3,295,080 | | | — | | | 3,295,080 | |
Construction | | | — | | | — | | | — | | | — | | | 13,204,053 | | | 73,300 | | | 13,277,353 | |
Consumer & Other | | | — | | | 480 | | | — | | | 480 | | | 1,160,243 | | | 5,798 | | | 1,166,521 | |
Total | | $ | 1,231,118 | | $ | 60,136 | | $ | — | | $ | 1,291,254 | | $ | 358,547,927 | | $ | 4,794,377 | | $ | 364,633,558 | |
| | | | | | | | | | | | | | | | | | | | | | |
Purchased credit impaired loans | | | | | | | | | | | | | | | | | | | | | 28,607,009 | |
Total Loans | | | | | | | | | | | | | | | | | | | | $ | 393,240,567 | |
The following table presents the classes of the loan portfolio summarized by the aging categories of performing loans and nonaccrual loans as of December 31, 2014. PCI loans are excluded from this aging and nonaccrual loans schedule.
| | | | | | | | | | | | | | | | | | | | | | |
| | Accrual Loans | | | | | | | |
| | 30-59 | | 60-89 | | 90 or More | | | | | | | | | | | | | |
| | Days | | Days | | Days | | Total | | | | | Nonaccrual | | Total | |
| | Past Due | | Past Due | | Past Due | | Past Due | | Current | | Loans | | Loans | |
Commercial & Industrial | | $ | — | | $ | — | | $ | — | | $ | — | | $ | 31,093,412 | | $ | 338,202 | | $ | 31,431,614 | |
Commercial Real Estate - Investor | | | 159,786 | | | — | | | — | | | 159,786 | | | 88,920,589 | | | 608,084 | | | 89,688,458 | |
Commercial Real Estate - Owner Occupied | | | — | | | — | | | — | | | — | | | 48,755,651 | | | 165,984 | | | 48,921,635 | |
Residential Real Estate - Investor | | | 312,422 | | | — | | | — | | | 312,422 | | | 39,508,855 | | | 1,063,643 | | | 40,884,920 | |
Residential Real Estate - Owner Occupied | | | 924,608 | | | 550,604 | | | — | | | 1,475,213 | | | 83,255,356 | | | 2,741,114 | | | 87,471,683 | |
Home Equity Line of Credit | | | 456,248 | | | 24,199 | | | — | | | 480,446 | | | 34,205,969 | | | 320,329 | | | 35,006,745 | |
Land | | | — | | | — | | | — | | | — | | | 2,448,388 | | | — | | | 2,448,388 | |
Construction | | | — | | | — | | | — | | | — | | | 17,380,581 | | | — | | | 17,380,581 | |
Consumer & Other | | | — | | | 500 | | | — | | | 500 | | | 880,679 | | | — | | | 881,179 | |
Total | | $ | 1,853,063 | | $ | 575,303 | | $ | — | | $ | 2,428,367 | | $ | 346,449,479 | | $ | 5,237,356 | | $ | 354,115,202 | |
| | | | | | | | | | | | | | | | | | | | | | |
Purchased credit impaired loans | | | | | | | | | | | | | | | | | | | | | 38,935,990 | |
Total Loans | | | | | | | | | | | | | | | | | | | | $ | 393,051,192 | |
Troubled Debt Restructurings
The restructuring of a loan constitutes a troubled debt restructuring, or TDR, if the creditor, for economic or legal reasons related to the debtor’s financial difficulties, grants a concession to the debtor that it would not otherwise consider in the normal course of business. A concession may include an extension of repayment terms which would not normally be granted, a reduction of interest rate or the forgiveness of principal and/or accrued interest. If the debtor is experiencing financial difficulty and the creditor has granted a concession, the Company will make the necessary disclosures related to the TDR. In certain cases, a modification may be made in an effort to retain a customer who is not experiencing financial difficulty. This type of modification is not considered to be a TDR. Once a loan has been modified and is considered a TDR, it is reported as an impaired loan. All TDRs are evaluated individually for impairment on a quarterly basis as part of the allowance for credit losses calculation. A specific allowance for TDR loans is established when the discounted cash flows, collateral value or observable market price, whichever is
appropriate, of the TDR is lower than the carrying value. If a loan deemed a TDR has performed for at least six months at the level prescribed by the modification, it is not considered to be non-performing; however, it will generally continue to be reported as impaired, but may be returned to accrual status. A TDR is deemed in default on its modified terms once a contractual payment is 30 or more days past due.
The following table presents a breakdown of loans the Company modified during the years ended December 31, 2015 and 2014:
| | | | | | | | | | | | | | | | | |
| | Year Ended December 31, 2015 | | Year Ended December 31, 2014 | |
| | | | Pre-Modification | | Post-Modification | | | | Pre-Modification | | Post-Modification | |
| | | | Outstanding | | Outstanding | | | | Outstanding | | Outstanding | |
| | Number of | | Recorded | | Recorded | | Number of | | Recorded | | Recorded | |
| | Contracts | | Investment | | Investment | | Contracts | | Investment | | Investment | |
Troubled Debt Restructurings: | | | | | | | | | | | | | | | | | |
Commercial & Industrial | | 3 | | $ | 101,772 | | $ | 101,772 | | 1 | | $ | 85,397 | | $ | 85,397 | |
Commercial Real Estate – Investor | | — | | | — | | | — | | — | | | — | | | — | |
Commercial Real Estate – Owner Occupied | | — | | | — | | | — | | — | | | — | | | — | |
Residential Real Estate - Investor | | 10 | | | 370,210 | | | 370,210 | | — | | | — | | | — | |
Residential Real Estate - Owner Occupied | | 1 | | | 122,097 | | | 122,097 | | 2 | | | 612,118 | | | 612,118 | |
Home Equity Line of Credit | | 1 | | | 129,033 | | | 129,033 | | — | | | — | | | — | |
Land | | — | | | — | | | — | | — | | | — | | | — | |
Construction | | — | | | — | | | — | | — | | | — | | | — | |
Consumer & Other | | — | | | — | | | — | | — | | | — | | | — | |
Totals | | 15 | | $ | 723,112 | | $ | 723,112 | | 3 | | $ | 697,515 | | $ | 697,515 | |
During the year ended December 31, 2015, there were 15 loans modified as TDRs. The restructuring of a C&I loan consolidated two loans into one and termed out the remaining balance over seven years at an interest rate lower than the current rate for new debt with similar risk. This C&I TDR was on accrual status at December 31, 2015. The restructuring of a C&I loan closed the revolving line of credit, established a term note at a higher interest rate and extended the maturity date. This C&I TDR was on accrual status at December 31, 2015. The restructuring of seven Residential Real Estate – Investor loans established a global forbearance agreement to provide for the orderly liquidation of collateral along with the establishment of a deficiency note agreement. The two remaining Residential Real Estate – Investor loans were on nonaccrual status at December 31, 2015. The restructuring of a Residential Real Estate – Investor loan deferred all payments of principal and interest until the sale of the existing collateral as well as additional collateral that was provided. This Residential Real Estate – Investor loan was on nonaccrual status at December 31, 2015. The restructuring of the Residential Real Estate – Investor loan termed out the balance owed over seven years with a forgiveness of debt at the end of the term, if all payments are made as agreed. This Residential Real Estate – Investor loan was on nonaccrual status at December 31, 2015. The restructuring of a HELOC loan reduced payments for six months equal to approximately 50% of the current payment while the borrower sells the property. This HELOC loan was paid off as of December 31, 2015. The restructuring of this Residential Real Estate - Investor loan extends the maturity date for one year to allow the borrower a period to correct cash flow impairments. This Residential Real Estate - Investor loan was on accrual status at December 31, 2015. The restructuring of a Residential Real Estate – Owner Occupied loan re-amortized the existing balance over 10 years, extended the maturity date and established a first lien on the borrower’s primary residence in exchange for releasing the second lien on the borrower’s condo. This Residential Real Estate – Owner Occupied loan was on accrual status at December 31, 2015.
During the year ended December 31, 2014, there were three loans modified as TDRs. The restructuring of a C&I loan included an extension of loan maturity date at an interest rate lower than the current rate for new debt with similar risk. This loan was on nonaccrual as of December 31, 2014. The restructuring of a Residential Real Estate – Owner Occupied loan valued at $376,742 included an extension of the interest only period for an additional 12 months to allow more manageable debt servicing by the borrower. This loan was on nonaccrual as of December 31, 2014. In November 2014, the Bank restructured a Residential Real Estate – Owner Occupied loan valued at $235,376 by extending the loan maturity date at an interest rate lower than the current rate for a new debt with similar risk. As of December 31, 2014, this loan was still accruing.
One of the loans modified as a TDR during the previous 12 months with a carrying value of $90,300 was in default of its modified terms at December 31, 2015. At December 31, 2015 and 2014, the Bank had $2,030,090 and $2,347,989 in loans identified as TDRs, respectively, of which $1,406,179 and $1,192,481 were on nonaccrual status, respectively.
NOTE 5 – ACCOUNTING FOR CERTAIN LOANS ACQUIRED IN A TRANSFER
Loans purchased with evidence of credit deterioration since origination and for which it is probable that all contractually required payments will not be collected are considered to be credit impaired. Evidence of credit quality deterioration as of the purchase date may include information such as past due and nonaccrual status, borrower credit scores and recent loan to value percentages. Purchased credit-impaired loans are initially measured at fair value, which considers estimated future loan losses expected to be incurred over the life of the loan. Accordingly, an allowance for loan losses related to these loans was not carried over and recorded at the acquisition date. The Company monitors actual loan cash flows to determine any improvement or deterioration from those forecasted as of the acquisition date.
The following table reflects the carrying amount of PCI loans, which are included in the loan categories in Note 4 – Loans and Allowances for Loan Losses:
| | | | | | | |
| | December 31, 2015 | | December 31, 2014 | |
Commercial & Industrial | | $ | 1,446,616 | | $ | 2,022,667 | |
Commercial Real Estate | | | 15,324,034 | | | 20,104,460 | |
Residential Real Estate | | | 9,184,082 | | | 12,017,432 | |
Home Equity Line of Credit | | | 717,712 | | | 711,238 | |
Land | | | 1,934,565 | | | 3,408,487 | |
Construction | | | — | | | 671,706 | |
Total Loans | | $ | 28,607,009 | | $ | 38,935,990 | |
The contractual amount outstanding for these loans totaled $33,895,849 and $47,678,935 as of December 31, 2015 and December 31, 2014, respectively.
The following table reflects activity in the accretable discount for these loans for the years ended December 31, 2015 and 2014:
| | | | | | |
| | 2015 | | 2014 |
Balance at beginning of period | | $ | 2,095,891 | | $ | 1,991,662 |
Acquired through Slavie Acquisition | | | — | | | 1,114,951 |
Reclassification from nonaccretable difference | | | 1,675,389 | | | 3,434,246 |
Accretion into interest income | | | (1,391,913) | | | (4,441,859) |
Disposals | | | (2,103,637) | | | (3,109) |
Balance at end of period | | $ | 275,730 | | $ | 2,095,891 |
The following table reflects activity in the allowance for these loans for the years ended December 31, 2015 and 2014:
| | | | | | |
| | 2015 | | 2014 |
Balance at beginning of period | | $ | — | | $ | — |
Charge-offs | | | (359,237) | | | (125,999) |
Recoveries | | | 45,689 | | | 30,307 |
Provision for loan losses | | | 313,548 | | | 95,692 |
Balance at end of period | | $ | — | | $ | — |
NOTE 6 – REAL ESTATE ACQUIRED THROUGH FORECLOSURE
The following table reflects activity in real estate acquired through foreclosure for the 12 months ended December 31, 2015 and 2014:
| | | | | | |
| | 2015 | | 2014 |
Balance at beginning of period | | $ | 1,480,472 | | $ | 1,290,120 |
New transfers from loans | | | 1,926,928 | | | 1,307,191 |
Sales | | | (1,676,984) | | | (704,496) |
Write-downs | | | (270,684) | | | (412,343) |
Balance at end of period | | $ | 1,459,732 | | $ | 1,480,472 |
NOTE 7 – PREMISES AND EQUIPMENT
The components of premises and equipment at December 31, 2015 and 2014 are as follows:
| | | | | | | | | | | |
| | | | | | | | Useful Life | |
| | 2015 | | 2014 | | (in years) | |
Land | | $ | 1,210,000 | | $ | 1,210,000 | | | | | |
Buildings and improvements | | | 1,152,885 | | | 1,129,500 | | 10 | — | 40 | |
Leasehold improvements | | | 2,541,136 | | | 2,492,543 | | 10 | — | 25 | |
Furniture, fixtures and equipment | | | 1,873,027 | | | 1,999,929 | | 3 | — | 10 | |
Software | | | 479,993 | | | 430,260 | | 3 | — | 10 | |
| | | 7,257,041 | | | 7,262,232 | | | | | |
Accumulated depreciation and amortization | | | (2,196,239) | | | (1,708,276) | | | | | |
Net premises and equipment | | $ | 5,060,802 | | $ | 5,553,957 | | | | | |
Depreciation and amortization expense for premises and equipment amounted to $732,618 and $880,644 for the years ended December 31, 2015 and 2014, respectively.
The Company leases five branches as well as its administrative, operations, and mortgage banking offices under noncancellable operating leases with initial terms varying from three to 10 years and providing for one or more renewal options. Three additional branch sites are subject to noncancellable ground leases with initial terms of 20 years and providing for four 5-year renewal options. The Company also owns three properties with a branch at each location.
Rent expense applicable to operating leases for the years ended December 31, 2015 and 2014 was $1,654,297 and $1,892,097, respectively.
At December 31, 2015, future minimum lease payments under non-cancelable operating leases having an initial term in excess of one year are as follows:
| | | | |
Periods ending December 31: | | Operating Leases | |
2016 | | $ | 1,278,829 | |
2017 | | | 1,024,855 | |
2018 | | | 997,511 | |
2019 | | | 773,366 | |
2020 | | | 590,920 | |
Thereafter | | | 3,369,740 | |
Total minimum lease payments | | $ | 8,035,221 | |
NOTE 8 – CORE DEPOSIT INTANGIBLE ASSETS
The Company's core deposit intangible assets at December 31, 2015 had a remaining weighted average amortization period of approximately 2.6 years. The following table presents the changes in the net book value of core deposit intangible assets for the years ended December 31, 2015 and 2014:
| | | | | | |
| | | | | | |
| | 2015 | | 2014 |
Balance at beginning of period | | $ | 3,478,282 | | $ | 3,993,679 |
Additions from the Carrollton Merger | | | — | | | — |
Additions from the Slavie Acquisition | | | — | | | 477,563 |
Amortization expense | | | (854,098) | | | (992,960) |
Balance, December 31, 2015 | | $ | 2,624,184 | | $ | 3,478,282 |
The following table presents the gross carrying amount, accumulated amortization, and net carrying amount of core deposit intangible assets as of December 31, 2015 and December 31, 2014:
| | | | | | | |
| | 2015 | | 2014 | |
Gross carrying amount | | $ | 5,578,211 | | $ | 5,578,211 | |
Accumulated amortization | | | (2,954,027) | | | (2,099,929) | |
Net carrying amount | | $ | 2,624,184 | | $ | 3,478,282 | |
The following table sets forth the future amortization expense for the Company’s core deposit intangible assets at December 31, 2015:
| | | | |
Periods ending December 31: | | Amount | |
2016 | | $ | 649,939 | |
2017 | | | 490,847 | |
2018 | | | 402,243 | |
2019 | | | 368,806 | |
2020 | | | 352,101 | |
Subsequent years | | | 360,248 | |
Total | | $ | 2,624,184 | |
NOTE 9 – DEPOSITS
The following table presents the composition of deposits at December 31, 2015 and 2014:
| | | | | | | |
| | 2015 | | 2014 | |
Noninterest-bearing deposits | | $ | 101,838,210 | | $ | 91,676,534 | |
Interest-bearing deposits: | | | | | | | |
Checking | | | 53,992,300 | | | 54,844,855 | |
Savings | | | 38,086,749 | | | 36,233,369 | |
Money market | | | 88,946,436 | | | 82,651,992 | |
Total interest-bearing checking, savings and money market deposits | | | 181,025,485 | | | 173,730,216 | |
Time deposits below $100,000 | | | 41,150,349 | | | 50,313,096 | |
Time deposits $100,000 or above | | | 43,401,894 | | | 72,110,286 | |
Total time deposits | | | 84,552,243 | | | 122,423,382 | |
Total interest-bearing deposits | | | 265,577,728 | | | 296,153,598 | |
Total Deposits | | $ | 367,415,938 | | $ | 387,830,132 | |
The following table sets forth the maturity distribution for the Company’s time deposits at December 31, 2015:
| | | | |
| | Amount | |
Maturing within one year | | $ | 45,067,147 | |
Maturing over one to two years | | | 14,122,712 | |
Maturing over two to three years | | | 5,814,058 | |
Maturing over three to four years | | | 15,917,507 | |
Maturing over four to five years | | | 3,599,248 | |
Maturing over five years | | | 31,571 | |
Total Time Deposits | | $ | 84,552,243 | |
Interest expense on deposits for the years ended December 31, 2015 and 2014 is as follows:
| | | | | | | |
| | 2015 | | 2014 | |
Interest-bearing checking | | | 49,992 | | | 51,315 | |
Savings | | | 44,605 | | | 80,629 | |
Money market | | | 263,822 | | | 305,217 | |
Total interest-bearing checking, savings and money market deposits | | | 358,419 | | | 437,161 | |
Time deposits below $100,000 | | | 571,126 | | | 251,359 | |
Time deposits $100,000 or above | | | 832,354 | | | 543,123 | |
Total time deposits | | | 1,403,480 | | | 794,482 | |
Total Interest Expense | | $ | 1,761,899 | | $ | 1,231,643 | |
The Company’s deposits include brokered deposits obtained through the Promontory Interfinancial Network, which consist of Certificate of Deposit Registry Service (“CDARS”) balances included in time deposits, and insured cash sweep service (“ICS”) balances included in money market deposits. At December 31, 2015, CDARS and ICS deposits were $0.6 million and $8.7 million, respectively. At December 31, 2014, CDARS and ICS deposits were $4.1 million and $4.8 million, respectively.
In April 2014, the Bank announced its exit from the Individual Retirement Account (“IRA”) product line. At the time, as a result of the announcement, the Bank stopped offering IRAs to new customers and resigned as custodian for its existing IRAs. IRA deposit balances of $24 million or 6% of total deposits were either transferred to new IRA custodians or disbursed to customers by May 23, 2014. The IRA exit increased second quarter other income $2.4 million, resulting from the recognition of the remaining interest rate mark-to-market adjustment on IRA deposits, that was recorded in connection with the Jefferson Merger (defined in Note 2).
The aggregate amount of time deposit accounts (including certificates of deposits) in denominations that meet or exceed the FDIC insurance limit of $250,000 totaled $6.5 million and $14.8 million at December 31, 2015 and 2014, respectively.
NOTE 10 – BORROWINGS
Borrowings at December 31, 2015 and 2014 consisted of the following:
| | | | |
| | December 31, 2015 | |
Federal Home Loan Bank Advances | | | | |
Due January, 2016, Fixed Rate 0.24% | | $ | 3,300,000 | |
Due January, 2016, Fixed Rate 0.40% | | | 5,000,000 | |
Due January, 2016, Fixed Rate 0.38% | | | 15,000,000 | |
Due January, 2016, Fixed Rate 0.35% | | | 5,100,000 | |
Due June, 2016, Fixed Rate 0.73% | | | 10,000,000 | |
Due December, 2016, Daily Rate 0.49% | | | 13,600,000 | |
Atlantic Central Bankers Bank Advances | | | | |
Due November, 2016, Fixed Rate 4.00% | | | 300,000 | |
Total | | $ | 52,300,000 | |
As of and for the Year Ended December 31, 2015 | | | | |
Weighted average interest rate at year end: | | | | |
Federal Home Loan Bank overnight advance | | | 0.490 | % |
Federal Home Loan Bank short term advances | | | 0.458 | % |
Atlantic Central Bankers Bank advances | | | 4.000 | % |
Maximum amount outstanding at month end during the year: | | | | |
Federal Home Loan Bank overnight advance | | $ | 15,100,000 | |
Federal Home Loan Bank short term advances | | $ | 38,400,000 | |
Atlantic Central Bankers Bank advances | | $ | 300,000 | |
Average amount outstanding during the year: | | | | |
Federal Home Loan Bank overnight advance | | $ | 7,766,849 | |
Federal Home Loan Bank short term advances | | $ | 15,581,644 | |
Atlantic Central Bankers Bank advances | | $ | 200,018 | |
Weighted average interest rate during the year: | | | | |
Federal Home Loan Bank overnight advance | | | 0.380 | % |
Federal Home Loan Bank short term advances | | | 0.228 | % |
Atlantic Central Bankers Bank advances | | | 4.425 | % |
| | | | |
| | | | |
| | December 31, 2014 | |
Federal Home Loan Bank Advances | | | | |
Due January, 2015, Fixed Rate 0.24% | | $ | 8,000,000 | |
Due December, 2015, Daily Rate 0.355% | | | 14,000,000 | |
Atlantic Central Bankers Bank Advances | | | | |
Due November, 2015, Fixed Rate 4.50% | | | 150,000 | |
Total | | $ | 22,150,000 | |
As of and for the Year Ended December 31, 2014 | | | | |
Weighted average interest rate at year end: | | | | |
Federal Home Loan Bank overnight advance | | | 0.355 | % |
Federal Home Loan Bank short term advances | | | 0.240 | % |
Atlantic Central Bankers Bank advances | | | 4.500 | % |
Maximum amount outstanding at month end during the year: | | | | |
Federal Home Loan Bank overnight advance | | $ | 20,000,000 | |
Federal Home Loan Bank short term advances | | $ | 8,000,000 | |
Atlantic Central Bankers Bank advances | | $ | 150,000 | |
Average amount outstanding during the year: | | | | |
Federal Home Loan Bank overnight advance | | $ | 6,605,393 | |
Federal Home Loan Bank short term advances | | $ | 2,646,988 | |
Atlantic Central Bankers Bank advances | | $ | 16,849 | |
Weighted average interest rate during the year: | | | | |
Federal Home Loan Bank overnight advance | | | 0.362 | % |
Federal Home Loan Bank short term advances | | | 0.194 | % |
Atlantic Central Bankers Bank advances | | | 2.893 | % |
Interest expense on FHLB advances and other borrowed funds for the years ended December 31, 2015 and 2014 were $72,380 and $25,556, respectively.
The Company had no long-term borrowings at December 31, 2015.
NOTE 11 – STOCK-BASED COMPENSATION
The Bay Bancorp, Inc. 2015 Equity Compensation Plan (the “2015 Plan”) was adopted by Bay Bancorp’s Board of Directors in March 2015 and the Annual Meeting of Stockholders in May 2015. The 2015 Plan is a broad-based plan that permits the grant of stock options, stock awards and other stock-based awards. The 2015 Plan is available to all employees of the Company and its subsidiaries, including employees who are officers or members of the Board, all non-employee directors of the Company, and consultants of the Company and its subsidiaries. The Board’s Compensation Committee administers the 2015 Plan.
The aggregate number of shares that may be issued or transferred under the 2015 Plan is 100,000. Also, the aggregate number of shares that may be issued or transferred pursuant to incentive options is 100,000. In any calendar year, a participant may not be awarded grants covering more than 20,000 Shares. The aggregate number of shares that may be issued or transferred to any participant in a calendar year pursuant to grants designated as qualified performance-based compensation is 20,000. There were no grants of shares authorized under the 2015 Plan at December 31, 2015.
The Jefferson Bancorp, Inc. 2010 Stock Option Plan (the “Jefferson Plan”) was approved by the Jefferson Board of Directors in September 2010 and received regulatory approvals in June 2011. The Jefferson Plan provides for the granting of incentive stock options intended to comply with the requirements of Section 422 of the Internal Revenue Code and non-qualified stock options (collectively “Awards”). Awards were available for grant to officers, employees and non-employee directors, independent consultants and contractors of Jefferson and its affiliates, including the Bank.
The Jefferson Plan authorized the issuance of up to 577,642 shares of common stock adjusted for the post-merger exchange ratio of 2.2217 and had a term of 10 years. In general, options granted under the Jefferson Plan have an exercise price equal to 100% of the fair market value of the common stock at the date of the grant and have a 10-year terms. Options relating to a total of 259,940 shares of common stock were outstanding as of December 31, 2015. As a result of the Jefferson Merger, the Jefferson Plan is now administered by Bay Bancorp, Inc.’s Board of Directors.
The Carrollton Bancorp 2007 Equity Plan (the “Equity Plan” and, together with the Jefferson Plan, the “Plans”) was approved at the 2007 annual meeting of stockholders of Bay Bancorp, Inc. Under the Equity Plan, 500,000 shares of common stock were reserved for issuance. Options relating to a total of 235,892 shares of common stock were outstanding as of December 31, 2015.
Stock Options
The following weighted average assumptions were used for options granted during the years ended December 31, 2015 and 2014:
| | | | | | |
| | 2015 | | 2014 |
Dividend yield | | — | % | | — | % |
Expected life | | 4 | years | | 6 | years |
Expected volatility | | 22.8 | % | | 27.2 | % |
Risk-free interest rate | | 1.44 | % | | 1.91 | % |
The dividend yield is based on estimated future dividend yields. The expected term of share options granted is generally derived from historical experience. Expected volatilities are generally based on historical volatilities. The risk-free rate for periods within the contractual term of the share option is based on the U.S. Treasury yield curve in effect at the time of the grant.
The following tables summarize changes in the Company's stock options outstanding for the year ended December 31, 2015 and 2014:
| | | | | | | | | | | |
| | | | Weighted | | | | | | |
| | | | Average | | Weighted Average | | Aggregate | |
| | Stock Options | | Exercise | | Remaining | | Intrinsic | |
| | Outstanding | | Price | | Contractual Life | | Value | |
Outstanding, January 1, 2015 | | 743,015 | | $ | 4.99 | | 6.85 | years | $ | — | |
Granted | | 30,000 | | | 5.26 | | | | | | |
Exercised | | (202,651) | | | 4.50 | | | | $ | 113,218 | |
Forfeited or expired | | (74,532) | | | 5.21 | | | | | | |
Outstanding, December 31, 2015 | | 495,832 | | $ | 5.17 | | 6.32 | years | $ | 146,453 | |
Exercisable, December 31, 2015 | | 407,686 | | $ | 5.17 | | 5.89 | years | $ | 145,313 | |
Weighted average fair value of options granted during the year | | | | $ | 1.08 | | | | | | |
| | | | | | | | | | | |
| | | | Weighted | | | | | | |
| | | | Average | | Weighted Average | | Aggregate | |
| | Stock Options | | Exercise | | Remaining | | Intrinsic | |
| | Outstanding | | Price | | Contractual Life | | Value | |
Outstanding, January 1, 2014 | | 608,905 | | $ | 5.23 | | 7.11 | years | $ | 175,426 | |
Granted | | 187,000 | | | 4.97 | | | | | — | |
Forfeited or expired | | (52,890) | | | 7.72 | | | | | (175,426) | |
Outstanding, December 31, 2014 | | 743,015 | | $ | 4.99 | | 6.85 | years | $ | — | |
Exercisable at December 31, 2014 | | 557,224 | | $ | 4.94 | | 6.43 | years | $ | — | |
Weighted average fair value of options granted during the year | | | | $ | 1.60 | | | | | | |
Stock-based compensation expense is recognized on a straight-line basis over the vesting period of the stock options and is recorded in noninterest expense. For the years ended December 31, 2015 and 2014, stock-based compensation expense applicable to the Plans was $63,932 and $415,560, respectively. Unrecognized stock-based compensation expense attributable to non-vested options was $118,272 at December 31, 2015. This amount is expected to be recognized over a remaining weighted average period of approximately 3.54 years.
The summary of the activity for the Company’s non-vested options for the years ended December 31, 2015 and 2014 is presented in the following table:
| | | | | | | | | | | |
| | 2015 | | 2014 | |
| | | | Weighted- | | | | Weighted- | |
| | | | Average Grant- | | | | Average Grant- | |
| | Shares | | Date Fair Value | | Shares | | Date Fair Value | |
Non-vested options at January 1, | | 145,791 | | $ | 2.05 | | 231,650 | | $ | 2.30 | |
Granted | | 30,000 | | | 1.08 | | 187,000 | | | 1.47 | |
Vested | | (69,707) | | | 1.41 | | (232,859) | | | 1.88 | |
Cancelled, forfeited or expired | | (17,939) | | | 1.85 | | (40,000) | | | 1.85 | |
Non-vested options at December 31, | | 88,145 | | $ | 1.73 | | 145,791 | | $ | 2.05 | |
Restricted Stock Awards
On June 26, 2013, the Company’s Board of Directors revised its director compensation policy to provide for an annual grant to each non-employee director of an award of shares of restricted common stock having a fair market value of $10,000 that will vest one year after the date of the grant. A total of 48,997 shares of restricted common stock have been granted through December 31, 2015, with 15,296 shares granted to the eight eligible directors on May 27, 2015. Total stock based compensation expense attributable to the shares of restricted common stock was $79,989 and $84,153 for the years ended December 31, 2015 and 2014, respectively. The total unrecognized compensation expense attributable to the shares of restricted common stock was $33,333 at December 31, 2015.
A summary of the activity for the Company’s non-vested restricted stock for the period indicated is presented in the following table:
| | | | | | | | | | | |
| | 2015 | | 2014 | |
| | | | Weighted- | | | | Weighted- | |
| | | | Average Fair | | | | Average Fair | |
| | Shares | | Value | | Shares | | Value | |
Non-vested restricted stock at January 1, | | 16,256 | | $ | 4.92 | | 15,488 | | $ | 5.17 | |
Granted | | 15,296 | | | 5.23 | | 16,256 | | | 4.92 | |
Vested | | (16,256) | | | 4.92 | | (15,488) | | | 5.17 | |
Non-vested restricted stock at December 31, | | 15,296 | | $ | 5.23 | | 16,256 | | $ | 4.92 | |
Other Stock Awards
There were no other stock awards for the 12 months ended December 31, 2015.
On July 29, 2014, the Company’s Board of Directors granted a one-time award of common stock to an employee director and certain non-employee directors, totaling 212,000 shares that vested immediately. Total stock based compensation expense attributable to the shares of unrestricted common stock was $1,007,000 for the 12 months ended December 31, 2014.
NOTE 12 – DEFINED BENEFIT PENSION PLAN
The Carrollton Bank Retirement Income Plan (the “Pension Plan”) provides defined benefits based on years of service and final average salary. Effective December 31, 2004, all benefit accruals for existing employees were frozen and no new employees were eligible for benefits under the Pension Plan.
Obligations and Funded Status
| | | | | | | |
| | 2015 | | 2014 | |
Change in Benefit Obligation | | | | | | | |
Benefit obligation at beginning of year | | $ | 9,470,210 | | $ | 9,897,739 | |
Service cost | | | 72,639 | | | 60,738 | |
Interest cost | | | 443,370 | | | 442,705 | |
Actuarial loss/(gain) | | | 1,106,605 | | | (421,439) | |
Disbursements made | | | (465,344) | | | (509,533) | |
Benefit obligation at end of year | | | 10,627,480 | | | 9,470,210 | |
Change in Plan Assets | | | | | | | |
Fair value of plan assets at beginning of year | | | 10,150,878 | | | 9,855,247 | |
Actual return on plan assets | | | (176) | | | 499,052 | |
Employer contribution | | | 112,885 | | | 306,112 | |
Disbursements made | | | (465,344) | | | (509,533) | |
Fair value of plan assets at end of year | | | 9,798,243 | | | 10,150,878 | |
Funded Status at End of Year | | $ | (829,237) | | $ | 680,668 | |
The accumulated benefit obligation was $10,627,480 and $9,470,210 at December 31, 2015 and 2014, respectively.
The amount recognized on the consolidated balance sheet as defined benefit pension liability and asset was ($829,237) and $680,668 at December 31, 2015 and 2014, respectively.
Amounts recognized in accumulated other comprehensive income (net of taxes at 39.445%) consist of the following:
| | | | | | | |
| | 2015 | | 2014 | |
Net loss/(gain) | | $ | 1,047,474 | | $ | (1,452,220) | |
Components of Net Periodic Pension Cost and Other Amounts Recognized in Other Comprehensive Income
| | | | | | | |
| | | | | | | |
Net Periodic Pension Benefit | | 2015 | | 2014 | |
Service cost | | $ | 72,639 | | $ | 60,738 | |
Interest cost | | | 443,370 | | | 442,705 | |
Expected return on plan assets | | | (629,783) | | | (598,359) | |
Amortization of net loss/(gain) | | | — | | | (78,828) | |
Net periodic pension benefit | | | (113,774) | | | (173,744) | |
| | | | | | | |
Other Changes in Plan Assets and Benefit Obligations | | | | | | | |
Net loss (gain) for the period | | | 1,729,790 | | | (243,303) | |
Amortization of prior service cost | | | — | | | — | |
Amortization of net transition liability | | | — | | | — | |
Amortization of net gain | | | — | | | — | |
Total recognized in other comprehensive income | | | 1,729,790 | | | (243,303) | |
Total recognized in net periodic pension cost and other comprehensive income | | $ | 1,616,016 | | $ | (417,047) | |
Additional Information
The weighted-average assumptions used in the actuarial computation of the Pension Plan’s benefit obligations were as follows:
| | | | | |
| | 2015 | | 2014 | |
Discount rates | | 4.14 | % | 3.77 | % |
Rates of compensation increase | | NA | | NA | |
Expected rate of return | | NA | | NA | |
The weighted-average assumptions used in the actuarial computation of the Pension Plan’s periodic cost were as follows:
| | | | | |
| | 2015 | | 2014 | |
Discount rates | | 3.77 | % | 4.72 | % |
Expected rate on plan assets | | 6.60 | % | 6.60 | % |
Rate of compensation increase | | NA | | NA | |
The target and actual allocations expressed as a percentage of the Pension Plan’s assets as of December 31, 2015 and 2014 were as follows:
| | | | | |
December 31, 2015 | | Target | | Actual | |
Equity Securities | | 40-65 | % | 62 | % |
Debt securities | | 35-60 | % | 38 | % |
Total | | 100 | % | 100 | % |
| | | | | |
December 31, 2014 | | | | | |
Equity Securities | | Target | | Actual | |
Fixed income-guaranteed fund | | 40-65 | % | 59 | % |
Total | | 35-60 | % | 41 | % |
| | 100 | % | 100 | % |
Estimated future benefit payments are as follows:
| | | | |
Periods ending December 31: | | Amount | |
2016 | | $ | 483,374 | |
2017 | | | 457,072 | |
2018 | | | 465,076 | |
2019 | | | 468,583 | |
2020 | | | 490,135 | |
2021-2025 | | | 2,739,509 | |
There is no required minimum amount of contribution to be made by the Company to the Pension Plan during 2016.
The Pension Plan’s investment strategy is predicated on its investment objectives and the risk and return expectations of asset classes appropriate for the Pension Plan. Investment objectives have been established by considering the Pension Plan’s liquidity needs and time horizon and the fiduciary standards under ERISA. The asset allocation strategy is developed to meet the Pension Plan’s long- term needs in a manner designed to control volatility and to reflect the Company’s risk tolerance.
Fair Value Measurement of Plan Assets
The following table summarizes the fair value of the Pension Plan’s investments at December 31, 2015 and 2014.
| | | | | | | | | | | | | |
| | | | | Quoted Prices in | | | | | | | |
| | | | | Active markets for | | Significant Other | | Significant Other | |
| | Total as of December 31, | | Identical Assets | | Observable Inputs | | Unobservable Inputs | |
Asset Category | | 2015 | | (Level 1) | | (Level 2) | | (Level 3) | |
Equity Securities – Pooled Separate Account: | | | | | | | | | | | | | |
Large-cap | | $ | 2,111,647 | | $ | — | | $ | 2,111,647 | | $ | — | |
Mixed-cap | | | 2,473,587 | | | — | | | 2,473,587 | | | | |
Small-cap | | | 816,159 | | | — | | | 816,159 | | | — | |
International | | | 638,434 | | | — | | | 638,434 | | | — | |
Guaranteed Deposit | | | 3,758,416 | | | — | | | 3,758,416 | | | — | |
Total | | $ | 9,798,243 | | $ | — | | $ | 9,798,243 | | $ | — | |
| | | | | | | | | | | | | |
| | | | | Quoted Prices in | | | | | | | |
| | | | | Active markets for | | Significant Other | | Significant Other | |
| | Total as of December 31, | | Identical Assets | | Observable Inputs | | Unobservable Inputs | |
Asset Category | | 2014 | | (Level 1) | | (Level 2) | | (Level 3) | |
Equity Securities - Pooled Separate Account: | | | | | | | | | | | | | |
Mixed-cap | | $ | 4,475,708 | | $ | — | | $ | 4,475,708 | | $ | — | |
Small-cap | | | 822,709 | | | — | | | 822,709 | | | — | |
International | | | 665,773 | | | — | | | 665,773 | | | — | |
Guaranteed Deposit | | | 4,186,688 | | | — | | | 4,186,688 | | | — | |
Total | | $ | 10,150,878 | | $ | — | | $ | 10,150,878 | | $ | — | |
401(k) Plan
The Company has a contributory thrift plan (“Thrift Plan”) qualifying under Section 401(k) of the Code, which allows employees to make contributions to the savings plan on a pretax basis. Employees with three months of service are eligible for participation in the Thrift Plan. The Company may match a percentage of the employee’s contributions, which is determined at the end of each year based on the Company’s profitability and is contributed in Company stock. The expense associated with this plan for 2015 and 2014 is $0. The 2016 match based on 2015 Company performance and employee contributions will be 50% of the employee’s 401(k) contribution up to 2% of the contributions beginning July 1, 2015.
NOTE 13 – INCOME TAXES
The components of income tax expense (benefit) are as follows for the years ended December 31, 2015 and 2014:
| | | | | | | |
| | 2015 | | 2014 | |
Current income tax (benefit) expense: | | | | | | | |
Federal | | $ | (72,963) | | $ | (3,066,917) | |
State | | | 7,334 | | | (651,942) | |
Total current tax benefit | | | (65,629) | | | (3,718,859) | |
| | | | | | | |
Deferred income tax expense: | | | | | | | |
Federal | | | 962,930 | | | 2,470,018 | |
State | | | 237,364 | | | 522,056 | |
Total deferred tax expense | | | 1,200,294 | | | 2,992,074 | |
| | | | | | | |
Total income tax expense (benefit) | | $ | 1,134,665 | | $ | (726,785) | |
The differences between the statutory federal income tax rate of 34% and the effective tax rate for the Company are reconciled as follows:
| | | | | | | | | | | |
| | Years Ended December 31, | |
| | 2015 | | 2014 | |
| | | | | Percentage of | | | | | Percentage of | |
| | Amount | | Pretax Income | | Amount | | Pretax Income | |
Income tax expense at federal statutory rate | | $ | 1,042,246 | | 34 | % | $ | 784,014 | | 34 | % |
Increase (decrease) resulting from: | | | | | | | | | | | |
Recognized Built-In Losses/Amended Returns | | | — | | — | % | | (1,768,601) | | (76.7) | % |
Tax exempt income | | | (17,104) | | (0.6) | % | | (20,258) | | (0.9) | % |
Bank owned life insurance | | | (42,831) | | (1.4) | % | | (43,793) | | (1.9) | % |
State income taxes, net of federal income tax benefit | | | 161,501 | | 5.3 | % | | 148,099 | | 6.4 | % |
Incentive stock options | | | (29,684) | | (1.0) | % | | 154,010 | | 6.7 | % |
Nondeductible expenses | | | 20,537 | | 0.7 | % | | 19,744 | | 0.9 | % |
Total income tax expense and effective tax rate | | $ | 1,134,665 | | 37.0 | % | $ | (726,785) | | (31.5) | % |
Deferred tax assets and liabilities resulting from the tax effects of temporary differences between the carrying amount of assets and liabilities for financial reporting purposes and the amounts used for income tax purposes at December 31, 2015 and 2014 are as follows:
| | | | | | | |
| | 2015 | | 2014 | |
Deferred Tax Assets | | | | | | | |
Bad Debts | | $ | 517,953 | | $ | 147,983 | |
Equity security impairment loss | | | 179,692 | | | 159,890 | |
Deferred compensation | | | 175,039 | | | 191,317 | |
Nonaccrual loan interest income | | | 203,520 | | | 244,180 | |
Stock based compensation plans | | | 122,342 | | | 110,632 | |
Accrued pension expense | | | 457,148 | | | 801,696 | |
Real estate acquired through foreclosure | | | 119,335 | | | 100,503 | |
Purchase accounting adjustment - loans | | | 1,048,480 | | | 1,858,465 | |
Purchase accounting adjustment - lease obligations | | | 276,876 | | | 282,022 | |
AMT credit carryforwards | | | 300,166 | | | 277,331 | |
NOL carryforwards | | | 1,087,179 | | | 2,029,613 | |
Other | | | — | | | 14,552 | |
Subtotal | | | 4,487,730 | | | 6,218,184 | |
Less: Valuation allowance | | | (76,289) | | | (38,346) | |
Total deferred tax assets | | | 4,411,441 | | | 6,179,838 | |
| | | | | | | |
Deferred Tax Liabilities: | | | | | | | |
Basis difference on securities acquired in merger | | | 167,539 | | | 273,148 | |
Core deposit intangible | | | 1,035,106 | | | 1,372,008 | |
Purchase accounting adjustment - other | | | 15,633 | | | 36,696 | |
Depreciation and amortization | | | 78,269 | | | 164,792 | |
Prepaid pension expense | | | — | | | — | |
Net unrealized gain on pension plan assets | | | 263,649 | | | 945,964 | |
Net unrealized gains on available for sale securities | | | 110,118 | | | 137,552 | |
Other | | | 17,570 | | | 35,578 | |
Total deferred tax liabilities | | | 1,687,884 | | | 2,965,738 | |
Net Deferred Tax Asset | | $ | 2,723,557 | | $ | 3,214,100 | |
Previously, the Company disclosed that it incurred an ownership change within the meaning of Section 382 of the Internal Revenue Code as a consequence of the Jefferson Merger. As a result, applicable federal and state tax law places an annual limitation of approximately $351,000 on the amount of certain losses that may be used, including built-in losses that existed at the date of the ownership change. Further, the Company disclosed that, during 2013, the Company recognized built-in losses that were also subject to the annual Section 382 limitation and that a portion of these losses would not be realizable due to the limitation. Therefore, no deferred tax assets were recorded for recognized built-in losses in excess of the amount that the Company had the ability to utilize in the future and a valuation allowance was established against a portion of the remaining deferred tax assets with a built-in loss limitations.
Upon completion of the Jefferson Merger-related income tax returns, it was determined that the Company was subject to the Section 382 limitation for net operating losses, but that the built-in losses were below the de minimis threshold established in Section 382 and therefore were not subject to the annual limitation. Accordingly, the benefit associated with previously unrecorded deferred tax assets was recognized during 2014 and the valuation allowance associated with deferred tax assets previously thought to be subject to the built-in loss limitation was released.
The 2014 effective tax rate of (31.5%) includes a benefit of $1.8 million that resulted from the recognition of the deferred tax assets discussed above.
The bargain purchase gain recognized in 2014 was the result of the Slavie Acquisition from the FDIC in a taxable transaction. Therefore, there was no impact from the transaction on the effective tax rate for 2014.
At December 31, 2015, the Company had federal net operating loss carryforwards of $3.6 million, which begin to expire in 2033. As a result of the Jefferson Merger, $1.6 million of these net operating losses are subject to an annual
limitation of $0.35 million. At December 31, 2015, the Company had state net operating loss carryforwards of $7.4 million, which begin to expire in 2033. A valuation allowance of approximately $76,000 has been established against the corresponding deferred tax assets and state net operating losses that are not deemed to be more likely than not to be realized.
Realization of deferred tax assets is dependent upon the generation of sufficient future taxable income during the periods in which existing deferred tax assets are expected to become deductible for income tax purposes. Management has determined that the Company is more likely than not to realize existing net deferred tax assets as of December 31, 2015, with the exception of the items noted above.
As of December 31, 2015 and 2014, the Company did not have any unrecognized tax benefits. A tax position is recognized as a benefit only if it is “more likely than not” that the tax position would be sustained in a tax examination, with a tax examination being presumed to occur. The amount recognized is the largest amount of tax benefit that is greater than 50% likely to be realized upon examination. For tax positions not meeting the “more likely than not” test, no tax benefit is recorded. The Company does not expect the total amount of unrecognized tax benefits to significantly increase or decrease in the next 12 months.
The Company and its subsidiaries are subject to U.S. federal income tax, as well as income tax by the State of Maryland. The Company is currently being audited by the Internal Revenue Service for the 2011 and 2013 tax years. The Company is no longer subject to examination by taxing authorities in these jurisdictions for the years before 2011.
NOTE 14 – OTHER COMPREHENSIVE INCOME
Comprehensive income is defined as net income plus transactions and other occurrences that are the result of non-owner changes in equity. For financial statements presented by the Company, non-equity changes are comprised of unrealized gains or losses on available for sale securities and any minimum pension liability adjustments. These items
do not have an impact on the Company’s net income. The following table presents the activity in net accumulated other comprehensive income for the periods indicated:
| | | | | | | | | | |
| | Unrealized Gains | | | | | | | |
| | (Losses) on Investments | | Defined Benefit Pension | | | | |
| | Available for Sale | | Plan | | Total | |
Balance at December 31, 2014 | | $ | 211,294 | | $ | 1,452,220 | | $ | 1,663,514 | |
Other comprehensive loss: | | | | | | | | | | |
Other comprehensive income (loss) before reclassification adjustments | | | 135,643 | | | (1,047,474) | | | (911,831) | |
Amounts reclassified from comprehensive loss | | | (178,123) | | | — | | | (178,123) | |
Other comprehensive loss | | | (42,480) | | | (1,047,474) | | | (1,089,954) | |
Balance at December 31, 2015 | | $ | 168,814 | | $ | 404,746 | | $ | 573,560 | |
| | | | | | | | | | |
| | Unrealized Gains | | | | | |
| | (Losses) on Investments | | Defined Benefit Pension | | | |
| | Available for Sale | | Plan | | Total | |
Balance at December 31, 2013 | | $ | (190,971) | | $ | 1,304,888 | | $ | 1,113,917 | |
Other comprehensive income | | | 402,265 | | | 147,332 | | | 549,597 | |
Balance December 31, 2014 | | $ | 211,294 | | $ | 1,452,220 | | $ | 1,663,514 | |
| | | | | | | | | | |
| | | | | | | | | | |
| | Before Tax Amount | | Tax (Expense) Benefit | | Net of Tax Amount | |
For the year ended December 31, 2015 | | | | | | | | | | |
Other comprehensive loss: | | | | | | | | | | |
Unrealized gain on AFS debt securities: | | | | | | | | | | |
Gross AFS securities gain | | $ | 219,996 | | $ | (84,353) | | $ | 135,643 | |
Reclassification adjustments | | | (289,913) | | | 111,790 | | | (178,123) | |
Net loss recognized in other comprehensive loss | | | (69,917) | | | 27,437 | | | (42,480) | |
Defined benefit pension plan adjustments: | | | | | | | | | | |
Net actuarial losses | | | (1,729,790) | | | 682,316 | | | (1,047,474) | |
Net loss recognized in other comprehensive loss | | | (1,729,790) | | | 682,316 | | | (1,047,474) | |
Other comprehensive loss | | $ | (1,799,707) | | $ | 709,753 | | $ | (1,089,954) | |
| | | | | | | | | | |
For the year ended December 31, 2014 | | | | | | | | | | |
Other comprehensive income: | | | | | | | | | | |
Unrealized gain on AFS debt securities | | | 664,241 | | $ | (261,976) | | $ | 402,265 | |
Unrealized gain on defined benefit pension plan | | | 243,303 | | | (95,971) | | | 147,332 | |
Other comprehensive income: | | $ | 907,544 | | $ | (357,947) | | $ | 549,597 | |
NOTE 15- NET INCOME PER COMMON SHARE
The calculation of net income per common share for the years ended December 31, 2015 and 2014 are as follows:
| | | | | | |
| | | | | | |
| | 2015 | | 2014 |
Basic earnings per share: | | | | | | |
Net income | | $ | 1,930,765 | | $ | 3,032,708 |
Weighted average shares outstanding | | | 11,040,159 | | | 10,370,795 |
Basic net income per share | | $ | 0.17 | | $ | 0.29 |
| | | | | | |
Diluted earnings per share: | | | | | | |
Net income | | $ | 1,930,765 | | $ | 3,032,708 |
Weighted average shares outstanding | | | 11,040,159 | | | 10,370,795 |
Dilutive potential shares | | | 137,974 | | | 194,541 |
Total diluted average shares outstanding | | | 11,178,133 | | | 10,565,336 |
Total diluted net income per share | | $ | 0.17 | | $ | 0.29 |
| | | | | | |
Anti-dilutive shares | | | 264,362 | | | 292,939 |
NOTE 16 – RELATED PARTY TRANSACTIONS
The Company’s executive officers and directors, or other entities to which they are related, enter into loan transactions with the Bank in the ordinary course of business. The terms of these transactions are similar to the terms provided to other borrowers entering into similar loan transactions and do not involve more than normal risk of collectability. Related party loan activity for the years ended December 31 was as follows:
| | | | | | | |
| | 2015 | | 2014 | |
Beginning Balance | | $ | 7,644,857 | | $ | 5,437,593 | |
Additions | | | 3,900,126 | | | 2,366,328 | |
Repayments | | | (1,868,093) | | | (159,064) | |
Ending Balance | | $ | 9,676,890 | | $ | 7,644,857 | |
The Bank routinely enters into deposit relationships with its directors, officers and employees in the normal course of business. These deposits bear the same terms and conditions of those prevailing at the time for comparable transactions with unrelated parties. Deposit balances of executive officers, directors and their related interests as of December 31, 2015 and 2014 were $6,238,805 and $7,044,100, respectively.
A principal for a commercial real estate services company, through which the Bank entered into a third-party lease agreement for the Lutherville headquarters offices and branch in 2010, became a director of the Company and the Bank on April 19, 2013. The Bank paid approximately $254,356 in 2015 and $340,552 in 2014 as lease payments for the office and branch facilities. In addition, the Bank paid approximately $25,167 and $0 to the real estate services company in 2015 and 2014, respectively, for several small leasehold improvement projects.
In August of 2013, the managing member of the ownership group that advises the then-majority owner of the Company entered into an agreement to sublease office space from the Company in the Bank’s Columbia operations center. The managing member paid $1,721 and $17,382 to the Company during 2015 and 2014, respectively.
Also in August of 2013, the managing member of the ownership group that advises the then-majority owner of the Company entered into a cost sharing agreement for services to be performed by one of the Bank’s employees. The managing member reimbursed the Bank for $14,103 and $37,380 of the pro-rata share of this employee’s salary and benefits costs in 2015 and 2014, respectively.
In July 2014, the Company entered into an agreement with its largest shareholder whereby the shareholder will provide management and advisory services to the Company and the Bank. The Bank paid $122,500 to the sharedholder owner during 2015 and $125,000 during 2014.
The Company believes these transactions are at terms comparable to those between unrelated parties.
NOTE 17 - COMMITMENTS AND CONTINGENT LIABILITIES
The Company is a party to financial instruments with off-balance sheet risk in the normal course of business. These financial instruments include loan commitments, unused lines of credit, standby letters of credit and mortgage loan repurchase obligations. The Company uses these financial instruments to meet the financing needs of its customers. 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 the accompanying consolidated financial statements.
Outstanding loan commitments and lines and letters of credit were as follows:
| | | | | | | |
| | December 31, 2015 | | December 31, 2014 | |
Loan commitments | | $ | 6,054,409 | | $ | 5,021,857 | |
Unused lines of credit | | | 78,100,042 | | | 64,761,646 | |
Standby letters of credit | | | 2,925,984 | | | 1,632,927 | |
Mortgage loan repurchase obligation | | | 2,790,836 | | | 10,110,416 | |
Loan commitments and unused lines of credit are agreements to lend to a customer as long as there is no violation of any condition established in the contract. The Company generally requires collateral to support financial instruments with credit risk on the same basis as it does for on-balance sheet instruments. The collateral requirement is based on management's credit evaluation of the counter party. Commitments generally have fixed expiration dates or other termination clauses and may require payment of a fee. Since many of the commitments are expected to expire without being drawn upon, the total commitment amount does not necessarily represent future cash requirements. Each customer's creditworthiness is evaluated on a case-by-case basis.
Standby letters of credit are conditional commitments issued to guarantee the performance of a customer to a third party. The credit risk involved in issuing letters of credit is essentially the same as that involved in extending loan facilities to customers.
In the ordinary course of business, the Company has various outstanding contingent liabilities that are not reflected in the accompanying consolidated financial statements. In the opinion of management, after consulting with legal counsel, the ultimate disposition of these matters is not expected to have a material adverse effect on the financial condition of the Company.
Mortgage Loan Repurchase Obligations: The Company originates and sells mortgage loans, primarily to other financial institutions, and provides various representations and warranties related to, among other things, the ownership of the loans, the validity of the liens, the loan selection and origination process, and the compliance to the origination criteria established by the purchasing institution. In the event of a breach of our representations and warranties, we may be obligated to repurchase the loans with identified defects or to indemnify the buyers. The Company’s contractual obligation arises only when the breach of representations and warranties are discovered and repurchase is demanded. The maximum potential future payment related to these guarantees is not readily determinable because the Company’s obligation under these agreements depends on the occurrence of future events. The loan balances subject to repurchase were $2.8 million and $10.1 million at December 31, 2015 and 2014, respectively. Management does not expect losses resulting from repurchase requests to be material to reported financial results.
NOTE 18 – FAIR VALUE
The Company uses fair value measurements to record fair value adjustments to certain assets and liabilities and to determine fair value disclosures. In accordance with FASB ASC Topic 820, Fair Value Measurements and Disclosures, the fair value of a financial instrument is the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. Fair value is best determined based upon quoted market prices. However, in many instances, there are no quoted market prices for the Company’s various financial instruments. In cases where quoted market prices are not available, fair values are based on estimates using present value or other valuation techniques. Those techniques are significantly affected by the assumptions used,
including the discount rate and estimates of future cash flows. Accordingly, the fair value estimates may not be realized in an immediate settlement of the instrument.
The fair value guidance provides a consistent definition of fair value, which focuses on exit price in an orderly transaction (that is, not a forced liquidation or distressed sale) between market participants at the measurement date under current market conditions. If there has been a significant decrease in the volume and level of activity for the asset or liability, a change in valuation technique or the use of multiple valuation techniques may be appropriate. In such instances, determining the price at which willing market participants would transact at the measurement date under current market conditions depends on the facts and circumstances and requires the use of significant judgment. The fair value is a reasonable point within the range that is most representative of fair value under current market conditions.
The Fair Value Hierarchy
In accordance with this guidance, the Company groups its financial assets and financial liabilities generally measured at fair value in three levels, based on the markets in which the assets and liabilities are traded and the reliability of the assumptions used to determine fair value.
Level 1 - Valuation is based on quoted prices in active markets for identical assets or liabilities that the reporting entity has the ability to access at the measurement date. Level 1 assets and liabilities generally include debt and equity securities that are traded in an active exchange market. Valuations are obtained from readily available pricing sources for market transactions involving identical assets and liabilities.
Level 2 - Valuation is based on inputs other than quoted prices included in Level 1 that are observable for the asset or liability, either directly or indirectly. The valuation may be based on quoted prices for similar assets and liabilities; quoted prices in markets that are not active; or other inputs that are observable or can be corroborated by observable market data for substantially the full term of the asset or liability.
Level 3 – Valuation is based on unobservable inputs that are supported by little or no market activity and that are significant to the fair value of the assets or liabilities. Level 3 assets and liabilities include financial instruments whose value is determined using pricing models, discounted cash flow methodologies, or similar techniques, as well as instruments for which determination of fair value requires significant management judgment or estimation.
A financial instrument’s categorization within the valuation hierarchy is based upon the lowest level of input that is significant to the fair value measurement.
In accordance with FASB’s guidance, impaired loans where an allowance is established based on the fair value of collateral and real estate acquired through foreclosure requires classification in the fair value hierarchy. When the fair value of the collateral is based on an observable market price or a current appraised value, the Company measures and records the loan or real estate acquired through foreclosure as nonrecurring Level 2. When an appraised value is not available or management determines the fair value of the collateral is further impaired below the appraised value and there is no observable market price, the Company measures and records the loan or real estate acquired through foreclosure as nonrecurring Level 3. The value of real estate collateral is determined based on appraisals by qualified licensed appraisers hired by the Company. Impaired loans and real estate acquired through foreclosure are reviewed and evaluated on at least a quarterly basis for additional impairment and adjusted accordingly, based on the same factors identified above.
Assets Recorded at Fair Value on a Recurring Basis
The following methods and assumptions were used by the Company to measure certain assets recorded at fair value on a recurring basis in the consolidated financial statements:
Investment Securities Available for Sale
The fair value of investment securities available for sale is the market value based on quoted market prices, when available (Level 1). If listed prices or quotes are not available, fair value is based upon quoted market prices for similar assets or, due to the limited market activity of the instrument, externally developed models that use significant observable inputs (Level 2) or externally developed models that use unobservable inputs due to limited or no market
activity of the instrument (Level 3). It includes model pricing, defined as valuing securities based upon their relationship with other benchmark securities and market information from third party sources. In the absence of current market activity, securities may be evaluated either by reference to similarly situated bonds or based on the liquidation value or restructuring value of the underlying assets. There was no change in valuation techniques used to measure fair value of securities available for sale for the period ended December 31, 2015.
The tables below present the recorded amount of assets measured at fair value on a recurring basis as of December 31, 2015 and 2014:
| | | | | | | | | | | | | |
| | | | | | Significant Other | | Significant Other | |
| | Carrying Value | | Quoted Prices | | Observable Inputs | | Unobservable | |
December 31, 2015 | | (Fair Value) | | (Level 1) | | (Level 2) | | Inputs (Level 3) | |
U.S. government agency | | $ | 3,810,639 | | $ | — | | $ | 3,810,639 | | $ | — | |
U.S. treasury securities | | | 5,872,140 | | | — | | | 5,872,140 | | | — | |
Residential mortgage-backed securities | | | 15,023,225 | | | — | | | 15,023,225 | | | — | |
State and municipal | | | 4,531,554 | | | — | | | 4,531,554 | | | — | |
Corporate obligations | | | 4,058,140 | | | — | | | 4,058,140 | | | — | |
Equity securities | | | 56,535 | | | 56,335 | | | — | | | — | |
| | $ | 33,352,233 | | $ | 56,335 | | $ | 33,295,698 | | $ | — | |
| | | | | | | | | | | | | |
| | | | | | Significant Other | | Significant Other | |
| | Carrying Value | | Quoted Prices | | Observable Inputs | | Unobservable | |
December 31, 2014 | | (Fair Value) | | (Level 1) | | (Level 2) | | Inputs (Level 3) | |
U.S. government agency | | $ | 7,778,271 | | $ | — | | $ | 7,778,271 | | $ | — | |
Residential mortgage-backed securities | | | 20,870,927 | | | — | | | 20,870,927 | | | — | |
State and municipal | | | 4,654,146 | | | — | | | 4,654,146 | | | — | |
Corporate obligations | | | 2,030,000 | | | — | | | 2,030,000 | | | — | |
Equity securities | | | 16,545 | | | 16,545 | | | — | | | — | |
| | $ | 35,349,889 | | $ | 16,545 | | $ | 35,333,344 | | $ | — | |
Assets Recorded at Fair Value on a Nonrecurring Basis
On a nonrecurring basis, the Company may be required to measure certain assets at fair value in accordance with generally accepted accounting principles. These adjustments to fair value usually result from application of lower of cost or fair value accounting or write-downs of individual assets due to impairment.
The following methods and assumptions were used by the Company to measure certain assets recorded at fair value on a nonrecurring basis in the consolidated financial statements:
Loans Held for Sale
Loans held for sale are recorded at the lower of cost or estimated market value on an aggregate basis. Market value is determined based on the price secondary markets are currently offering for similar loans using observable market data which is not materially different than cost due to the short duration between origination and sale. As such, the Company records any fair value adjustments on a nonrecurring basis. No nonrecurring fair value adjustments were recorded on loans held for sale during the years ended December 31, 2015 and 2014.
Impaired Loans
Loans for which it is probable that payment of principal and interest will not be made in accordance with the contractual terms of the loan are considered impaired. Once a loan is identified as individually impaired, management measures impairment in accordance with ASC Topic 310, using the present value of expected cash flows, the loan’s observable market price, or the fair value of collateral (less estimated selling costs) if the loan is collateral dependent. A specific allowance for loan loss is then established or a charge-off is recorded if the loan is collateral dependent and the loan is classified at a Level 3 in the fair value hierarchy. Appraised collateral values may be discounted based on management’s historical knowledge, changes in market conditions from the time of valuation, and/or management’s expertise and knowledge of the borrower’s business. Impaired loans are reviewed and evaluated on at least a quarterly
basis for additional impairment and adjusted accordingly, based on the factors identified above. Valuation techniques are consistent with those applied in prior periods.
Real Estate Acquired Through Foreclosure
Real estate acquired through foreclosure (“REO”) is adjusted to fair value upon transfer of the loan to REO and is classified at a Level 3 in the fair value hierarchy. Subsequently, the REO is carried at the lower of carrying value or fair value. The estimated fair value for REO included in Level 3 is determined by independent market based appraisals and other available market information, less estimated costs to sell, that may be reduced further based on market expectations or an executed sales agreement. If the fair value of REO deteriorates subsequent to the period of transfer, the REO is also classified at a Level 3 in the fair value hierarchy. Valuation techniques are consistent with those techniques applied in prior periods.
The tables below present the recorded assets measured at fair value on a nonrecurring basis as of December 31, 2015 and 2014:
| | | | | | | | | | | | | |
| | | | | | | | Significant Other | | Significant Other | |
| | Carrying Value | | Quoted Prices | | Observable Inputs | | Unobservable | |
December 31, 2015 | | (Fair Value) | | (Level 1) | | (Level 2) | | Inputs (Level 3) | |
Impaired loans | | $ | 477,967 | | $ | — | | $ | — | | $ | 477,967 | |
Real estate acquired through foreclosure | | | 976,689 | | | — | | | — | | | 976,689 | |
| | $ | 1,454,656 | | $ | — | | $ | — | | | 1,454,656 | |
| | | | | | | | | | | | | |
| | | | | | | | Significant Other | | Significant Other | |
| | Carrying Value | | Quoted Prices | | Observable Inputs | | Unobservable | |
December 31, 2014 | | (Fair Value) | | (Level 1) | | (Level 2) | | Inputs (Level 3) | |
Impaired loans | | $ | 374,459 | | $ | — | | $ | — | | $ | 374,459 | |
Real estate acquired through foreclosure | | | 983,276 | | | — | | | — | | | 983,276 | |
| | $ | 1,357,735 | | $ | — | | $ | — | | | 1,357,735 | |
| | | | | | | | | | | | |
| | | Quantitative Information about Level 3 Fair Value Measurements |
December 31, 2015: | | | Fair Value | | | Valuation Technique | | | Unobservable Input | | | Range |
Impaired loans | | $ | 477,967 | | | Appraisal of collateral (1) | | | Appraisal adjustments (2) | | | 0% - 10% |
| | | | | | | | | | | | |
Real estate acquired through foreclosure | | $ | 976,689 | | | Appraisal of collateral (1) | | | Appraisal adjustments (2) | | | 0% - 10% |
| | | | | | | | | Estimated selling cost (2) | | | 0% - 10% |
| | | | | | | | | | | | |
| | | Quantitative Information about Level 3 Fair Value Measurements |
December 31, 2014: | | | Fair Value | | | Valuation Technique | | | Unobservable Input | | | Range |
Impaired loans | | $ | 374,459 | | $ | Appraisal of collateral (1) | | | Appraisal adjustments (2) | | | 0% - 10% |
| | | | | | | | | | | | |
Real estate acquired through foreclosure | | $ | 983,276 | | | Appraisal of collateral (1) | | | Appraisal adjustments (2) | | | 0% - 10% |
| | | | | | | | | Estimated selling cost (2) | | | 0% - 10% |
| (1) | | Fair value is generally determined through independent appraisals of the underlying collateral, which generally include various level 3 inputs which are not observable. |
| (2) | | Appraisals may be adjusted by management for qualitative factors such as estimated selling cost. The range and weighted average of estimated selling cost and other appraisal adjustments are presented as a percent of the appraisal. |
Fair Value of Financial Instruments
The Company discloses fair value information about financial instruments, for which it is practicable to estimate the value, whether or not such financial instruments are recognized on the balance sheets. Fair value is the amount at which a financial instrument could be exchanged in a current transaction between willing parties, other than in a forced sale or liquidation, and is best evidenced by a quoted market price, if one exists.
Quoted market prices, where available, are shown as estimates of fair market values. Because no quoted market prices are available for a significant part of the Company's financial instruments, the fair values of such instruments have been derived based on the amount and timing of estimated future cash flows and using market discount rates.
Present value techniques used in estimating the fair value of many of the Company's financial instruments are significantly affected by the assumptions used. In that regard, the derived fair value estimates cannot be substantiated by comparison to independent markets and, in many cases, could not be realized in immediate cash settlement of the instrument. Additionally, the accompanying estimates of fair values are only representative of the fair values of the individual financial assets and liabilities and should not be considered an indication of the fair value of the Company.
The following disclosure of estimated fair values of the Company's financial instruments at December 31, 2015 and 2014 is made in accordance with the requirements of ASC Topic 820:
| | | | | | | | | | | | | | |
| | Level in Fair | | December 31, 2015 | | December 31, 2014 | |
| | Value | | Carrying | | Estimated fair | | Carrying | | Estimated fair | |
| | Hierarchy | | Amount | | value | | Amount | | value | |
Financial assets: | | | | | | | | | | | | | | |
Cash and cash equivalents | | Level 1 | | $ | 34,413,222 | | $ | 34,413,222 | | $ | 16,892,174 | | 16,892,174 | |
Investment securities available for sale (debt) | | Level 2 | | | 33,295,698 | | | 33,295,698 | | | 35,333,344 | | 35,333,344 | |
Investment securities available for sale (equity) | | Level 1 | | | 56,535 | | | 56,535 | | | 16,545 | | 16,545 | |
Investment securities held to maturity (debt) | | Level 2 | | | 1,573,165 | | | 1,596,262 | | | 1,315,718 | | 1,324,797 | |
Restricted equity securities | | Level 2 | | | 2,969,595 | | | 2,969,595 | | | 1,862,995 | | 1,862,995 | |
Loans held for sale | | Level 2 | | | 4,864,344 | | | 4,864,344 | | | 7,233,306 | | 7,233,306 | |
Loans, net of allowance | | Level 3 | | | 391,467,558 | | | 397,258,339 | | | 391,756,216 | | 401,651,659 | |
Accrued interest receivable | | Level 2 | | | 1,271,871 | | | 1,271,871 | | | 1,306,111 | | 1,306,111 | |
| | | | | | | | | | | | | | |
Financial liabilities: | | | | | | | | | | | | | | |
Deposits | | Level 3 | | | 367,415,938 | | | 367,398,372 | | | 387,830,132 | | 388,705,645 | |
Accrued interest payable | | Level 2 | | | 21,161 | | | 21,161 | | | 25,350 | | 25,350 | |
Borrowings | | Level 2 | | | 52,300,000 | | | 52,300,000 | | | 22,150,000 | | 22,150,000 | |
The following methods and assumptions were used to estimate the fair value of each category of financial instruments for which it is practicable to estimate that value:
Cash and due from banks, federal funds sold and overnight investments. The carrying amount approximated the fair value.
Investment securities (available for sale). See recurring fair value measurements above for methods.
Investment securities (held to maturity). The fair value of debt securities is based upon quoted prices for similar assets or externally developed models that use significant observable inputs.
Restricted equity securities. Since these stocks are restricted as to marketability, the carrying value approximated fair value.
Loans held for sale. The carrying amount approximated the fair value. Loans held for sale are recorded at the lower of cost or estimated market value on an aggregate basis. Market value is determined based on the price secondary markets are currently offering for similar loans using observable market data which is not materially different than cost due to the short duration between origination and sale.
Loans. The fair value of loans, except for PCI loans that are collateral-dependent, was estimated by computing the discounted value of estimated cash flows, adjusted for probable credit losses, for pools of loans having similar characteristics. The discount rate was based upon the current market rate for a similar loan. The fair value of PCI loans that are collateral-dependent was determined based on the estimated fair value of collateral less estimated costs to sell. Nonperforming loans have an assumed interest rate of 0%.
Accrued interest receivable and payable. The carrying amount approximated the fair value of accrued interest, considering the short-term nature of the instrument and its expected collection.
Deposit liabilities. The fair value of demand, money market savings and regular savings deposits, which have no stated maturity, were considered equal to their carrying amount, representing the amount payable on demand. The fair value of time deposits was based upon the discounted value of contractual cash flows at current rates for deposits of similar remaining maturity.
Short-term borrowings. The carrying amount of fixed rate FHLB advances and ACBB borrowings approximated fair value due to the short-term nature of the instrument. The carrying amount of variable rate FHLB advances and ACBB borrowings approximated the fair value.
Off-balance sheet instruments. The Company charges fees for commitments to extend credit. Interest rates on loans, for which these commitments are extended, are normally committed for periods of less than one month. Fees charged on standby letters of credit and other financial guarantees are deemed to be immaterial and these guarantees are expected to be settled at face amount or expire unused. It is impractical to assign any fair value to these commitments.
NOTE 19 – REGULATORY MATTERS
The Bank is subject to various regulatory capital requirements administered by federal banking agencies. Failure to meet minimum capital requirements can initiate certain mandatory and possibly additional discretionary actions by regulators that, if undertaken, could have a direct material effect on our financial statements. Under capital adequacy guidelines and the regulatory framework for prompt corrective action, the Bank must meet specific capital guidelines that involve quantitative measures of its assets, liabilities and certain off-balance sheet items as calculated under regulatory accounting practices. The capital amounts and classification are also subject to qualitative judgments by the regulators about components, risk weightings and other factors.
In July 2013, federal bank regulatory agencies issued final rules to revise their risk-based capital requirements and the method for calculating risk-weighted assets to make them consistent with agreements that were reached by the Basel Committee on Banking Supervision and certain provisions of the Dodd-Frank Act (“Basel III”). On January 1, 2015, the Basel III rules became effective and include transition provisions which implement certain portions of the rules through January 1, 2019. Under the final rules, the effects of certain accumulated other comprehensive items are not excluded; however, banking organizations like the Company and the Bank that are not considered “advanced approaches” banking organizations may make a one-time permanent election to continue to exclude these items. With the submission of the Call Report for the first quarter of 2015, the Company and the Bank made this election in order to avoid significant variations in the level of capital that can be caused by interest rate fluctuations on the fair value of the Bank’s available for sale securities portfolio and by fluctuations in the net periodic pension benefit/obligation attributable to the Bank’s defined benefit pension plan.
In addition, the OCC requires that FSBs, like the Bank, maintain a minimum level of Tier 1 capital to total assets excluding intangibles. This measure is known as the leverage ratio. The current regulatory minimum for the leverage ratio for institutions to be considered “adequately capitalized” is 4%, but an individual institution could be required to maintain a higher level. In connection with the Merger, the Bank entered into an Operating Agreement with the OCC (the “Operating Agreement”) pursuant to which the Bank agreed, among other things, to maintain a leverage ratio of 10% for the term of the Operating Agreement. The Operating Agreement will remain in effect until it is terminated by the OCC or the Bank ceases to be an FSB.
The following table summarizes capital ratios and related information in accordance with Basel III as measured at December 31, 2015 and pre-existing rules at December 31, 2014. For disclosure regarding changes resulting from Basel III see the Item 7 of Part I of this report under the heading, “CAPITAL RESOURCES”, Management’s Discussion and Analysis of Financial Condition and Results of Operations, Financial Condition, Capital Resources, Basel III. The Bank was classified in the well capitalized category at both December 31, 2015 and December 31, 2014 under the regulatory capital rules in effect at each date. Since December 31, 2015, no conditions or events have occurred, of which the Company is aware, that have resulted in a material change in the Bank's regulatory risk category other than as reported in this report.
Actual capital amounts and ratios for the Bank are presented on the following tables (dollars in thousands):
| | | | | | | | | | | | | | | | | | |
| | | | | | | | | | | | | | To Be Well | |
| | | | | | | | | | | | | | Capitalized Under | |
| | | | | | | | To Be Considered | | | Prompt Corrective | |
| | Actual | | | Adequately Capitalized | | | Action Provisions | |
| | Amount | | Ratio | | | Amount | | Ratio | | | Amount | | Ratio | |
As of December 31, 2015: | | | | | | | | | | | | | | | | | | |
| | | | | | | | | | | | | | | | | | |
Common Equity Tier 1 Capital | | $ | 65,465 | | 16.14 | % | | $ | 18,249 | | 4.50 | % | | $ | 26,360 | | 6.50 | % |
| | | | | | | | | | | | | | | | | | |
Tier I Risk-Based Capital Ratio | | $ | 65,465 | | 16.14 | % | | $ | 24,332 | | 6.00 | % | | $ | 32,443 | | 8.00 | % |
| | | | | | | | | | | | | | | | | | |
Total Risk-Based Capital Ratio | | $ | 67,238 | | 16.58 | % | | $ | 32,443 | | 8.00 | % | | $ | 40,553 | | 10.00 | % |
| | | | | | | | | | | | | | | | | | |
Tier 1 Leverage Ratio | | $ | 65,465 | | 13.75 | % | | $ | 19,041 | | 4.00 | % | | $ | 23,801 | | 5.00 | % |
| | | | | | | | | | | | | | | | | | |
As of December 31, 2014: | | | | | | | | | | | | | | | | | | |
| | | | | | | | | | | | | | | | | | |
Common Equity Tier 1 Capital | | | N/A | | N/A | | | | N/A | | N/A | | | | N/A | | N/A | |
| | | | | | | | | | | | | | | | | | |
Tier I Risk-Based Capital Ratio | | $ | 61,448 | | 16.31 | % | | $ | 15,066 | | 4.00 | % | | $ | 22,599 | | 6.00 | % |
| | | | | | | | | | | | | | | | | | |
Total Risk-Based Capital Ratio | | $ | 62,743 | | 16.66 | % | | $ | 30,132 | | 8.00 | % | | $ | 37,665 | | 10.00 | % |
| | | | | | | | | | | | | | | | | | |
Tier 1 Leverage Ratio | | $ | 61,448 | | 12.94 | % | | $ | 18,988 | | 4.00 | % | | $ | 23,735 | | 5.00 | % |
Banking regulations also limit the amount of dividends that may be paid without prior approval by an FSB's regulatory agencies. In addition to these regulations, the Bank agreed in the Operating Agreement that it would not declare or pay any dividends or otherwise reduce its capital unless it is in compliance with the Operating Agreement, including the minimum capital requirements. The Company and Bank have applied for regulatory approval to pay a one-time cash dividend related to the planned Merger with Hopkins. Due to the Bank’s desire to preserve capital to fund its growth, the Company currently does not anticipate paying dividends beyond the foregoing described need for the foreseeable future. In addition to these regulatory restrictions, it should be noted that the declaration of dividends is at the discretion of the Company’s Board of Directors and will depend, in part, on the Company’s earnings and future capital needs. Accordingly, there can be no assurance that dividends will be declared in any future period.
The Bank is required to maintain reserves against certain deposit liabilities which was satisfied with vault cash and balances on deposit with the Federal Reserve Bank of Richmond during the reserve maintenance periods that included December 31, 2015 and 2014.
Under current Federal Reserve regulations, the Bank is limited in the amount it may lend to the parent company and its nonbank subsidiaries. Loans to a single affiliate may not exceed 10%, and loans to all affiliates may not exceed 20% of the Bank’s capital stock, surplus, and undivided profits, plus the allowance for loan and lease losses. Loans from the Bank to nonbank affiliates, including the parent company, are also required to be collateralized according to regulatory guidelines. At December 31, 2015, there were no loans from the Bank to any nonbank affiliate, including the parent company.
NOTE 20– CONDENSED FINANCIAL STATEMENTS OF PARENT COMPANY
The condensed financial statements for Bay Bancorp, Inc. (Parent only) are presented below:
| | | | | | | |
| | December 31, | |
| | 2015 | | 2014 | |
ASSETS | | | | | | | |
Cash and cash equivalents | | $ | 90,914 | | $ | 108,712 | |
Investment securities available for sale, at fair value | | | 92,722 | | | 66,343 | |
Investment in subsidiary | | | 67,872,587 | | | 66,756,548 | |
Other assets | | | 28,631 | | | 38,954 | |
Total Assets | | $ | 68,084,854 | | $ | 66,970,557 | |
| | | | | | | |
LIABILITIES | | | | | | | |
Borrowings | | | 300,000 | | | 150,000 | |
Accrued expenses and other liabilities | | | 102,365 | | | 177,271 | |
Total Liabilities | | | 402,365 | | | 327,271 | |
| | | | | | | |
STOCKHOLDERS’ EQUITY | | | | | | | |
Common stock | | | 11,046,676 | | | 11,014,517 | |
Additional paid-in capital | | | 43,395,183 | | | 43,228,950 | |
Retained earnings | | | 12,667,070 | | | 10,736,305 | |
Accumulated other comprehensive income | | | 573,560 | | | 1,663,514 | |
Total Stockholders' Equity | | | 67,682,489 | | | 66,643,286 | |
Total Liabilities and Stockholders' Equity | | $ | 68,084,854 | | $ | 66,970,557 | |
| | | | | | | |
| | Years Ended December 31, | |
| | 2015 | | 2014 | |
Income: | | | | | | | |
Interest and dividends on deposits and investment securities | | $ | 188 | | $ | 366 | |
Other income | | | — | | | 2,832 | |
Total Income | | | 188 | | | 3,198 | |
| | | | | | | |
Expenses: | | | | | | | |
Interest on short-term borrowings | | | 7,255 | | | 488 | |
Other noninterest expenses | | | 208,267 | | | 236,818 | |
Total Expenses | | | 215,522 | | | 237,306 | |
| | | | | | | |
Loss before income taxes and equity in undistributed net income of subsidiary | | | (215,334) | | | (234,108) | |
Income tax benefit | | | (73,214) | | | (105,769) | |
Loss before equity in undistributed net income of subsidiary | | | (142,120) | | | (128,339) | |
Equity in undistributed net income of subsidiary | | | 2,072,885 | | | 3,161,047 | |
Net income | | $ | 1,930,765 | | $ | 3,032,708 | |
| | | | | | | |
| | Years Ended December 31, | |
| | 2015 | | 2014 | |
Cash flows from operating activities: | | | | | | | |
Net income | | $ | 1,930,765 | | $ | 3,032,708 | |
Adjustments to reconcile net income to net cash (used in) provided by operating activities: | | | | | | | |
Equity in undistributed net income of subsidiary | | | (2,072,885) | | | (3,161,047) | |
Net (increase) decrease in accrued interest receivable and other assets | | | (5,452) | | | 15,841 | |
Net (decrease) increase in intercompany accounts payable | | | (10,858) | | | 1,856 | |
Net decrease in accrued taxes | | | (73,215) | | | (105,770) | |
Net increase (decrease) in accrued expenses and other liabilities | | | 9,167 | | | (22,852) | |
Net cash used in operating activities | | | (222,478) | | | (239,264) | |
| | | | | | | |
Cash flows from investing activities: | | | | | | | |
Additional equity investment in subsidiary | | | — | | | (7,000,000) | |
Net cash used in investing activities | | | — | | | (7,000,000) | |
| | | | | | | |
Cash flows from financing activities: | | | | | | | |
Proceeds from issuance of common stock | | | — | | | 7,000,000 | |
Repurchase of common stock | | | (857,574) | | | — | |
Proceeds from issuance of common stock on stock option exercise | | | 912,254 | | | — | |
Proceeds from short term borrowings | | | 150,000 | | | 150,000 | |
Net cash provided by financing activities | | | 204,680 | | | 7,150,000 | |
| | | | | | | |
Net decrease in cash and cash equivalents | | | (17,798) | | | (89,264) | |
Cash and cash equivalents at beginning of period | | | 108,712 | | | 197,976 | |
Cash and cash equivalents at end of period | | $ | 90,914 | | $ | 108,712 | |
NOTE 21 – QUARTERLY FINANCIAL RESULTS (UNAUDITED)
| | | | | | | | | | | | | |
| | Year Ended December 31, 2015 | |
| | First Quarter | | Second Quarter | | Third Quarter | | Fourth Quarter | |
Interest income | | $ | 5,837,326 | | $ | 5,981,886 | | $ | 5,878,417 | | $ | 5,511,877 | |
Interest expense | | | 498,177 | | | 474,642 | | | 456,659 | | | 405,405 | |
Net interest income | | | 5,339,149 | | | 5,507,244 | | | 5,421,758 | | | 5,106,472 | |
Provision for loan losses | | | 275,109 | | | 296,700 | | | 306,387 | | | 264,326 | |
Net interest income after provision for loan losses | | | 5,064,040 | | | 5,210,544 | | | 5,115,371 | | | 4,842,146 | |
Noninterest income | | | 1,237,220 | | | 1,586,733 | | | 1,494,778 | | | 1,100,523 | |
Noninterest expenses | | | 5,699,884 | | | 5,931,998 | | | 5,755,755 | | | 5,198,288 | |
Income before income taxes | | | 601,376 | | | 865,279 | | | 854,394 | | | 744,381 | |
Income taxes | | | 258,123 | | | 319,364 | | | 324,977 | | | 232,201 | |
Net Income | | $ | 343,253 | | $ | 545,915 | | $ | 529,417 | | $ | 512,180 | |
| | | | | | | | | | | | | |
Net income per share-basic | | $ | 0.03 | | $ | 0.05 | | $ | 0.05 | | $ | 0.05 | |
Net income per share-diluted | | $ | 0.03 | | $ | 0.05 | | $ | 0.05 | | $ | 0.05 | |
| | | | | | | | | | | | | |
| | Year Ended December 31, 2014 | |
| | First Quarter | | Second Quarter | | Third Quarter | | Fourth Quarter | |
Interest income | | $ | 5,486,904 | | $ | 6,089,803 | | $ | 5,822,604 | | $ | 6,715,689 | |
Interest expense | | | 309,059 | | | 301,169 | | | 299,074 | | | 347,897 | |
Net interest income | | | 5,177,845 | | | 5,788,634 | | | 5,523,530 | | | 6,367,792 | |
Provision for loan losses | | | 219,165 | | | 140,679 | | | 220,373 | | | 221,471 | |
Net interest income after provision for loan losses | | | 4,958,680 | | | 5,647,955 | | | 5,303,157 | | | 6,146,321 | |
Bargain purchase gain | | | — | | | 524,432 | | | — | | | — | |
Other noninterest income | | | 1,253,372 | | | 3,740,534 | | | 1,127,392 | | | 1,118,497 | |
Total noninterest income | | | 1,253,372 | | | 4,264,966 | | | 1,127,392 | | | 1,118,497 | |
Noninterest expenses | | | 6,339,673 | | | 6,255,702 | | | 7,971,649 | | | 6,947,393 | |
(Loss) Income before income taxes | | | (127,621) | | | 3,657,219 | | | (1,541,100) | | | 317,425 | |
Income (benefit) taxes | | | (209,356) | | | 1,004,263 | | | (599,585) | | | (922,107) | |
Net Income (loss) | | $ | 81,735 | | $ | 2,652,956 | | $ | (941,515) | | $ | 1,239,532 | |
| | | | | | | | | | | | | |
Net income(loss) per share - basic | | $ | 0.01 | | $ | 0.26 | | $ | (0.09) | | $ | 0.12 | |
Net income(loss) per share - diluted | | $ | 0.01 | | $ | 0.25 | | $ | (0.09) | | $ | 0.12 | |
(1) The bargain purchase gain for the second quarter was retroactively restated downward for measurement period adjustments of $186,682 in the third quarter and adjusted upward for measurement period adjustments of $13,588 in the fourth quarter.
NOTE 22 – SUBSEQUENT EVENTS
On January 22, 2016, the Bank and Hopkins Bank filed an Interagency Bank Merger Act Application with the OCC to seek approval of the merger of Hopkins Bank with and into the Bank, with the Bank as the surviving federal savings bank.
On February 1, 2016, the Bay Bancorp, Inc., Hopkins, and Alvin M. Lapidus amended their previously-announced Agreement and Plan of Merger, dated as of December 18, 2015 (the “Parent Merger Agreement”), to increase, from $400,000 to $625,000, the aggregate amount of all bonuses that Hopkins and its affiliated companies may, subject to any required regulatory approval, pay to their directors and employees prior to the merger of Hopkins with and into Bay Bancorp, Inc.
On February 24, 2016, the Board of Directors of the Company approved a new stock purchase program that authorizes the Company to repurchase up to 250,000 shares of its common stock over a 12-month period commencing on February 24, 2016. The shares of common stock may be repurchased in open market transactions or privately negotiated transactions at times, in amounts and at prices to be determined in the discretion of the Company’s President and Chief Executive Officer, provided that the purchase price per share may not be less than the fair market value of a share of common stock as of the date of the purchase and provided further that each proposed repurchase must be consistent with applicable securities laws and regulations, including Rule 10b-18 promulgated under the Exchange Act and the Company’s blackout policy.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE
None.
ITEM 9A. CONTROLS AND PROCEDURES
The Company maintains disclosure controls and procedures that are designed to ensure that information required to be disclosed in the reports that the Company files under the Exchange Act with the SEC, such as this Annual Report on Form 10-K, is recorded, processed, summarized and reported within the time periods specified in those rules and forms, and that such information is accumulated and communicated to management, including the Company’s principal executive officer (“PEO”) and its principal accounting officer (“PAO”), as appropriate, to allow for timely
decisions regarding required disclosure. A control system, no matter how well conceived and operated, can provide only reasonable, not absolute, assurance that the objectives of the control system are met. Further, the design of a control system must reflect the fact that there are resource constraints, and the benefits of controls must be considered relative to their costs. These inherent limitations include the realities that judgments in decision-making can be faulty, and that breakdowns can occur because of simple error or mistake. Additionally, controls can be circumvented by the individual acts of some persons, by collusion of two or more people, or by management override of the control. The design of any system of controls also is based in part upon certain assumptions about the likelihood of future events, and there can be no assurance that any design will succeed in achieving its stated goals under all potential future conditions; over time, a control may become inadequate because of changes in conditions, or the degree of compliance with the policies or procedures may deteriorate.
An evaluation of the effectiveness of these disclosure controls as of December 31, 2015 was carried out under the supervision and with the participation of management, including the PEO and the PAO. Based on that evaluation, management, including the PEO and the PAO, has concluded that the Company’s disclosure controls and procedures are, in fact, effective at the reasonable assurance level.
During the quarter ended December 31, 2015, there were no changes in the Company’s internal controls over financial reporting that materially affected, or are reasonably likely to materially affect, the Company’s internal controls over financial reporting.
As required by Section 404 of the Sarbanes-Oxley Act, management has performed an evaluation and testing of the Company’s internal control over financial reporting as of December 31, 2015. Management’s report on the Company’s internal control over financial reporting appears on the following page. The Company is a “smaller reporting company” as defined by Rule 12b-2 under the Exchange Act and, accordingly, its independent registered public accounting firm is not required to attest to the foregoing management report.
Management’s Report on Internal Control Over Financial Reporting
The Board of Directors and Stockholders
Bay Bancorp, Inc.
Bay Bancorp, Inc.’s management is responsible for establishing and maintaining adequate internal control over financial reporting. This internal control system was designed to provide reasonable assurance to management and the Board of Directors as to the reliability of Bay Bancorp, Inc.’s financial reporting and the preparation and presentation of financial statements for external purposes in accordance with accounting principles generally accepted in the United States, as well as to safeguard assets from unauthorized use or disposition.
An internal control system, no matter how well designed, has inherent limitations. Therefore, even those systems determined to be effective can provide only reasonable assurance with respect to financial statement preparation and presentation and may not prevent or detect misstatements in the financial statements or the unauthorized use or disposition of Bay Bancorp’s assets. Also, projections of any evaluation of effectiveness of internal controls to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with policies and procedures may deteriorate.
Management assessed the effectiveness of Bay Bancorp’s internal control over financial reporting as of December 31, 2015, based on the criteria set forth by the Committee of Sponsoring Organizations of the Treadway Commission (COSO) in Internal Control-Integrated Framework (1992 Framework). Based on this assessment and on the foregoing criteria, management has concluded that, as of December 31, 2015, Bay Bancorp, Inc.’s internal control over financial reporting is effective.
| | | |
Dated: March 30, 2016 | | | |
| | | |
/s/Joseph J. Thomas | | /s/Larry D. Pickett | |
Joseph J. Thomas | | Larry D. Pickett | |
President and Chief Executive Officer | | Executive Vice President - Chief Financial Officer | |
(Principal Executive Officer) | | (Principal Accounting Officer) | |
ITEM 9B. OTHER INFORMATION
None.
PART III
ITEM 10. DIRECTORS, EXECUTIVE OFFICERS AND CORPORATE GOVERANCE
The Company has adopted a code of ethics that applies to all its directors and officers, and a copy of the code of ethics will be provided to any person, without charge, upon written request to Bay Bancorp, Inc., Attention: Corporate Secretary, 7151 Columbia Gateway Drive, Suite A, Columbia, Maryland 21046. There have been no material changes in the procedures previously disclosed by which stockholders may recommend nominees to Bay’s Board of Directors.
All other information required by this Item is incorporated herein by reference to the sections of Bay Bancorp Inc.’s definitive Proxy Statement for the 2016 Annual Meeting of Stockholders to be filed with the SEC pursuant to Regulation 14A (the “Proxy Statement”) entitled “Information Regarding Directors and Director Nominees”, “Executive Officers and Significant Employees”, “Section 16(a) Beneficial Ownership Reporting Compliance”, and “Corporate Governance” (under the heading, “Audit Committee”).
ITEM 11. EXECUTIVE COMPENSATION
The information required by this Item is incorporated herein by reference to the sections of the Proxy Statement entitled “Director Compensation” and “Executive Compensation”.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS
The Bay Bancorp, Inc. 2015 Equity Compensation Plan (the “2015 Plan”) was adopted by Bay Bancorp’s Board of Directors in March 2015 and the Annual Meeting of Stockholders in May 2015. The 2015 Plan is a broad-based plan that permits the grant of stock options, stock awards and other stock-based awards. The 2015 Plan is available to all employees of the Company and its subsidiaries, including employees who are officers or members of the Board, all non-employee directors of the Company, and consultants of the Company and its subsidiaries. The Board’s Compensation Committee will administer the 2015 Plan.
The aggregate number of shares that may be issued or transferred under the 2015 Plan is 100,000. Also, the aggregate number of shares that may be issued or transferred pursuant to incentive options is 100,000. In any calendar year, a participant may not be awarded grants covering more than 20,000 Shares. The aggregate number of shares that may be issued or transferred to any participant in a calendar year pursuant to grants designated as qualified performance-based compensation is 20,000. There were no grants of shares authorized under the 2015 Plan at December 31, 2015.
At the 2007 Annual Meeting of Stockholders, the Company’s stockholders approved the Carrollton Bancorp 2007 Equity Plan (the “Equity Plan”), which authorizes the grant of stock options, stock appreciation rights, restricted stock, restricted performance stock, unrestricted stock, and performance units. In connection with the Merger, all stock options that were outstanding under Jefferson’s 2010 Stock Option Plan (the “Jefferson Plan”) at the effective time of the Merger were assumed by the Company and converted into options to purchase shares of the Company’s common stock. The converted options have all of the same terms and conditions of such options immediately prior to the Merger (including vesting restrictions), except that (i) the number of shares of the Company’s common stock subject to each option was adjusted so that it is equal to the product of the number of shares of Jefferson’s common stock subject to the original option and the exchange ratio for the Merger (fractional shares resulting from such adjustment were rounded down to the nearest whole share) and (ii) the exercise price per share of each option was adjusted so that it is equal to the exercise price per share of Jefferson’s common stock under the original option divided by the exchange ratio for the Merger (rounded up to the nearest whole cent). No additional grants will be made under the Jefferson Plan. The following table contains information about the Equity Plan as of December 31, 2015:
| | | | | | | | |
| | | | | | Number of securities | |
| | Number of securities to be | | Weighted‑average | remaining available for future | |
| | issued upon exercise of | | exercise price of | | issuance under equity | |
| | outstanding options, | | outstanding options, | | compensation plans | |
| | warrants, and rights | | warrants, and rights | | (excluding securities reflected in column) | |
Plan Category | | (a) | | (b) | | (a) | |
Equity compensation plans approved by security holders | | 495,832 | | $ | 5.17 | | 138,111 | |
Equity compensation plans not approved by security holders | | — | | | — | | — | |
Total | | 495,832 | | $ | 5.17 | | 138,111 | |
| (1) | | In addition to stock options and stock appreciation rights, the Equity Plan permits the grant of stock awards of various types and performance units. As of December 31, 2015, restricted stock awards relating to 15,296 shares were outstanding that are not included in the number shown in column (a) Shares of common stock subject to restricted stock or unrestricted stock awards may not exceed 50% of the total number of shares available under the Equity Plan. Subject to the anti-dilution provisions of the Equity Plan, (i) the maximum number of shares of common stock for which stock options and stock appreciation rights may be granted to any participant in any fiscal year shall not exceed 500,000 shares, and (ii) the maximum aggregate dollar amount of, and the maximum number of shares of common stock subject to, restricted stock and performance unit awards to any employee with respect to a restriction period or performance period may not exceed $500,000 and 500,000 shares, respectively. |
All other information required by this Item is incorporated herein by reference to the sections of the Proxy Statement entitled “Security Ownership of Management and Certain Security Holders” and “Change in Control”.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS, AND DIRECTOR INDEPENDENCE
The information required by this Item is incorporated herein by reference to the sections of the Proxy Statement entitled “Certain Relationships and Related Transactions” and “Corporate Governance” (under the heading, “Director Independence”).
ITEM 14. PRINCIPAL ACCOUNTANT FEES AND SERVICES
The information required by this Item is incorporated herein by reference to the section of the Proxy Statement entitled “Audit Fees and Services”.
PART IV
ITEM 15. EXHIBITS AND FINANCIAL STATEMENT SCHEDULES
The following financial statements are included in this report:
All financial statement schedules have been omitted as the required information is either inapplicable or included in the consolidated financial statements or related notes.
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.
| | | | Bay Bancorp, Inc. |
| | | | |
Date: March 30, 2016 | | By: | | /s/ Joseph J. Thomas |
| | | | Joseph J. Thomas |
| | | | President and Chief Executive Officer |
| | | | (Principal Executive Officer) |
Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities and dates indicated.
| | | | |
Name | | Capacities | | Date |
| | | | |
/s/ Joseph J. Thomas | | President and Chief Executive Officer | | March 30, 2016 |
Joseph J. Thomas | | (Principal Executive Officer) | | |
| | | | |
/s/ Larry D. Pickett | | Executive Vice President - Chief Financial Officer | | March 30, 2016 |
Larry D. Pickett | | (Principal Accounting Officer) | | |
| | | | |
/s/ Robert J. Aumiller | | Director | | March 30, 2016 |
Robert J. Aumiller | | | | |
| | | | |
/s/ Steven K. Breeden | | Director | | March 30, 2016 |
Steven K. Breeden | | | | |
| | | | |
/s/ Pierre Abushacra | | Director | | March 30, 2016 |
Pierre Abushacra | | | | |
| | | | |
/s/ Mark M. Caplan | | Director | | March 30, 2016 |
Mark M. Caplan | | | | |
| | | | |
/s/ Michael J. Chiaramonte | | Director | | March 30, 2016 |
Michael J. Chiaramonte | | | | |
| | | | |
/s/ Howard I. Hackerman | | Director | | March 30, 2016 |
Howard I. Hackerman | | | | |
| | | | |
/s/ Eric D. Hovde | | Director | | March 30, 2016 |
Eric D. Hovde | | | | |
| | | | |
/s/ Charles L. Maskell | | Director | | March 30, 2016 |
Charles L. Maskell | | | | |
EXHIBIT INDEX
| | | |
Exhibit No. | | Description | |
| | | |
2.1 | | Purchase and Assumption Agreement, All Deposits, dated as of May 30, 2014, by and between Bay Bank, F.S.B. and the Federal Deposit Insurance Corporation (incorporated by reference to Exhibit 2.1 to the Registrant’s Current Report on Form 8-K, filed on June 5, 2014) | |
| | | |
2.2 | | Agreement and Plan of Merger, dated as of December 18, 2015, among Bay Bancorp, Inc., Hopkins Bancorp, Inc. and Alvin M. Lapidus (incorporated by reference to Exhibit 2.1 to the Registrant’s Current Report on Form 8-K filed on December 21, 2015) | |
| | | |
2.3 | | First Amendment to Agreement and Plan of Merger, dated as of February 1, 2016, among Bay Bancorp, Inc., Hopkins Bancorp, Inc. and Alvin M. Lapidus (incorporated by reference to Exhibit 2.1 to the Registrant’s Current Report on Form 8-K filed on February 5, 2016) | |
| | | |
3.1 | | Articles of Amendment and Restatement filed with SDAT on April 19, 2013 (incorporated by reference to Exhibit 3.1 to the Registrant’s Current Report on Form 8-K filed on April 25, 2013) | |
| | | |
3.2 | | Certificate of Correction filed with SDAT on June 5, 2014 (incorporated by reference to Exhibit 4.2 to the Registrant’s Registration Statement on Form S-3 filed on June 6, 2014) | |
| | | |
3.3 | | Articles of Amendment filed with SDAT on September 3, 2013 (incorporated by reference to Exhibit 3.2 to the Registrant’s Current Report on Form 8-K filed on November 1, 2013) | |
| | | |
3.4 | | Articles of Amendment filed with SDAT on October 29, 2013 (incorporated by reference to Exhibit 3.1 to the Registrant’s Current Report on Form 8-K filed on November 1, 2013) | |
| | | |
3.5 | | Articles Supplementary filed with SDAT on February 11, 2009 (incorporated by reference to Exhibit 4.1 to the Registrant’s Current Report on Form 8-K filed on February 17, 2009) | |
| | | |
3.6 | | Amended and Restated Bylaws (incorporated by reference to Exhibit 3.3 to the Registrant’s Current Report on Form 8-K filed on November 1, 2013) | |
| | | |
10.1 | | Registration Rights Agreement, dated as of April 19, 2013, by and between Carrollton Bancorp and Financial Services Partners Fund I, LLC (incorporated by reference to Exhibit 4.1 to the Registrant’s Current Report on Form 8-K filed on April 25, 2013) | |
| | | |
10.2 | | Securities Purchase Agreement, dated as of May 15, 2014, by and between Bay Bancorp, Inc. and each of the investors named therein (incorporated by reference to Exhibit 10.2 to the Registrant’s Quarterly Report on Form 10-Q filed on August 14, 2014) | |
| | | |
10.3 | | Registration Rights Agreement, dated as of May 15, 2014, by and between Bay Bancorp, Inc. and each of the holders named therein (incorporated by reference to Exhibit 10.3 to the Registrant’s Quarterly Report on Form 10-Q filed on August 14, 2014) | |
| | | |
10.4 | | Letter Agreement, dated as of July 29, 2014, by and between Bay Bancorp, Inc. and Joseph J. Thomas (incorporated by reference to Exhibit 10.3 to the Registrant’s Current Report on Form 8-K filed on August 5, 2014) | |
| | | |
10.5 | | Employment Agreement, dated February 26, 2014, by and between Kevin B. Cashen and Bay Bank, F.S.B. (incorporated by reference to Exhibit 10.1 to the Registrant’s Amendment No. 1 on Form 10-Q/A filed on November 26, 2014) | |
| | | |
10.6 | | Separation Agreement by and among Kevin B. Cashen, Bay Bank, F.S.B and Bay Bancorp, Inc. (incorporated by reference to Exhibit 10.1 to the Registrant’s Current Report on Form 8-K filed on December 5, 2014) | |
| | | |
10.7 | | Form of First Amendment to Stock Option Agreement between Bay Bancorp, Inc. and Kevin B. Cashen (incorporated by reference to Exhibit 10.2 to the Registrant’s Current Report on Form 8-K filed on December 5, 2014) | |
| | | |
10.8 | | Employment Agreement, dated as of January 2, 2014, by and between Bay Bank, F.S.B. and Larry D. Pickett (incorporated by reference to Exhibit 10.9 to the Registrant’s Quarterly Report on Form 10-Q filed on May 15, 2014) | |
| | | |
10.9 | | Employment Agreement, dated as of April 13, 2014, by and between H. King Corbett and Bay Bank, F.S.B. (incorporated by reference to Exhibit 10.1 to the Registrant’s Quarterly Report on Form 10-Q filed on August 14, 2014) | |
| | | |
10.10 | | Employment Agreement, dated as of November 23, 2013, by and between Bay Bank, F.S.B. and Gary M. Jewell (incorporated by reference to Exhibit 10.8 to the Registrant’s Quarterly Report on Form 10-Q filed on March 31, 2014) | |
| | | |
10.11 | | Carrollton Bancorp 1998 Long-Term Incentive Plan (incorporated by reference to Appendix A to the Registrant’s definitive proxy statement on Schedule 14A filed on March 16, 1998) | |
| | | |
10.12 | | Carrollton Bancorp 2007 Equity Plan (incorporated by reference to Appendix A to the Registrant’s definitive proxy statement on Schedule 14A filed on April 5, 2007) | |
| | | |
10.13 | | Form of Restricted Stock Award Agreement under the Carrollton Bancorp 2007 Equity Plan (incorporated by reference to Exhibit 10.1 to the Registrant’s Current Report on Form 8-K filed on July 1, 2013) | |
| | | |
10.14 | | Form of Incentive Stock Option Agreement under the Carrollton Bancorp 2007 Equity Plan (incorporated by reference to Exhibit 10.2 to the Registrant’s Current Report on Form 8-K filed on November 1, 2013) | |
| | | |
10.15 | | Jefferson Bancorp, Inc. 2010 Stock Option Plan (incorporated by reference to Exhibit 10.5 to the Registrant’s Current Report on Form 8-K filed on April 25, 2013) | |
| | | |
10.16 | | Form of Stock Option Agreement under the Jefferson Bancorp, Inc. 2010 Stock Option Plan (incorporated by reference to Exhibit 10.6 to the Registrant’s Current Report on Form 8-K filed on April 25, 2013) | |
| | | |
21 | | Subsidiary (filed herewith) | |
| | | |
23.1 | | Consent of Dixon Hughes Goodman, LLP (filed herewith) | |
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23.2 | | Consent of RSM US, LLP (filed herewith) | |
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31.1 | | Rule 13a-14(a) Certification by the Principal Executive Officer (filed herewith) | |
| | | |
31.2 | | Rule 13a-14(a) Certification by the Principal Accounting Officer (filed herewith) | |
| | | |
32.1 | | Certification by the Principal Executive Officer of the periodic financial reports, required by Section 906 of the Sarbanes-Oxley Act of 2002 (furnished herewith) | |
| | | |
32.2 | | Certification by the Principal Accounting Officer of the periodic financial reports, required by Section 906 of the Sarbanes-Oxley Act of 2002 (furnished herewith) | |
| | | |
101 | | Interactive Data Files pursuant to Rule 405 of Regulation S-T (filed herewith) | |
