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, 2017
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, a smaller reporting company or an emerging growth company. (See definition of “large accelerated filer”, “accelerated filer”, “smaller reporting company” and “emerging growth company” in Rule 12b-2 of the Exchange Act).
(Check one):Large accelerated filer ☐Accelerated filer ☐Non-accelerated filer ☐ (Do not check if a smaller reporting company)Smaller reporting company ☑Emerging growth company ☐
If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. ☐
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 $53,625,336, computed by reference to the closing sales price of such equity at the last business day of the registrant’s most recently completed second fiscal quarter (June 30, 2017). For the purposes of this calculation, directors, executive officers, and the controlling investor are considered affiliates.
At March 26, 2018, the number of shares outstanding of the registrant’s common stock was 10,717,889.
DOCUMENTS INCORPORATED BY REFERENCE
None.
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. Further, factors or events that could cause our actual results to differ from our forward-looking statements may emerge from time to time, and it is not possible for us to predict all of them. 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. Factors that might cause such differences include, but are not limited to:
| · | | 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 detail in the periodic reports that Bay Bancorp, Inc. files with the Securities and Exchange Commission (the “SEC”), 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 (see Part 1, Item 1A of this report for further information). The risks discussed 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
RECENT DEVELOPMENTS
On September 27, 2018, the Company and Old Line Bancshares, Inc. (“Old Line Bancshares”), the parent company of Old Line Bank, a Maryland trust company, entered into an Agreement and Plan of Merger (the “Merger Agreement”), pursuant to which the Company will be merged with and into Old Line Bancshares, with Old Line Bancshares as the surviving corporation (the “Merger”). The Merger Agreement, which has been approved by the boards of directors of both companies, provides that each outstanding share of the Company’s common stock will be converted into the right to receive a number of shares of common stock of Old Line, with the exact exchange ratio to be determined prior to closing. Immediately following the Merger, the Company’s federal savings bank (“FSB”) subsidiary, Bay Bank, FSB (the “Bank”), will be merged with and into Old Line Bank, with Old Line bank as the surviving depository institution (the “Bank Merger”).
Consummation of the Merger is subject to certain conditions, including, among others, the approval of the Merger by the stockholders of Old Line Bancshares and the Company and the receipt of required regulatory approvals. The stockholders of the Company and of Old Line Bancshares approved the Merger at special meetings thereof held on March 28, 2018. The Board of Governors of the Federal Reserve System (the “Federal Reserve”) approved the Merger and related transactions on March 2, 2018, the Federal Deposit Insurance Corporation (the “FDIC”) approved the Bank Merger on March 6, 2018, and the Maryland Commissioner of Financial Regulation approved the Bank Merger on March 9, 2018. Therefore, all required stockholder and regulatory approvals with respect to the Merger and its related transactions have now been received. However, a lawsuit has been filed against the Company, its directors and Old Line
Bancshares pursuant to which the plaintiff seeks, among other things, to enjoin the Merger unless certain conditions are satisfied. Information about this lawsuit is set forth in Item 1A of Part I of this annual report under the heading, “Pending litigation related to the Merger may delay or prevent the Merger and could cause Old Line Bancshares and the Company to incur significant costs and expenses.”
The Merger Agreement includes customary representations, warranties and covenants of the parties. The
Merger Agreement contains termination rights of the Company and Old Line Bancshares and further provides that we will be required to pay Old Line Bancshares a termination fee of $5,076,000 if the Merger Agreement is terminated under specified circumstances set forth therein.
We expect the Merger to close on or about April 13, 2018, but this date is subject to change. For additional information regarding the pending Merger, please see as our definitive proxy statement filed with the Securities and
Exchange Commission (the “SEC”) on March 14, 2018, as updated from time to time.
You should keep in mind that discussions in this annual report that refer to the Company’s business, operations and risks in the future refer to the Company as a stand-alone entity up to the closing of the proposed Merger or if the Merger does not close, and that these considerations will be different with respect to the combined company after the closing of the Merger.
GENERAL
The Company, a Maryland corporation organized in 1990, is a savings and loan holding company headquartered in Columbia, Maryland. The Bank is also headquartered in Columbia, Maryland. 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.
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. As part of planning for our proposed Merger, we expect to close this division in February 2018.
Investments in joint ventures are accounted for using the equity method. The total investment in joint ventures at December 31, 2017 and December 31, 2016 is not considered material to the consolidated financial statements as a whole.
On July 8, 2016, the Company completed its merger with Hopkins Bancorp, Inc. (“Hopkins”), the parent company of Hopkins Federal Savings Bank (“Hopkins Bank”), in which Hopkins was merged into the Company, with the Company as the surviving corporation. Immediately following that merger, Hopkins Bank was merged into the Bank, with the Bank as the surviving FSB (these merger transactions are collectively referred to as the “Hopkins Merger”). In the Hopkins Merger, the Company acquired all of the outstanding shares of common stock of Hopkins for $23,855,141 in cash, with each outstanding share of Hopkins common stock converted into the right to receive $98.7578 in cash. The Bank acquired Hopkins Bank’s 51% interest in iReverse Home Loans, LLC (“iReverse”), which is engaged in the business of brokering reverse mortgage loans. Effective March 31, 2017, the Bank sold its interest in iReverse to the other owner of iReverse for $70,000.
The Bank has three wholly-owned subsidiaries, Hopkins Financial Corporation, Hopkins Properties, Inc. and Encore Mortgage, Inc., all of which are Maryland entities that were acquired in the Hopkins Merger and engage in the business of investing excess cash in certificates of deposit issued by other depository institutions.
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 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. 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 at least two signatures; no individual commercial loan authority is given to Recommending Officers (“RO”). Loans up to $1,500,000 must be approved by the RO, Line Executive (“LE”) and Credit Administration (“CA”). CA includes the Chief Credit Officer (“CCO”) and/or a senior vice president (“SVP”) of CA. LEs include Baltimore Area President, Corridor Area President and Head of Real Estate. Loans between $1,500,001 and $3,000,000 must be approved by the Chief Executive Officer (“CEO”) or LE and CCO. Loans between $3,000,001 and $5,000,000 must be approved by the Credit Risk Management Committee (“CRMC”) which consists of the CEO, LEs, CCO and SVP CA. Loans greater than $5,000,001 must be approved by the Board Loan and Risk Committee with the prior approval of the CRMC. 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.
All loans by the Bank to our directors and executive officers and their affiliates require pre-approval by the Bank’s Board of Directors to ensure, among other things, compliance with Section 23A and Section 23B of the Federal Reserve Act and Regulation O promulgated thereunder. It is the Bank’s policy that all approved loans must be made on substantially the same terms as loans made to persons who are unrelated to the Bank.
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 twenty 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
Until February 2018, we originated residential mortgage loans for resale in the secondary mortgage market through our mortgage division. We terminated this activity in contemplation of the proposed Merger. These loans were underwritten pursuant to standard underwriting guidelines. While our intent was to sell all loans originated as loans held for sale, rarely, we were unable to sell a loan due to some underwriting defect. These loans were transferred to the loan portfolio at the lower of their cost or fair value at the date of transfer. Loans held for sale are sold with servicing rights released; gains or losses are recorded at the sale commitment date.
Other Banking Products
We offer our customers treasury services products that include wire transfer and ACH services, Check cards and 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
At December 31, 2017, the Bank had 121 full-time and 10 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 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.
Dodd-Frank Act
The Dodd-Frank Act, which was enacted in July 2010, significantly restructured 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, 2015, 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, 2015, 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.
Several of the Dodd-Frank Act’s provisions remain 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, 2017, the Bank’s capital exceeded all applicable regulatory requirements and the Bank was considered well capitalized. In addition at December 31, 2017, the Bank’s capital exceeded the capital conservation buffer requirements being phased at 1.25% and fully phased in 2.5%.
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 determinable marketable collateral, which generally does not include real estate. At December 31, 2017, 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, 2017, 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. At December 31, 2017, the Bank’s CRA rating was “Outstanding.” 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, 2017, 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. At December 31, 2017, the Bank was in compliance with this requirement.
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. At December 31, 2017, we are in compliance with these integrated mortgage disclosure rules.
Supervision and Regulation of Mortgage Brokerage Operations
Our mortgage brokerage operation is governed by a host of federal laws and regulations. For example, mortgage brokers must comply with: the Real Estate Settlement Procedures Act, the Truth in Lending Act, the Home Ownership and Equity Protection Act, the Fair Credit Reporting Act, the Equal Credit Opportunity Act, the Gramm-Leach-Bliley Act (the “GLB Act”) and the Federal Trade Commission Act (the “FTC Act”), as well as fair lending and fair housing laws. Many of these statutes, coupled with their implementing regulations, provide substantive protection to borrowers who seek mortgage financing. These laws impose disclosure requirements on brokers, define high-cost loans, and contain anti-discrimination provisions.
Additionally, mortgage brokers are under the oversight of HUD and the FTC Act; and to the extent their promulgated laws apply to mortgage brokers, the Federal Reserve Board, the Internal Revenue Service, and the Department of Labor. These agencies ensure that mortgage brokers comply with the aforementioned federal laws, along with the disclosure and reporting requirements associated with advertising, marketing and compensation for services.
Consumer Lending – Military Lending Act
The Military Lending Act (the “MLA”), which was initially implemented in 2007, was amended and its coverage significantly expanded in 2015. The Department of Defense issued a final rule under the MLA that took effect on October 15, 2015, but financial institutions were not required to take action until October 3, 2016. The types of credit covered under the MLA were expanded to include virtually all consumer loan and credit card products (except for loans secured by residential real property and certain purchase-money motor vehicle/personal property secured transactions). Lenders must now provide specific written and oral disclosures concerning the protections of the MLA to active duty members of the military and dependents of active duty members of the military (“covered borrowers”). The rule imposes a 36% “Military Annual Percentage Rate” cap that includes costs associated with credit insurance premiums, fees for ancillary products, finance charges associated with the transactions, and application and participation charges. In addition, loan terms cannot include (i) a mandatory arbitration provision, (ii) a waiver of consumer protection laws, (iii) mandatory allotments from military benefits, or (iv) a prepayment penalty. The revised rule also prohibits “roll-over” or refinances of the same loan unless the new loan provides more favorable terms for the covered borrower. Lenders may verify covered borrower status using a DOD database or information provided by credit bureaus. We believe that we are in compliance with the revised rule.
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 GLB Act, which places limitations on the sharing of consumer financial information by financial institutions with unaffiliated third parties. Specifically, the GLB 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. |
Savings and Loan 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 at 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 RELATED TO OUR PENDING MERGER WITH OLD LINE BANCSHARES
Completion of the Merger is conditioned upon the satisfaction of customary closing conditions.
Although the Company and Old Line Bancshares have agreed in the Merger Agreement to use reasonable best efforts to consummate the Merger, the Merger is subject to various closing conditions that might not be satisfied. The Merger will not be consummated unless and until all of those closing conditions are either satisfied or waived by the parties. In addition, satisfying the conditions to, and completion of, the Merger may take longer than, and could cost more than, we expect. Any delay in completing the Merger may adversely affect the benefits that the Company and Old Line Bancshares expect to achieve from the Merger and the integration of our businesses. In addition, failure to complete the Merger may adversely affect Old Line Bancshares.
Failure to complete the Merger could materially and adversely impact our stock price and future businesses and financial results. If the Merger is not completed, then our ongoing business may be materially and adversely affected and we will be subject to several risks, including the following:
| · | | We may be required, under certain circumstances, to pay Old Line Bancshares a termination fee of $5,076,000 under the Merger Agreement; |
| · | | We will be required to pay certain costs relating to the Merger, whether or not the Merger is completed, such as legal, accounting, financial advisor and printing fees; |
| · | | Under the Merger Agreement, we are subject to certain restrictions on the conduct of our business prior to completing the Merger, which may adversely affect our ability to execute certain of our business strategies; and |
| · | | Matters relating to the Merger have required and may require substantial commitments of time and resources by our management that could otherwise have been devoted to other opportunities that may have been beneficial the Company as an independent company. |
In addition, if the Merger is not completed, we may experience negative reactions from the financial markets and from our customers and employees. We also could be subject to litigation related to any failure to complete the
Merger or to enforcement proceedings commenced against us to perform our obligations under the Merger Agreement.
If the Merger is not completed, we cannot assure our stockholders that the risks described above will not materialize and will not materially and adversely affect our business, financial results and stock price.
The Merger Agreement limits our ability to pursue alternative transactions to the Merger and requires us to pay a termination fee if we do.
The Merger Agreement prohibits the Company and our directors, officers, representatives and agents, subject to narrow exceptions, from initiating, encouraging, soliciting or entering into discussions with any third party regarding alternative acquisition proposals. The prohibition limits our ability to pursue offers from other possible acquirers that may be superior to the pending Merger with Old Line Bancshares from a financial point of view. If we receive an unsolicited proposal from a third party that is superior from a financial point of view to that made by Old Line Bancshares and the Merger Agreement is terminated, we would be required to pay a termination fee of $5,076,000. This fee makes it less likely that a third party will make an alternative acquisition proposal.
If the Merger is completed, then Old Line Bancshares may fail to realize all of the anticipated benefits of the Merger.
Because the consideration to be paid to our stockholders in the Merger in exchange for their shares of the Company’s common stock consists of Old Line Bancshares common stock, realization of the anticipated benefits in the Merger for our stockholders in the Merger will depend, in part, on the combined company’s ability to successfully integrate the businesses and operations of the Company and Old Line Bancshares. The combined company will be required to devote significant management attention and resources to integrating its business practices, operations and support functions.
The success of the Merger will depend, in part, on Old Line Bancshares’ ability to realize the anticipated benefits and cost savings from combining the businesses of Old Line Bancshares and the Company. To realize these anticipated benefits and cost savings, however, Old Line Bancshares must successfully combine the businesses of Old Line Bancshares and the Company. If Old Line Bancshares is unable to achieve these objectives, then the anticipated benefits and cost savings of the Merger may not be realized fully or at all or may take longer to realize than expected.
Old Line Bancshares and the Company have operated and, until the completion of the Merger, will continue to operate, independently. It is possible that the integration process could result in the loss of key employees, the loss of key depositors or other bank customers, the disruption of each company’s ongoing businesses or inconsistencies in standards, controls, procedures and policies that adversely affect Old Line Bancshares’ and the Company’s ability to maintain their relationships with their respective clients, customers, depositors and employees or to achieve the anticipated benefits of the Merger. Integration efforts between the two companies may, to some extent, also divert management attention and resources. These integration matters could have an adverse effect on each of Old Line Bancshares and the Company during such transition period.
If the Merger is not completed, then we will have incurred substantial expenses without realizing the expected benefits.
We have incurred substantial expenses in connection with the execution of the Merger Agreement and the
Merger. The completion of the Merger depends on the satisfaction of specified conditions, including the approval of the
Merger by stockholders of Old Line Bancshares and the Company. There is no guarantee that these conditions will be satisfied. If the Merger is not completed, then these expenses could have a material and adverse impact on our financial condition and/or results of operations because we would not have realized the expected benefits of the Merger.
Because the aggregate consideration to be received in the Merger is subject to adjustment, our stockholders will not know the value of the consideration that they will receive in the Merger until its effective time.
Upon completion of the Merger, our stockholders will receive, for each share of the Company’s common stock they own, between approximately 0.4047 and 0.4600 shares of Old Line Bancshares common stock, subject to adjustment, provided that cash will be paid in lieu of any fractional shares. The consideration will be adjusted in
connection with the Company’s recent settlement of certain litigation and its resolution of certain loans. The consideration may also be adjusted if at any time during the five trading days before the effective date of the Merger, the volume-weighted average closing price of Old Line Bancshares common stock during the 20 prior trading days is less than $24.30 and the decrease in such price from $27.00 is more than 15% lower than the change in the average of NASDAQ Bank Index prices for the 20 consecutive trading days ending on the trading day prior to the determination date (the “Final Index Price”) relative to the NASDAQ Bank Index closing price as of September 27, 2017, which allows the Company to terminate the Merger Agreement, and Old Line Bancshares exercises its right to prevent the Company from so terminating by increasing the consideration (by increasing the number of shares, making a cash payment or a combination of both) so that the per share consideration is an amount that equals the lesser of (i) $11.178 or (ii) (a) the Final Index Price divided by the NASDAQ Bank Index closing price as of September 27, 2017, multiplied by (b) 0.3910 and the Old Line Bancshares 20 day volume-weighted average price, divided by (c) the quotient of the Old Line Bancshares 20 day volume-weighted average price divided by $27.00. Therefore, the value of the per share and aggregate consideration to be received in the Merger will depend on the market price of Old Line Bancshares common stock on the closing date of the Merger and the applicability and extent of any adjustments. The impact of these adjustments on the number of Old Line Bancshares common stock issued for each share of the Company’ common stock will vary based on the recent trading prices of Old Line Bancshares common stock as of the effective date of the Merger. Stock price changes may result from a variety of factors, including general market and economic conditions, changes in the businesses, operations and prospects of Old Line Bancshares and regulatory considerations. Many of these factors are beyond Old Line Bancshares’ control.
As noted above, the Company has the option, but is not required, to terminate the Merger Agreement if the
average price of the Old Line Bancshares common stock falls below certain thresholds, although the Company would not have this option if Old Line Bancshares, in its sole discretion, were to exercise its right to prevent the Company from so terminating by increasing the consideration. We cannot predict at this time whether our board of directors would exercise its right to terminate the Merger Agreement if these conditions were met. The Merger Agreement does not provide for a resolicitation of the Company’s stockholders in the event that the conditions are met following the approval of the Merger by the Company’s stockholders and our board nevertheless chooses to complete the transaction. Our board of directors has made no decision as to whether it would exercise its right to terminate the Merger Agreement. In considering whether to exercise its right to terminate the Merger Agreement, our board of directors would take into account all of the relevant facts and circumstances that exist at the time and would consult with our financial advisors and legal counsel.
Pending litigation related to the Merger may delay or prevent the Merger and could cause Old Line Bancshares and the Company to incur significant costs and expenses.
On December 14, 2017, Adam Franchi, both individually and on behalf of a putative class of the Company’s stockholders, filed a complaint in the United States District Court for the District of Maryland against Bay Bancorp and its directors as well as Old Line Bancshares (the “Litigation”). The complaint alleges that the version of the joint proxy statement/prospectus that was filed with the SEC on November 22, 2017 omitted certain material information in violation of Section 14(a) of the Exchange Act and Rule 14a-9 promulgated thereunder and asks the court to, among other things, enjoin the parties from proceeding with the Merger unless and until they revise the joint proxy statement/prospectus so that it includes the information that is alleged to have been omitted therefrom. In the event that the parties fail to do so and nevertheless proceed with the merger, the complaint asks the court to set aside the Merger or award rescissory damages. On February 14, 2018, without admitting any violation of law, Old Line Bancshares filed an amended joint proxy statement/prospectus with the SEC, and Mr. Franchi thereafter agreed to dismiss with prejudice all of his claims, but only as to himself and without prejudice to any other member of the putative class of stockholders. On March 28, 2018, the parties to the Litigation entered into a Stipulation and Proposed Order of Dismissal (the “Stipulation”) that, if approved by the court, will resolve all issues raised in the Litigation except for a claim for attorneys’ fees. No assurance can be given that the court will approve the Stipulation. If the court does not approve the Stipulation, then the Litigation could delay or even prevent the merger and would likely cause the Company and Old Line Bancshares to incur significant legal fees and other costs to defend the claims, which could adversely impact the financial condition and results of operations of the Company and Old Line Bancshares, both before and after the Merger. No assurance can be given that Old Line Bancshares, the Company or the Company’s directors would be successful in the defense of these claims if they are not dismissed.
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.
We grew significantly in 2013, 2015 and 2016 through acquisitions. 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 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 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 well as south along the Baltimore-Washington corridor. 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 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.
A new accounting standard will likely require us to increase our allowance for loan losses and may have a material adverse effect on our financial condition and results of operations.
The Financial Accounting Standards Board has adopted a new accounting standard that will be effective for the Company and the Bank beginning with our first full fiscal year after December 15, 2019. This standard, referred to as Current Expected Credit Loss, or CECL, will require financial institutions to determine periodic estimates of lifetime expected credit losses on loans, and recognize the expected credit losses as allowances for loan losses. This standard will change the current method of providing allowances for loan losses that are probable, which would likely require us to increase our allowance for loan losses, and to greatly increase the types of data we would need to collect and review to determine the appropriate level of the allowance for loan losses. Any increase in our allowance for loan losses or expenses incurred to determine the appropriate level of the allowance for loan losses may have a material adverse effect on our financial condition and results of operations.
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 at December 31, 2017. 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 65% of the commercial real estate loan portfolio and 28% 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, 2017, owner-occupied commercial real estate loans represented approximately 35% of the commercial real estate loan portfolio and 15% 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 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 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.
Impairment of deferred tax assets could require charges to earnings, which could result in a negative impact on our results of operations.
At December 31, 2017, our net deferred tax assets were valued at $1.8 million, which included $0.5 million associated with a federal and state net operating loss carryforward which we expect to be substantially utilized in the current year. A deferred tax asset is reduced by a valuation allowance if, based on the weight of the evidence available, both negative and positive, including the recent trend of quarterly earnings, management believes that it is more likely than not that some portion or all of the total deferred tax asset will not be realized. Moreover, our ability to utilize our net operating loss carryforwards to offset future taxable income may be significantly limited if we experience an “ownership change,” as determined under Section 382 of the Internal Revenue Code of 1986, as amended (the “Code”). If an ownership change were to occur, the limitations imposed by Section 382 of the Code could result in a portion of our net operating loss carryforwards expiring unused, thereby impairing their value. Section 382’s provisions are complex, and we cannot predict any circumstances surrounding the future ownership of the common stock. Accordingly, we cannot provide any assurance that we will not experience an ownership change in the future. The impact of such an impairment could have a material adverse effect on our business, results of operations, and financial condition.
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 some rule making efforts are still required to fully implement all of its requirements and the implementation of some enforcement efforts is just beginning. We anticipate continued increases in regulatory expenses as a result of the Dodd-Frank Act.
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.
Based on the text of the Dodd-Frank Act and the implementing regulations, 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.
The Consumer Financial Protection Bureau may continue to 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 as the CFPB has not yet released significant supervisory guidance.
As discussed above, the CFPB issued several rules in 2013 relating to mortgage operations and servicing, including a rule requiring 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, or to originate “qualified mortgages” that meet specific requirements with respect to terms, pricing and fees. These new rules have required the Bank to dedicate significant personnel resources and could have a material adverse effect on our operations.
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 was 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 2015 and 2016 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.
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 at 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.
The Bank is a community bank and our ability to maintain our reputation is critical to the success of our business.
The Bank is a community banking institution, and our reputation is one of the most valuable components of our business. A key component of our business strategy is to rely on our reputation for customer service and knowledge of local markets to expand our presence by capturing new business opportunities from existing and prospective customers in our current market and contiguous areas. As such, we strive to conduct our business in a manner that enhances our reputation. This is done, in part, by recruiting, hiring and retaining employees who share our core values of being an integral part of the communities we serve, delivering superior service to our customers and caring about our customers and associates. If our reputation is negatively affected by the actions of our employees, by our inability to conduct our operations in a manner that is appealing to current or prospective customers, or otherwise, our business and, therefore, our operating results may be materially adversely affected.
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.
Safeguarding our business and customer information increases our cost of operations. To the extent that we, or our third-party vendors, are unable to prevent the theft of or unauthorized access to this information, our operations may become disrupted, we may be subject to claims, and our net income may be adversely affected.
Our business depends heavily on the use of computer systems, the Internet and other means of electronic communication and recordkeeping. Accordingly, we must protect our computer systems and network from break-ins, security breaches, and other risks that could disrupt our operations or jeopardize the security of our business and customer information. Moreover, we use third party vendors to provide products and services necessary to conduct our day-to-day operations, which exposes us to risk that these vendors will not perform in accordance with the service arrangements, including by failing to protect the confidential information we entrust to them. Any security measures that we or our vendors implement, including encryption and authentication technology that we use to effect secure transmissions of confidential information, may not be effective to prevent the loss or theft of our information or to prevent risks associated with the Internet, such as cyber-fraud. Advances in computer capabilities, new discoveries in the field of cryptography, or other developments could permit unauthorized persons to gain access to our confidential information in spite of the use of security measures that we believe are adequate. Any compromise of our security measures or of the security measures employed by our vendors of our third party could disrupt our business and/or could subject us to claims from our customers, either of which could have a material adverse effect on our business, financial condition and results of operations.
We may be subject to claims and the costs of defensive actions, and such claims and costs could materially and adversely impact our financial condition and results of operations.
Our customers may sue us for losses due to alleged breaches of fiduciary duties, errors and omissions of employees, officers and agents, incomplete documentation, our failure to comply with applicable laws and regulations, or many other reasons. Also, our employees may knowingly or unknowingly violate laws and regulations. Management may not be aware of any violations until after their occurrence. This lack of knowledge may not insulate us from liability. Claims and legal actions will result in legal expenses and could subject us to liabilities that may reduce our profitability and hurt our financial condition.
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.
The Company’s largest stockholder, H Bancorp LLC (“H Bancorp”), beneficially owns approximately 26.5% of the Company’s common stock and is deemed to be a bank holding company under the BHC Act with respect to the Bank. 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.
The Company may need to raise additional capital in the future and, in such case, it may not be able to obtain such capital on favorable terms or at all. In such case, the Company may not be able to execute on its business plans, and its business, financial condition and/or results of operations could be adversely affected.
Banking authorities require the Company and the Bank to maintain adequate levels of capital to support their operations. In addition, the Company may elect to raise additional capital in the future to fund its growth or acquisition activities. Any sale of additional equity or debt securities may result in dilution to the Company’s stockholders. The Company’s ability to raise additional capital, if needed, will depend on conditions in the capital markets, economic conditions and a number of other factors, many of which are outside its control. Conditions in the capital markets may be such that traditional sources of capital may not be available to the Company on reasonable terms. Accordingly, the Company may not be able to raise additional capital if needed or on terms that are favorable or otherwise not dilutive to its existing stockholders. Furthermore, the significant amount of common stock that H Bancorp owns may discourage other potential investors from offering to acquire newly issued shares. If the Company is unable to obtain additional capital as and when needed, then it may be required to delay, reduce the scope of, or eliminate its growth and acquisition activities, which could adversely affect its business, financial condition and operating results.
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 therefore 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. Due to the Company’s desire to preserve its and the Bank’s capital to fund growth, the Company currently does not anticipate paying cash dividends on its common stock for the foreseeable future. In addition to these regulatory restrictions, it should be noted that the declaration of dividends by the Company and the Bank is at the discretion of their respective Boards of Directors and will depend, in part, on our earnings and future capital needs.
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. At December 31, 2017, the Bank operated 11 full-service branches, of which five were owned by the Bank and six were leased. See Note 8 to the Notes to the Consolidated Financial Statements for additional information.
We own the following properties, which had an aggregate book value of $1.3 million at December 31, 2017:
Location | | Description | |
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 $1.2 million at December 31, 2017:
Location | | Description | | Lease Expiration
Date (1) |
4600 Wilkens Avenue, Suite 105 | | Full service branch | | 31-July-21 |
Arbutus, MD 21229 | | | | |
| | | | |
1740 East Joppa Road | | Full service branch | | 31-Dec-21 |
Towson, MD 21234 | | | | |
| | | | |
7151 Columbia Gateway Dr., Ste. A | | Executive, administrative, and operational offices, | | 30-Apr-19 |
Columbia, MD 21046 | | electronic banking. Full service branch | | |
| | | | |
2328 West Joppa Road, | | Loan offices as well as a full service branch | | 30-Sep-19 |
Lutherville, MD 21093 | | | | |
| | | | |
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 and loan offices | | 31-May-26 |
Cockeysville, MD 21030 (2) | | | | |
| | | | |
4040 Schroeder Avenue | | Full service branch | | 31-Jan-28 |
Perry Hall, MD 21128 (2) | | | | |
| | | | |
1726 Reisterstown Road | | Full service branch | | 30-Sep-18 |
Pikesville, MD 21208 | | | | |
| (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
The information set forth in Item 1A of Part I of this annual report under the heading “Pending litigation related to the Merger may delay or prevent the Merger and could cause Old Line Bancshares and the Company to incur significant costs and expenses” is incorporated by reference into this Item 3.
We are at times, in the ordinary course of business, subject to legal actions. Management, upon the advice of counsel, believes that losses, if any, resulting from current ordinary course legal actions will not have a material adverse effect on our financial condition or results of operations.
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
MARKET FOR THE COMMON STOCK
Shares of the Company’s common stock are listed on The NASDAQ Capital Market under the symbol “BYBK”. At March 26, 2018, there were 266 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.
The high and low closing sales prices for the shares of the Company’s common stock for each quarterly period of 2017 and 2016 as reported on the NASDAQ Capital Market are set forth in the following table:
| | | | | | | |
| | High | | Low | |
2017 | | | | | | | |
1st Quarter | | $ | 8.10 | | $ | 6.50 | |
2nd Quarter | | | 7.65 | | | 6.80 | |
3rd Quarter | | | 11.35 | | | 7.20 | |
4th Quarter | | | 12.37 | | | 11.35 | |
| | | | | | | |
2016 | | | | | | | |
1st Quarter | | $ | 5.09 | | $ | 4.65 | |
2nd Quarter | | | 5.40 | | | 4.84 | |
3rd Quarter | | | 5.89 | | | 4.92 | |
4th Quarter | | | 6.80 | | | 5.26 | |
On March 27, 2018, the closing sales price of the common stock, ticker BYBK, as reported on the NASDAQ Capital Market, was $13.35 per share.
DIVIDENDS
During 2017 and 2016, the Company’s board of directors did not declare any dividends on the common stock.
The Company’s ability to 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 Company’s merger with Jefferson Bancorp, Inc. (“Jefferson”) in April 2013 (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. Due to the Company’s desire to preserve its and the Bank’s capital to fund growth, the Company currently does not anticipate paying cash dividends on its common stock for
the foreseeable future. In addition to these regulatory restrictions, it should be noted that the declaration of dividends by the Company and the Bank is at the discretion of their respective Boards of Directors and will depend, in part, on our earnings and future capital needs. Accordingly, there can be no assurance that dividends will be declared in any future period.
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.
ISSUER PURCHASES OF COMMON STOCK
Neither the Company nor any of its affiliates (as defined by Rule 10b-18 under the Exchange Act) purchased any shares of the Company’s common stock during the fourth quarter of 2017.
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
| | | | | | | | | | | | | | | | |
| | 2017 | | 2016 | | 2015 | | 2014 | | 2013(1) | |
Consolidated Income Statement Data: | | | | | | | | | | | | | | | | |
Interest income | | $ | 27,887,020 | | $ | 23,027,431 | | $ | 23,209,506 | | $ | 24,115,000 | | $ | 19,019,543 | |
Interest expense | | | 2,339,220 | | | 1,850,134 | | | 1,834,883 | | | 1,257,199 | | | 1,261,969 | |
Net interest income | | | 25,547,800 | | | 21,177,297 | | | 21,374,623 | | | 22,857,801 | | | 17,757,574 | |
Provision for loan losses | | | 1,656,983 | | | 1,389,533 | | | 1,142,522 | | | 801,688 | | | 842,207 | |
Net interest income after provision for loan losses | | | 23,890,817 | | | 19,787,764 | | | 20,232,101 | | | 22,056,113 | | | 16,915,367 | |
Bargain purchase gain | | | — | | | 893,127 | | | — | | | 524,432 | | | 2,860,199 | |
Other noninterest income | | | 6,590,464 | | | 5,100,469 | | | 5,373,969 | | | 7,181,749 | | | 6,084,779 | |
Merger related expense | | | 439,055 | | | 1,758,337 | | | 22,097 | | | 1,028,239 | | | 2,041,756 | |
Other noninterest expenses | | | 21,200,161 | | | 21,428,071 | | | 22,518,543 | | | 26,428,132 | | | 20,073,365 | |
Income before income taxes | | | 8,842,065 | | | 2,594,952 | | | 3,065,430 | | | 2,305,923 | | | 3,745,224 | |
Income taxes (benefit) | | | 4,000,579 | | | 1,001,596 | | | 1,134,665 | | | (726,785) | | | 504,090 | |
Net income from continuing operations, net of taxes | | $ | 4,841,486 | | $ | 1,593,356 | | $ | 1,930,765 | | $ | 3,032,708 | | $ | 3,241,134 | |
Net income from discontinued operations, net of taxes | | | — | | | 366,034 | | | — | | | — | | | — | |
Net income from discontinued operations attributable to
non-controlling interest | | | — | | | 199,491 | | | — | | | — | | | — | |
Net income available to common stockholders | | $ | 4,841,486 | | $ | 1,759,899 | | $ | 1,930,765 | | $ | 3,032,708 | | $ | 3,241,134 | |
| | | | | | | | | | | | | | | | |
| | | | | | | | | | | | | | | | |
Shares outstanding and per share data: | | | | | | | | | | | | | | | | |
Average shares outstanding - basic | | | 10,607,217 | | | 10,734,748 | | | 11,040,159 | | | 10,370,795 | | | 8,322,811 | |
Average shares outstanding - diluted | | | 10,740,982 | | | 10,860,153 | | | 11,178,133 | | | 10,565,336 | | | 8,342,646 | |
Number of shares outstanding, at year-end | | | 10,667,227 | | | 10,456,098 | | | 11,062,932 | | | 11,014,517 | | | 9,379,753 | |
Net income - basic per share | | $ | 0.46 | | $ | 0.16 | | $ | 0.17 | | $ | 0.29 | | $ | 0.39 | |
Net income - diluted per share | | | 0.45 | | | 0.16 | | | 0.17 | | | 0.29 | | | 0.39 | |
Book value per share at period end | | | 6.74 | | | 6.29 | | | 6.12 | | | 6.05 | | | 5.82 | |
| | | | | | | | | | | | | | | | |
Financial Condition data: | | | | | | | | | | | | | | | | |
Assets | | $ | 658,972,924 | | $ | 620,303,594 | | $ | 491,161,838 | | $ | 479,942,985 | | $ | 419,089,303 | |
Investment Securities | | | 58,189,618 | | | 63,214,160 | | | 39,789,742 | | | 36,665,607 | | | 36,586,669 | |
Loans (net of deferred fees and costs) | | | 542,250,292 | | | 487,103,713 | | | 393,240,567 | | | 393,051,192 | | | 320,680,332 | |
Allowance for loan losses | | | 4,156,425 | | | 2,823,153 | | | 1,773,009 | | | 1,294,976 | | | 851,000 | |
Deposits | | | 572,754,560 | | | 526,458,394 | | | 367,415,938 | | | 387,830,132 | | | 360,933,471 | |
Borrowings | | | 10,000,000 | | | 20,000,000 | | | 52,300,000 | | | 22,150,000 | | | — | |
Equity attributable to non-controlling interest | | | — | | | 199,491 | | | — | | | — | | | — | |
Equity attributable to common shareholders | | | 71,876,129 | | | 65,727,735 | | | 67,682,489 | | | 66,643,286 | | | 54,554,268 | |
| | | | | | | | | | | | | | | | |
Average Balances: | | | | | | | | | | | | | | | | |
Assets | | $ | 632,726,301 | | $ | 536,333,860 | | $ | 481,145,938 | | $ | 459,782,360 | | $ | 358,397,210 | |
Investment Securities | | | 64,331,571 | | | 42,154,769 | | | 36,649,655 | | | 36,561,271 | | | 24,427,877 | |
Loans | | | 507,166,275 | | | 436,793,412 | | | 389,684,221 | | | 364,511,290 | | | 259,698,504 | |
Interest-bearing Deposits | | | 413,365,793 | | | 343,229,087 | | | 290,969,449 | | | 292,056,338 | | | 231,245,789 | |
Borrowings | | | 29,728,293 | | | 26,493,284 | | | 23,188,219 | | | 9,269,231 | | | 92,328 | |
Stockholders' equity | | | 66,781,799 | | | 66,146,705 | | | 65,747,418 | | | 61,530,969 | | | 48,537,003 | |
| | | | | | | | | | | | | | | | |
Selected performance ratios: | | | | | | | | | | | | | | | | |
Return on average assets | | | 0.77 | % | | 0.37 | % | | 0.40 | % | | 0.66 | % | | 0.90 | % |
Return on average equity | | | 7.25 | % | | 2.96 | % | | 2.94 | % | | 4.93 | % | | 6.68 | % |
Yield on average interest-earning assets | | | 4.62 | % | | 4.50 | % | | 5.10 | % | | 5.60 | % | | 5.71 | % |
Rate on average interest-bearing liabilities | | | 0.53 | % | | 0.50 | % | | 0.58 | % | | 0.42 | % | | 0.55 | % |
Net interest spread | | | 4.09 | % | | 4.00 | % | | 4.51 | % | | 5.18 | % | | 5.16 | % |
Net interest margin | | | 4.23 | % | | 4.14 | % | | 4.70 | % | | 5.31 | % | | 5.33 | % |
| | | | | | | | | | | | | | | | |
Asset Quality ratios: | | | | | | | | | | | | | | | | |
Allowance for loan losses to loans | | | 0.77 | % | | 0.58 | % | | 0.45 | % | | 0.33 | % | | 0.27 | % |
Nonperforming loans to total loans | | | 2.08 | % | | 3.02 | % | | 2.26 | % | | 3.41 | % | | 2.59 | % |
Nonperforming assets to total assets | | | 1.83 | % | | 2.55 | % | | 2.10 | % | | 3.10 | % | | 2.29 | % |
Net charge-offs to average loans | | | 0.21 | % | | — | % | | 0.03 | % | | 0.10 | % | | 0.25 | % |
| | | | | | | | | | | | | | | | |
Capital ratios: | | | | | | | | | | | | | | | | |
Leverage ratio (2) | | | 10.54 | % | | 10.45 | % | | 13.75 | % | | 12.94 | % | | 11.41 | % |
Tier 1 risk-based capital ratio (2) | | | 12.11 | % | | 12.32 | % | | 16.14 | % | | 16.31 | % | | 14.42 | % |
Total risk-based capital ratio (2) | | | 12.85 | % | | 12.87 | % | | 16.58 | % | | 16.66 | % | | 14.68 | % |
Average equity to average assets | | | 12.11 | % | | 12.32 | % | | 13.66 | % | | 13.38 | % | | 13.54 | % |
| (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 mergers and acquisitions 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 a payment sponsorship division. Our sales organization was restructured from a chief lending officer and head of commercial real estate to market presidents for two regions and business lines. In addition, we launched industry groups (dental, cyber and transportation) and product lines (asset-back, investor owned residential real estate and small business administration lending) to drive loan origination and deposit growth. Amid the growth, our focus is on a high quality balance sheet, expense efficiency and improved profitability.
The Bank’s loan origination activities resulted in $55 million in net new loan growth in the Bank’s originated portfolio which represented an 11% annualized pace for 2017. In the third quarter of 2016, following the Hopkins Merger, and continuing throughout 2017, the Bank resumed its focus on organic growth. The Bank has a strong capital position and capacity for future growth with total regulatory capital to risk weighted assets of 12.85% at December 31, 2017. The Bank has a proven record of success in acquisitions and acquired problem asset resolutions and had $6.5 million in remaining net purchase discounts on acquired loan portfolios at December 31, 2017.
At December 31, 2017, the Bank remained above all “well-capitalized” regulatory requirement levels. The Bank’s tier 1 risk-based capital ratio was 12.11% at December 31, 2017 as compared to 12.32% at December 31, 2016. Our liquidity position remained strong due to available 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.
Balance Sheet Review
Total assets were $659 million at December 31, 2017, an increase of $39 million, or 6%, when compared to December 31, 2016. The increase was due mainly to the $55 million increase in loans held for investment offset primarily by $5 million in lower investment securities and $8 million in lower cash and interest-bearing deposits with banks.
Total deposits were $573 million at December 31, 2017, an increase of $46 million, or 9%, when compared to December 31, 2016. The increase was due to a $23 million increase in non-interest bearing deposits and a $23 million increase in interest bearing deposits (which included a $20 million temporary escrow deposit that was returned in January 2018). Short term borrowings were $10 million at December 31, 2017, a decrease of $10 million when compared to $20 million at December 31, 2016.
Stockholders’ equity increased to $72 million at December 31, 2017, compared to $66 million at December 31, 2016. The $6 million, or 9%, increase for the year ended December 31, 2017 resulted primarily from the $5 million of corporate earnings and $1 million in the issuance of common stock and stock compensation expense under the Company’s stock option plans.
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, 2017 and 2016 was 0.77% and 0.37%, 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, 2017 and 2016 was 7.25% and 2.96%, respectively.
Nonperforming assets, which consist of nonaccrual loans, troubled debt restructurings, or “TDRs”, accruing loans past due 90 days or more, and real estate acquired through foreclosure, decreased to $12 million at December 31, 2017 from $16 million at December 31, 2016. The decrease of $4 million was primarily driven by $1 million in net
decreases in nonaccrual loans and $2 million in lower PCI loans past due 90 days or more. Nonperforming assets represented 2% of total assets at December 31, 2017, compared to 3% at December 31, 2016.
At December 31, 2017, the Bank maintained capital in excess of all “well-capitalized” regulatory requirements. The Bank’s tier 1 risk-based capital ratio was 12.11% at December 31, 2017 as compared to 12.32% at December 31, 2016. 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, 2017 was $4.8 million, compared to $2.0 million for the same period of 2016. The increase in net income was primarily the result of our organic loan growth resulting in an increase of $4.3 million in net interest income. In 2017, noninterest income increased as a result of a $1.4 million insurance income gain and a $0.5 million increase in sponsorship fees which offset last year’s $1.6 million in a net bargain purchase gain attributable to the Hopkins Merger and gains on securities sold resulting from increased sales and redemption of available for sale securities. Noninterest expenses decreased by $1.6 million primarily from lower merger related expenses to the Hopkin Merger in 2016. These net increases were offset by $3.0 million in higher income tax expenses partially due to the revaluation of our deferred tax assets and liabilities at a lower federal income tax rate of 21% in light of the enactment of the Tax Cuts and Jobs Act (the “Tax Act”) in December 2017.
Net interest income increased to $25.5 million for the year ended December 31, 2017, compared to $21.2 million for the same period of 2016. The increase of $4.3 million resulted from a net growth in interest earning assets of $91.7 million, driven primarily by new loan originations and the assets acquired in the Hopkins Merger.
The net interest margin for the year ended December 31, 2017 increased to 4.23%, compared to 4.14% for 2016 due to a slightly higher yield on average earning assets.
Noninterest income for the year ended December 31, 2017 was $6.6 million, compared to $6.0 million for the same period of 2016. This increase was primarily the result of a $1.4 million insurance income gain related to the settlement of litigation and $0.5 million in higher sponsorship fees, offset by the absence of the $0.9 million bargain purchase gain resulting from the Hopkins Merger in 2016, and a $0.7 million gain on securities sold resulting from increased sales and redemption of available for sale securities in 2016. Other noninterest income increases of $0.4 million, primarily related to earnings on policies of bank owned life insurance (“BOLI”), were offset by decreases of $0.3 million in mortgage banking fees.
Noninterest expense for the year ended December 31, 2017 was $21.6 million compared to $23.2 million for 2016, a decrease of $1.6 million. The primary contributors to the decrease were $1.8 million in merger and acquisition related expenses in 2016 related to the Hopkins Merger offset by $0.2 million in merger expenses related to the Hopkins Merger in 2017 and $0.3 million in merger expenses in 2017 related to the proposed Merger with Old Line Bancshares. Additional decreases in noninterest expenses were related to $0.5 million in lower occupancy and equipment expenses, $0.4 million in lower legal, accounting and professional fees, $0.3 million in lower foreclosure property expenses, and $0.2 million in lower FDIC insurance costs, offset by increases of $1.1 million in higher salary and employee benefits related to higher incentive and health insurance costs and $0.2 million in higher data and item processing costs.
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 at 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 purchase credit impaired (“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 at 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 at 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. The recently enacted Tax Act reduces the maximum U.S. federal corporate tax rate from 35% to 21% and the Company completed its accounting for the tax effects of the enactment and has made a reasonable estimate of the effects on our existing deferred tax balances as of December 31, 2017. The Company revalued all of its deferred tax assets and liabilities based on the rates at which they are expected to reverse in the future. 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.
| | | | | | | | | | | | | | | | | | | | | | | | | |
| | Year Ended December 31, 2017 | | Year Ended December 31, 2016 | | Year Ended December 31, 2015 | |
| | 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 | | $ | 30,676,989 | | $ | 375,735 | | 1.22 | % | $ | 29,235,495 | | $ | 208,981 | | 0.71 | % | $ | 18,200,042 | | $ | 37,297 | | 0.20 | % |
Investment securities available for sale | | | 61,363,054 | | | 1,387,270 | | 2.26 | % | | 39,333,535 | | | 909,153 | | 2.31 | % | | 35,370,228 | | | 821,969 | | 2.32 | % |
Investment securities held to maturity | | | 1,121,548 | | | 25,834 | | 2.30 | % | | 1,204,399 | | | 32,782 | | 2.72 | % | | 1,279,427 | | | 32,779 | | 2.56 | % |
Restricted equity securities | | | 1,846,969 | | | 78,899 | | 4.27 | % | | 1,616,835 | | | 87,444 | | 5.41 | % | | 1,453,728 | | | 58,763 | | 4.04 | % |
Total interest-bearing deposits with banks, fed funds sold, and investments | | | 95,008,560 | | | 1,867,738 | | 1.97 | % | | 71,390,264 | | | 1,238,360 | | 1.73 | % | | 56,303,425 | | | 950,808 | | 1.69 | % |
| | | | | | | | | | | | | | | | | | | | | | | | | |
Loans held for sale | | | 1,123,299 | | | 43,358 | | 3.86 | % | | 3,456,844 | | | 120,997 | | 3.50 | % | | 9,268,964 | | | 350,833 | | 3.79 | % |
Loans, net | | | | | | | | | | | | | | | | | | | | | | | | | |
Commercial & Industrial | | | 72,415,132 | | | 3,484,170 | | 4.81 | % | | 56,060,718 | | | 2,654,860 | | 4.74 | % | | 35,800,127 | | | 1,888,496 | | 5.28 | % |
Commercial Real Estate | | | 224,356,725 | | | 11,371,849 | | 5.07 | % | | 186,954,260 | | | 9,431,078 | | 5.04 | % | | 162,950,066 | | | 9,131,583 | | 5.60 | % |
Residential Real Estate | | | 147,016,700 | | | 7,732,536 | | 5.26 | % | | 137,510,914 | | | 7,042,723 | | 5.12 | % | | 131,931,315 | | | 7,756,119 | | 5.88 | % |
HELOC | | | 32,759,222 | | | 1,587,851 | | 4.85 | % | | 33,103,754 | | | 1,459,779 | | 4.41 | % | | 33,674,244 | | | 1,653,351 | | 4.91 | % |
Construction | | | 23,359,760 | | | 1,211,700 | | 5.19 | % | | 16,200,572 | | | 811,515 | | 5.01 | % | | 18,741,548 | | | 1,101,524 | | 5.88 | % |
Land | | | 4,719,739 | | | 424,105 | | 8.99 | % | | 5,378,023 | | | 155,056 | | 2.88 | % | | 5,439,531 | | | 263,058 | | 4.84 | % |
Consumer & Other | | | 2,538,997 | | | 163,713 | | 6.45 | % | | 1,585,171 | | | 113,063 | | 7.13 | % | | 1,147,390 | | | 113,734 | | 9.91 | % |
Total loans, net (1) | | | 507,166,275 | | | 25,975,924 | | 5.12 | % | | 436,793,412 | | | 21,668,074 | | 4.96 | % | | 389,684,221 | | | 21,907,865 | | 5.62 | % |
Total earning assets | | | 603,298,134 | | $ | 27,887,020 | | 4.62 | % | | 511,640,520 | | $ | 23,027,431 | | 4.50 | % | | 455,256,610 | | $ | 23,209,506 | | 5.10 | % |
Cash | | | 6,671,442 | | | | | | | | 6,679,212 | | | | | | | | 3,955,371 | | | | | | |
Allowance for loan losses | | | (3,522,074) | | | | | | | | (2,137,016) | | | | | | | | (1,291,307) | | | | | | |
Market valuation | | | 87,417 | | | | | | | | 627,296 | | | | | | | | 538,025 | | | | | | |
Other assets | | | 26,191,382 | | | | | | | | 19,523,848 | | | | | | | | 22,687,239 | | | | | | |
Total non-earning assets | | | 29,428,167 | | | | | | | | 24,693,340 | | | | | | | | 25,889,328 | | | | | | |
Total Assets | | $ | 632,726,301 | | | | | | | $ | 536,333,860 | | | | | | | $ | 481,145,938 | | | | | | |
| | | | | | | | | | | | | | | | | | | | | | | | | |
LIABILITIES AND STOCKHOLDERS' EQUITY | | | | | | | | | | | | | | | | | | | | | | | | | |
Interest-bearing liabilities: | | | | | | | | | | | | | | | | | | | | | | | | | |
Interest-bearing checking and savings | | $ | 174,005,586 | | $ | 481,738 | | 0.28 | % | $ | 129,299,405 | | $ | 322,233 | | 0.25 | % | $ | 84,326,839 | | $ | 94,597 | | 0.11 | % |
Money market | | | 121,221,482 | | | 492,063 | | 0.41 | % | | 98,303,236 | | | 264,108 | | 0.27 | % | | 91,545,248 | | | 263,821 | | 0.29 | % |
Time deposits | | | 118,138,725 | | | 1,045,328 | | 0.88 | % | | 115,626,446 | | | 1,072,357 | | 0.93 | % | | 115,097,362 | | | 1,403,481 | | 1.22 | % |
Total interest-bearing deposits | | | 413,365,793 | | | 2,019,129 | | 0.49 | % | | 343,229,087 | | | 1,658,698 | | 0.48 | % | | 290,969,449 | | | 1,761,899 | | 0.61 | % |
Borrowed funds: | | | | | | | | | | | | | | | | | | | | | | | | | |
Federal funds purchased | | | 6,437 | | | 132 | | 2.05 | % | | 2,985 | | | 28 | | 0.94 | % | | 65,753 | | | 604 | | 0.92 | % |
FHLB advances and other borrowed funds | | | 29,721,856 | | | 319,959 | | 1.08 | % | | 26,490,299 | | | 191,408 | | 0.72 | % | | 23,188,219 | | | 72,380 | | 0.31 | % |
Total borrowed funds | | | 29,728,293 | | | 320,091 | | 1.08 | % | | 26,493,284 | | | 191,436 | | 0.72 | % | | 23,253,972 | | | 72,984 | | 0.31 | % |
Total interest-bearing funds | | | 443,094,086 | | | 2,339,220 | | 0.53 | % | | 369,722,371 | | | 1,850,134 | | 0.50 | % | | 314,223,421 | | | 1,834,883 | | 0.58 | % |
Noninterest-bearing deposits | | | 117,709,317 | | | — | | | | | 99,915,024 | | | — | | | | | 97,275,956 | | | — | | | |
Total cost of funds | | | 560,803,403 | | $ | 2,339,220 | | 0.42 | % | | 469,637,395 | | $ | 1,850,134 | | 0.39 | % | | 411,499,377 | | $ | 1,834,883 | | 0.45 | % |
Other liabilities and accrued expenses | | | 5,141,099 | | | | | | | | 549,760 | | | | | | | | 3,899,143 | | | | | | |
Total Liabilities | | | 565,944,502 | | | | | | | | 470,187,155 | | | | | | | | 415,398,520 | | | | | | |
Stockholders' Equity | | | 66,781,799 | | | | | | | | 66,146,705 | | | | | | | | 65,747,418 | | | | | | |
Total Liabilities and Stockholders' Equity | | $ | 632,726,301 | | | | | | | $ | 536,333,860 | | | | | | | $ | 481,145,938 | | | | | | |
Net interest income and spread(2) | | | | | $ | 25,547,800 | | 4.09 | % | | | | $ | 21,177,297 | | 4.00 | % | | | | $ | 21,374,623 | | 4.51 | % |
Net interest margin(3) | | | | | | | | 4.23 | % | | | | | | | 4.14 | % | | | | | | | 4.70 | % |
| (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 increased to $25.5 million for the year ended December 31, 2017, compared to $21.2 million for the same period of 2016. The increase of $4.3 million resulted from a $4.9 million increase in total interest income, offset by related interest expense primarily due to $91.7 million of net growth in average interest-earning assets driven primarily by new loan originations and assets acquired in the Hopkins Merger.
Total interest income increased by 21% for the year ended December 31, 2017 when compared to the same period of 2016. Interest income on loans increased by $4.3 million, or 20%, and loans held for sale decreased $0.1 million, or 64%, for the year ended December 31, 2017 when compared to the same period of 2016. Interest income on investment securities and interest-bearing deposits in banks and federal funds sold increased by $0.6 million for the year ended December 31, 2017 when compared to the same period of 2016.
Total interest expense increased by $0.5 million, or 26%, for the year ended December 31, 2017 when compared to the same period of 2016. The increase in interest expense was primarily related to a $0.4 million increase in interest on deposits and a $0.1 million increase in interest on borrowings. Average interest-bearing deposits increased $70.1 million in 2017 when compared to the same period of 2016, while the percentage of average noninterest-bearing deposits to total deposits was 22% for 2017 and 23% for 2016.
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:
| | | | | | | | | | | | | | | | | | | |
| | 2017 versus 2016 | | 2016 versus 2015 | |
| | 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 | | $ | 3,604,341 | | $ | 703,509 | | $ | 4,307,850 | | $ | 2,425,970 | | $ | (2,665,761) | | $ | (239,791) | |
Total interest-bearing deposits with banks, fed funds sold, and investments | | | 464,303 | | | 165,075 | | | 629,378 | | | 130,439 | | | 157,113 | | | 287,552 | |
Loans held for sale | | | (90,072) | | | 12,433 | | | (77,639) | | | (205,211) | | | (24,625) | | | (229,836) | |
Total interest income | | | 3,978,572 | | | 881,017 | | | 4,859,589 | | | 2,351,198 | | | (2,533,273) | | | (182,075) | |
| | | | | | | | | | | | | | | | | | | |
Interest expense: | | | | | | | | | | | | | | | | | | | |
Time deposits | | | 22,229 | | | (49,258) | | | (27,029) | | | 6,422 | | | (337,546) | | | (331,124) | |
Other interest-bearing deposits | | | 216,800 | | | 170,660 | | | 387,460 | | | 87,968 | | | 139,955 | | | 227,923 | |
Borrowings | | | 34,832 | | | 93,823 | | | 128,655 | | | 11,047 | | | 107,405 | | | 118,452 | |
Total interest expense | | | 273,861 | | | 215,225 | | | 489,086 | | | 105,437 | | | (90,186) | | | 15,251 | |
| | | | | | | | | | | | | | | | | | | |
Increase (decrease) in net interest income | | $ | 3,704,711 | | $ | 665,792 | | $ | 4,370,503 | | $ | 2,245,761 | | $ | (2,443,087) | | $ | (197,326) | |
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 $1.7 million and $1.4 million for the years ended December 31, 2017 and 2016, respectively. As a result, the allowance for loan losses was $4.2 million at December 31, 2017, representing 0.77% of total loans, compared to $2.8 million, or 0.58% of total loans, at December 31, 2016. 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, 2017 and December 31, 2016:
| | | | | | | | | | | | |
| | Year Ended December 31, | | 2017 vs 2016 | |
| | 2017 | | 2016 | | $ Change | | % Change | |
| | | | | | | | | | | | |
Payment sponsorship fees | | $ | 3,039,162 | | $ | 2,524,101 | | $ | 515,061 | | 20 | % |
Mortgage banking fees and gains | | | 527,947 | | | 832,990 | | | (305,043) | | (37) | % |
Service charges on deposit accounts | | | 337,012 | | | 278,949 | | | 58,063 | | 21 | % |
Bargain purchase gain | | | — | | | 893,127 | | | (893,127) | | (100) | % |
(Loss) gain on securities | | | (59,377) | | | 680,982 | | | (740,359) | | (109) | % |
Other noninterest income | | | 2,745,720 | | | 783,447 | | | 1,962,273 | | 250 | % |
Total noninterest Income | | $ | 6,590,464 | | $ | 5,993,596 | | $ | 596,868 | | 10 | % |
| | | | | | | | | | | | |
Noninterest income for the year ended December 31, 2017 was $6.6 million, compared to $6.0 million for the same period of 2016. The increase in 2017 was primarily the result of a $1.4 million insurance income gain related to the settlement of litigation and $0.5 million in higher sponsorship fees, offset by the absence of the $0.9 million bargain purchase gain resulting from the Hopkins Merger in 2016, and a $0.7 million gain on securities sold resulting from increased sales and redemption of available for sale securities in 2016. Other noninterest income increases of $0.4 million, primarily related to BOLI earnings, were offset by decreases of $0.3 million in mortgage banking fees.
Noninterest Expenses
The following table reflects the amounts and changes in noninterest expense for the years ended December 31, 2017 and 2016:
| | | | | | | | | | | | |
| | Year Ended December 31, | | 2017 vs 2016 |
| | 2017 | | 2016 | | $ Change | | % Change |
| | | | | | | | | | | | |
Salary and benefits | | $ | 12,413,164 | | $ | 11,301,774 | | $ | 1,111,390 | | 10 | % |
Occupancy and equipment expenses | | | 2,832,945 | | | 3,341,221 | | | (508,276) | | -15 | % |
Data processing and item processing services | | | 1,390,458 | | | 1,212,471 | | | 177,987 | | 15 | % |
Legal, accounting and other professional fees | | | 716,358 | | | 1,082,206 | | | (365,848) | | -34 | % |
Advertising and marketing related expenses | | | 408,147 | | | 378,924 | | | 29,223 | | 8 | % |
FDIC insurance costs | | | 311,063 | | | 464,616 | | | (153,553) | | -33 | % |
Foreclosed property expenses | | | 200,596 | | | 474,652 | | | (274,056) | | -58 | % |
Loan collection costs | | | 78,547 | | | 106,361 | | | (27,814) | | -26 | % |
Core deposit intangible amortization | | | 789,182 | | | 790,876 | | | (1,694) | | 0 | % |
Merger related expenses | | | 439,055 | | | 1,758,337 | | | (1,319,282) | | -75 | % |
Other expenses | | | 2,059,701 | | | 2,274,970 | | | (215,269) | | -9 | % |
Total Noninterest Expenses | | $ | 21,639,216 | | $ | 23,186,408 | | $ | (1,547,192) | | -7 | % |
Noninterest expense for the year ended December 31, 2017 was $21.6 million compared to $23.2 million for 2016, a decrease of $1.6 million. The primary contributors to the decrease were $1.8 million in merger and acquisition related expenses in 2016 related to the Hopkins Merger, offset by $0.2 million in merger expenses related to the Hopkins Merger in 2017 and $0.3 million in merger expenses in 2017 related to the proposed Merger with Old Line Bancshares. Additional decreases in noninterest expenses were related to $0.5 million in lower occupancy and equipment expenses, $0.4 million in lower legal, accounting and professional fees, $0.3 million in lower foreclosure property expenses, and $0.2 million in lower FDIC insurance costs, offset by increases of $1.1 million in higher salary and employee benefits related to higher incentive and health insurance costs and $0.2 million in higher data and item processing costs.
Income Taxes
For the year ended December 31, 2017, the provision for income taxes totaled $4.0 million, or an effective tax rate of 45.2%, compared to a provision for income taxes of $1.0 million, or an effective tax rate of 38.6%, for 2016. The increase in the provision for 2017 was primarily related to the increase in net income before taxes and the change in the rate was primarily related to a $0.7 million increase in income taxes expense in 2017 related to the revaluation of our deferred assets and liabilities upon the enactment of the Tax Act signed into law on December 22, 2017.
FINANCIAL CONDITION
Our total assets were $659 million at December 31, 2017, an increase of $39 million, or 6%, when compared to the $620 million recorded at December 31, 2016. Loans, net of deferred fees and costs, increased by $55 million, or 11%, as a result of new loan originations. Cash and cash investments and investment securities decreased by $13 million as a result of timing and increased maturities in 2017. Total deposits were $573 million at December 31, 2017, an increase of $47 million, or 9%, when compared to the $526 million recorded at December 31, 2016. The increase was due to an increase in noninterest-bearing deposits of $23 million and a $23 million increase in interest-bearing deposits of $23 million, primarily related to a $20 million temporary escrow deposit returned in January 2018. Short term borrowings were $10 million at December 31, 2017, a decrease of $10 million when compared to December 31, 2016. Stockholders’ equity increased to $72 million at December 31, 2017, compared to $66 million at December 31, 2016. The $6 million, or 9%, increase for the year ended December 31, 2017 resulted primarily from the $5 million in corporate earnings and $1 million in stock compensation plan related increases. The book value of the Company’s common stock was $6.74 at December 31, 2017 and $6.29 at December 31, 2016.
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, state and municipal obligations and corporate bonds. 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 $5 million to $58 million at December 31, 2017 from $63 at December 31, 2016. This decrease was primarily driven by $7 million of net sales and redemption of investment securities and principal pay downs of $9 million offset by $11 million in net purchases.
The composition of investment securities, at carrying value, at December 31, 2017, 2016 and 2015 are presented in the following table:
| | | | | | | | | | | | | | | | |
| | 2017 | | 2016 | | 2015 | |
| | Amount | | % | | Amount | | % | | Amount | | % | |
Available for sale securities | | | | | | | | | | | | | | | | |
U.S. government agency | | $ | 6,821,547 | | 12.2 | % | $ | 7,773,118 | | 12.9 | % | $ | 3,810,639 | | 11.4 | % |
U.S. treasury securities | | | 8,652,660 | | 15.5 | % | | 8,623,259 | | 14.3 | % | | 5,872,140 | | 17.6 | % |
Residential mortgage-backed securities | | | 31,397,837 | | 56.3 | % | | 30,813,481 | | 51.2 | % | | 15,023,225 | | 45.0 | % |
State and municipal bonds | | | 2,564,647 | | 4.6 | % | | 2,637,280 | | 4.4 | % | | 4,531,554 | | 13.6 | % |
Corporate bonds | | | 6,359,500 | | 11.4 | % | | 10,328,455 | | 17.1 | % | | 4,058,140 | | 12.2 | % |
Total debt securities | | | 55,796,191 | | 100.0 | % | | 60,175,593 | | 99.9 | % | | 33,295,698 | | 99.8 | % |
Equity securities | | | 18,025 | | — | % | | 57,134 | | 0.1 | % | | 56,535 | | 0.2 | % |
Total available for sale | | $ | 55,814,216 | | 100.0 | % | $ | 60,232,727 | | 100.0 | % | $ | 33,352,233 | | 100.0 | % |
| | | | | | | | | | | | | | | | |
| | | | | | | | | | | | | | | | |
Held to maturity securities | | | | | | | | | | | | | | | | |
U.S. government agency | | $ | - | | — | % | $ | — | | — | % | $ | 334,257 | | 21.2 | % |
Residential mortgage-backed securities | | | 1,073,107 | | 100.0 | % | | 1,158,238 | | 100.0 | % | | 1,238,908 | | 78.8 | % |
Total held to maturity | | $ | 1,073,107 | | 100.0 | % | $ | 1,158,238 | | 100.0 | % | $ | 1,573,165 | | 100.0 | % |
| | | | | | | | | | | | | | | | |
Restricted equity securities, at cost | | | | | | | | | | | | | | | | |
Stock equity investments | | $ | 1,302,295 | | | | $ | 1,823,195 | | | | $ | 4,864,344 | | | |
| | | | | | | | | | | | | | | | |
Maturities and weighted average yields for investment securities at December 31, 2017 are presented in the following table:
| | | | | | | | | |
| | 2017 | |
| | Amortized | | Fair | | Yield | |
| | Cost | | Value | | (1), (2) | |
Maturing - Available for sale | | | | | | | | | |
Within one year | | $ | 5,543,158 | | $ | 5,537,907 | | 1.24 | % |
Over one to five years | | | 7,971,926 | | | 8,027,149 | | 2.72 | % |
Over five to ten years | | | 10,834,180 | | | 10,833,298 | | 3.24 | % |
Residential mortgage-backed securities | | | 31,581,368 | | | 31,397,837 | | 2.43 | % |
Total debt securities | | $ | 55,930,632 | | $ | 55,796,191 | | | |
| | | | | | | | | |
Maturing - Held to maturity | | | | | | | | | |
Residential mortgage-backed securities | | | 1,073,107 | | | 1,060,406 | | 2.45 | % |
Total held to maturity | | $ | 1,073,107 | | $ | 1,060,406 | | | |
| | | | | | | | | |
| (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 decreased $0.5 million to $1.3 million at December 31, 2017, from $1.8 million at December 31, 2016. This decrease resulted primarily from the net purchase and redemption of FHLB stock required as a result of increases and decreases in borrowings from the FHLB.
Loans Held for Sale
Loans held for sale were $1.1 million at December 31, 2017, compared to $1.6 million at December 31, 2016. The decrease in loans held for sale for 2017 was due to lower originations and loan sales due to a fewer number of loan originators during 2017.
Loans
A comparison of the loan portfolio for the years indicated is presented in the following table:
| | | | | | | | | | | | | | | | | | | | | | | | | | |
| | 2017 | | 2016 | | 2015 | | 2014 | | 2013 | |
| | Amount | | % | | Amount | | % | | Amount | | % | | Amount | | % | | Amount | | % | |
Commercial & Industrial | | $ | 79,776,508 | | 15 | % | $ | 67,234,642 | | 14 | % | $ | 46,464,340 | | 12 | % | $ | 33,454,280 | | 9 | % | $ | 34,278,539 | | 11 | % |
Commercial Real Estate | | | 234,097,013 | | 43 | % | | 205,495,337 | | 42 | % | | 168,569,159 | | 43 | % | | 158,714,554 | | 40 | % | | 157,450,876 | | 49 | % |
Residential Real Estate | | | 145,568,138 | | 27 | % | | 153,368,115 | | 32 | % | | 124,810,853 | | 32 | % | | 140,374,035 | | 36 | % | | 73,323,554 | | 23 | % |
Home Equity Line of Credit | | | 33,810,692 | | 6 | % | | 33,256,012 | | 7 | % | | 33,722,696 | | 9 | % | | 35,717,982 | | 9 | % | | 33,257,822 | | 10 | % |
Land | | | 5,805,203 | | 1 | % | | 5,870,999 | | 1 | % | | 5,229,645 | | 1 | % | | 5,856,875 | | 1 | % | | 1,716,747 | | 1 | % |
Construction | | | 40,482,660 | | 8 | % | | 19,804,912 | | 4 | % | | 13,277,353 | | 3 | % | | 18,052,287 | | 5 | % | | 19,343,013 | | 6 | % |
Consumer & Other | | | 2,710,078 | | - | % | | 2,073,696 | | - | % | | 1,166,521 | | - | % | | 881,179 | | - | % | | 1,309,781 | | - | % |
Total Loans | | | 542,250,292 | | 100 | % | | 487,103,713 | | 100 | % | | 393,240,567 | | 100 | % | | 393,051,192 | | 100 | % | | 320,680,332 | | 100 | % |
Less: Allowance for Loan Losses | | | (4,156,425) | | | | | (2,823,153) | | | | | (1,773,009) | | | | | (1,294,976) | | | | | (851,000) | | | |
Net Loans | | $ | 538,093,867 | | | | $ | 484,280,560 | | | | $ | 391,467,558 | | | | $ | 391,756,216 | | | | $ | 319,829,332 | | | |
Loans, net of deferred fees and costs, increased by $55 million to $542 million at December 31, 2017 from $487 million at December 31, 2016, primarily due to new originations outpacing pay downs.
The following table summarizes the scheduled repayments of our loan portfolio, both by loan category and by fixed and adjustable rates, at December 31, 2017:
| | | | | | | | | | | | | |
| | | | | After One Through | | | | | | | |
| | One Year or Less | | Five Years | | After Five Years | | Total | |
By Loan Category: | | | | | | | | | | | | | |
Commercial & Industrial | | $ | 25,234,277 | | $ | 21,940,550 | | $ | 32,601,681 | | $ | 79,776,508 | |
Commercial Real Estate | | | 35,746,958 | | | 73,276,908 | | | 125,073,147 | | | 234,097,013 | |
Residential Real Estate | | | 18,148,753 | | | 21,644,294 | | | 105,775,091 | | | 145,568,138 | |
Home Equity Line of Credit | | | 30,864,840 | | | 225,027 | | | 2,720,825 | | | 33,810,692 | |
Land | | | 4,893,318 | | | 866,274 | | | 45,611 | | | 5,805,203 | |
Construction | | | 27,874,017 | | | 1,485,536 | | | 11,123,107 | | | 40,482,660 | |
Consumer & Other | | | 1,660,256 | | | 314,262 | | | 735,560 | | | 2,710,078 | |
Total | | $ | 144,422,419 | | $ | 119,752,851 | | $ | 278,075,022 | | $ | 542,250,292 | |
| | | | | | | | | | | | | |
By Rate Terms: | | | | | | | | | | | | | |
Fixed rate | | | 29,016,199 | | | 109,870,792 | | | 240,720,479 | | | 379,607,470 | |
Adjustable rate | | | 115,406,220 | | | 9,882,059 | | | 37,354,543 | | | 162,642,822 | |
Total | | $ | 144,422,419 | | $ | 119,752,851 | | $ | 278,075,022 | | $ | 542,250,292 | |
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, 2017, we had 218 impaired loans totaling $27 million (including PCI loans of $21 million). Of this amount, 123 impaired loans totaling $11 million were classified as nonaccrual loans. At December 31, 2017, TDRs included in impaired loans totaled $0.4 million, one loan of which was included in nonaccrual loans having a total balance of $0.1 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, 2017, the total valuation allowance for impaired loans was $0.4 million.
At December 31, 2016, we had 261 impaired loans totaling $36 million (including PCI loans of $31 million). Of this amount, 132 impaired loans totaling $12 million were classified as nonaccrual loans. At December 31, 2016, TDRs included in impaired loans totaled $1.8 million, nine loans of which were included in nonaccrual loans having a total balance of $1.3 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, 2016, the total valuation allowance for impaired loans was $0.3 million.
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, | |
| | 2017 | | 2016 | | 2015 | | 2014 | | 2013 | |
| | | | | | | | | | | | | | | | |
Nonaccrual loans excluding PCI loans | | $ | 5,809,391 | | $ | 5,001,338 | | $ | 4,794,377 | | $ | 5,237,356 | | $ | 3,809,000 | |
Nonaccrual PCI loans | | | 4,646,325 | | | 6,686,085 | | | 1,089,461 | | | 1,620,710 | | | 179,114 | |
TDR loans excluding those in nonaccrual loans | | | 352,161 | | | 500,411 | | | 623,912 | | | 1,155,508 | | | 1,633,980 | |
Accruing PCI loans past due 90+ days | | | 222,281 | | | 2,421,735 | | | 2,354,891 | | | 5,380,847 | | | 2,692,572 | |
| | | | | | | | | | | | | | | | |
Total nonperforming loans | | | 11,030,158 | | | 14,609,569 | | | 8,862,641 | | | 13,394,421 | | | 8,314,666 | |
| | | | | | | | | | | | | | | | |
Real estate acquired through foreclosure | | | 991,615 | | | 1,224,939 | | | 1,459,732 | | | 1,480,472 | | | 1,290,120 | |
| | | | | | | | | | | | | | | | |
Total nonperforming assets | | $ | 12,021,773 | | $ | 15,834,508 | | $ | 10,322,373 | | $ | 14,874,893 | | $ | 9,604,786 | |
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 $12 million at December 31, 2017 from $16 million at December 31, 2016. Nonperforming assets represented 1.8% of total assets at December 31, 2017, compared to 2.6% at December 31, 2016. 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.
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. At December 31, 2017, these loans totaled $10.5 million and consisted primarily of Commercial Real Estate and Residential Real Estate loans which had balances of $1.2 million and $7.8 million, respectively. At December 31, 2016, these loans totaled $12.1 million and consisted primarily of Commercial Real Estate and Residential Real Estate loans which had balances of $4.9 million and $4.8 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 at 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 at acquisition 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 $4 million at December 31, 2017, compared to $3 million at December 31, 2016. The allowance as a percentage of total portfolio loans was 0.77% at December 31, 2017 and 0.58% at December 31, 2016. 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 $0.2 million and $0.4 million at December 31, 2017 and December 31, 2016, respectively, which represented 2.3% 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 $0.9 million and $1.0 million at December 31, 2017 and December 31, 2016, respectively, which represented 1.3% and 1.2%, respectively, of the related loan balance. For non-impaired acquired legacy Slavie Federal Savings Bank portfolio loans without evidence of deteriorated credit quality, there was net unamortized discount of $1.1 million and $1.6 million at December 31, 2017 and December 31, 2016, respectively, which represented 3.8% and 4.1%, respectively, of the related loan balance. For non-impaired acquired legacy Hopkins Bank portfolio loans without evidence of deteriorated credit quality, there was net unamortized discount of $0.3 million and $0.4 million at December 31, 2017 and December 31, 2016, respectively, which represented 1.1% and 0.8%, 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, 2017, we recorded net charge offs of $323,711, compared to net charge offs of $339,389 during the year ended December 31, 2016.
The following table reflects activity in the allowance for loan losses for the periods indicated:
| | | | | | | | |
| | Year Ended December 31, | | |
| | 2017 | | 2016 | | |
Balance at beginning of year | | $ | 2,823,153 | | $ | 1,773,009 | | |
Charge offs: | | | | | | | | |
Residential Real Estate | | | (559,369) | | | (385,069) | | |
Home Equity Line of Credit | | | — | | | (5,203) | | |
Construction | | | (15,593) | | | — | | |
Consumer & Other | | | (14,999) | | | (455) | | |
Total charge offs | | | (589,961) | | | (390,727) | | |
| | | | | | | | |
Recoveries: | | | | | | | | |
Commercial & Industrial | | | 375 | | | — | | |
Residential Real Estate | | | 167,350 | | | 51,338 | | |
Land | | | 98,091 | | | — | | |
Consumer & Other | | | 434 | | | — | | |
Total recoveries | | | 266,250 | | | 51,338 | | |
| | | | | | | | |
Net (charge offs) recoveries | | | (323,711) | | | (339,389) | | |
Provision for loan loss | | | 1,656,983 | | | 1,389,533 | | |
| | | | | | | | |
Balance at end of period | | $ | 4,156,425 | | $ | 2,823,153 | | |
| | | | | | | | |
Net (charge offs) recoveries as a percentage of average loans | | | 0.09 | % | | 0.10 | % | |
The following table presents the allowance for loan losses by loan category at the dates indicated below:
| | | | | | | | | | | | | | | | | | | | | | | | | | |
| | 2017 | | 2016 | | 2015 | | 2014 | | 2013 | |
| | Amount | %Loan | %Total | | Amount | %Loan | %Total | | Amount | %Loan | %Total | | Amount | %Loan | %Total | | Amount | %Loan | %Total | |
Commercial & Industrial | | $ | 577,702 | 0.7% | 14% | | $ | 369,857 | 0.6% | 13% | | $ | 210,798 | 0.5% | 12% | | $ | 200,510 | 0.6% | 15% | | $ | 167,400 | 0.5% | 20% | |
Commercial Real Estate | | | 1,658,803 | 0.7% | 40% | | | 1,082,855 | 0.5% | 38% | | | 727,869 | 0.4% | 41% | | | 554,585 | 0.3% | 43% | | | 324,080 | 0.2% | 38% | |
Residential Real Estate | | | 1,316,732 | 0.9% | 32% | | | 1,043,778 | 0.7% | 37% | | | 593,084 | 0.5% | 33% | | | 203,413 | 0.1% | 16% | | | 80,239 | 0.1% | 9% | |
Home Equity Line of Credit | | | 246,161 | 0.7% | 6% | | | 184,296 | 0.6% | 7% | | | 157,043 | 0.5% | 9% | | | 166,733 | 0.5% | 13% | | | 129,203 | 0.4% | 15% | |
Land | | | 40,988 | 0.7% | 1% | | | 19,159 | 0.3% | 1% | | | 15,713 | 0.3% | 1% | | | 8,687 | 0.1% | 1% | | | 6,918 | 0.4% | 1% | |
Construction | | | 296,133 | 0.7% | 7% | | | 111,503 | 0.6% | 4% | | | 62,967 | 0.5% | 4% | | | 153,089 | 0.8% | 12% | | | 135,416 | 0.7% | 16% | |
Consumer & Other | | | 19,906 | 0.7% | 0% | | | 11,705 | 0.6% | 0% | | | 5,535 | 0.5% | 0% | | | 7,959 | 0.9% | 1% | | | 7,744 | 0.6% | 1% | |
Total Loans | | $ | 4,156,425 | 0.8% | 100% | | $ | 2,823,153 | 0.6% | 100% | | $ | 1,773,009 | 0.5% | 100% | | $ | 1,294,976 | 0.3% | 100% | | $ | 851,000 | 0.3% | 100% | |
Deposits
The following deposit table presents the composition of deposits at December 31, 2017 and 2016:
| | | | | | | | | | | | | | | | |
| | December 31, 2017 | | December 31, 2016 | | 2017 vs 2016 | |
| | Amount | | % of Total | | Amount | | % of Total | | $ Change | | % Change | |
Noninterest-bearing deposits | | $ | 134,617,261 | | 24 | % | $ | 111,378,694 | | 21 | % | $ | 23,238,567 | | 21 | % |
| | | | | | | | | | | | | | | | |
Interest-bearing deposits: | | | | | | | | | | | | | | | | |
Checking | | | 65,077,405 | | 11 | % | | 58,482,158 | | 11 | % | | 6,595,247 | | 11 | % |
Savings | | | 107,112,529 | | 19 | % | | 120,376,229 | | 23 | % | | (13,263,700) | | (11) | % |
Money market | | | 150,534,960 | | 26 | % | | 109,550,925 | | 21 | % | | 40,984,035 | | 37 | % |
Total interest-bearing checking, savings and money market deposits | | | 322,724,894 | | 56 | % | | 288,409,312 | | 55 | % | | 34,315,582 | | 12 | % |
| | | | | | | | | | | | | | | | |
Time deposits $100,000 and below | | | 60,970,287 | | 11 | % | | 72,021,712 | | 14 | | | (11,051,425) | | (15) | % |
Time deposits above $100,000 and below $250,000 | | | 40,537,390 | | 7 | % | | 42,849,544 | | 8 | % | | (2,312,154) | | (5) | % |
Time deposits above $250,000 | | | 13,904,728 | | 2 | % | | 11,799,132 | | 2 | % | | 2,105,596 | | 18 | % |
Total time deposits | | | 115,412,405 | | 21 | % | | 126,670,388 | | 24 | % | | (11,257,983) | | (9) | % |
| | | | | | | | | | | | | | | | |
Total interest bearing deposits | | | 438,137,299 | | 76 | % | | 415,079,700 | | 79 | % | | 23,057,599 | | 6 | % |
| | | | | | | | | | | | | | | | |
Total Deposits | | $ | 572,754,560 | | 100 | % | $ | 526,458,394 | | 100 | % | $ | 46,296,166 | | 9 | % |
Total deposits were $573 million at December 301 2017, an increase of $46 million, or 9%, when compared to December 31, 2016. Within the deposit base, noninterest-bearing deposits increased by $23 million, or 21%, interest-bearing checking account balances increased $7 million, or 11%, interest-bearing savings account balances decreased by $13 million, or 11%, money market balances increased $41 million, or 37%, and time deposit balances decreased by $11 million, or 9%, when compared to the amounts at December 31, 2016.
The ratio of noninterest-bearing deposits to total deposits was 24% at December 31, 2017, an increase of 3% from December 31, 2016. Included in our deposit portfolio are brokered deposits through the Promontory Interfinancial Network. Through this deposit matching network, which included CDARS and 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, 2017, we had zero and $15.0 million in CDARS and ICS deposits through the reciprocal deposit program, respectively, compared to $0.6 million and $10.5 million, respectively, at December 31, 2016. We can also choose to place deposits through this network without receiving matching deposits. At December 31, 2017 and at December 31, 2016, there were no non-reciprocating balances through this network.
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, | |
| | 2017 | | 2016 | | 2015 | |
| | Average | | Average | | Average | | Average | | Average | | Average | |
| | Balance | | Rate Paid | | Balance | | Rate Paid | | Balance | | Rate Paid | |
Noninterest-bearing deposits | | $ | 117,709,317 | | 0.00 | % | $ | 99,915,024 | | 0.00 | % | $ | 97,275,956 | | 0.00 | % |
Interest-bearing deposits: | | | | | | | | | | | | | | | | |
Checking and savings | | | 174,005,586 | | 0.28 | % | | 129,299,405 | | 0.25 | % | | 84,326,839 | | 0.11 | % |
Money market | | | 121,221,482 | | 0.41 | % | | 98,303,236 | | 0.27 | % | | 91,545,248 | | 0.29 | % |
Total interest-bearing checking, savings and money market deposits | | | 295,227,068 | | 0.33 | % | | 227,602,641 | | 0.26 | % | | 175,872,087 | | 0.20 | % |
| | | | | | | | | | | | | | | | |
Total time deposits | | | 118,138,725 | | 0.88 | % | | 115,626,446 | | 0.93 | % | | 115,097,362 | | 1.22 | % |
| | | | | | | | | | | | | | | | |
Total interest-bearing deposits | | | 413,365,793 | | 0.53 | % | | 343,229,087 | | 0.50 | % | | 290,969,449 | | 0.58 | % |
| | | | | | | | | | | | | | | | |
Total deposits | | $ | 531,075,110 | | 0.41 | % | $ | 443,144,111 | | 0.39 | % | $ | 388,245,405 | | 0.44 | % |
The following table presents the maturity distribution for time deposits of $250 thousand or more at December 31, 2017:
| | | | |
| | Amount | |
Three months or less | | $ | 297,726 | |
Over three months through six months | | | 253,764 | |
Over six months through twelve months | | | 2,613,262 | |
Over twelve months | | | 10,739,976 | |
Total Time Deposits | | $ | 13,904,728 | |
Borrowings
Borrowings at December 31, 2017 consist of FHLB overnight borrowings of $10 million, compared to FHLB overnight borrowings of $20 million at December 31, 2016. The $10 million decrease in FHLB borrowings was primarily related to the timing of an increase in deposits in December 2017 related to a temporary escrow deposit.
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 assets and liabilities effectively.
At December 31, 2017, our total stockholders’ equity increased to $72 million from $66 million at December 31, 2016, primarily as a result of $5 million in corporate earnings and $1 million for the issuance of common stock and stock-based compensation expense under the Company’s stock compensation plans.
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 $1.0 billion in total consolidated assets. The Federal Reserve Board raised the threshold for the small bank holding company exclusion from $500 million to $1 billion in April 2015.
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 at 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, 2017, $0.7 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 “well capitalized” is 5%, but an individual institution could be required to maintain a higher level. In connection with the merger of Carrollton Bank with and into the Bank, 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. In 2016, the OCC reduced the
required leverage ratio for the Bank to at least 8.5%. 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, 2017 and 2016, 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 | |
| | | | | | | | | | | | | | Minimum Capital | | | Capitalized Under | |
| | | | | | | | Minimum | | | Requirements with | | | Prompt Corrective | |
| | Actual | | | Capital Requirements | | | Conservation Buffer | | | Action Provisions | |
| | Amount | | Ratio | | | Amount | | Ratio | | | Amount | | Ratio | | | Amount | | Ratio | |
At December 31, 2017: | | | | | | | | | | | | | | | | | | | | | | | | |
| | | | | | | | | | | | | | | | | | | | | | | | |
Common Equity Tier 1 Capital | | $ | 68,579 | | 12.11 | % | | $ | 25,476 | | 4.50 | % | | $ | 32,553 | | 5.75 | % | | $ | 36,799 | | 6.50 | % |
| | | | | | | | | | | | | | | | | | | | | | | | |
Tier I Risk-Based Capital Ratio | | $ | 68,579 | | 12.11 | % | | $ | 33,968 | | 6.00 | % | | $ | 41,045 | | 7.25 | % | | $ | 45,291 | | 8.00 | % |
| | | | | | | | | | | | | | | | | | | | | | | | |
Total Risk-Based Capital Ratio | | $ | 72,735 | | 12.85 | % | | $ | 45,291 | | 8.00 | % | | $ | 52,367 | | 9.25 | % | | $ | 56,613 | | 10.00 | % |
| | | | | | | | | | | | | | | | | | | | | | | | |
Tier 1 Leverage Ratio | | $ | 68,579 | | 10.54 | % | | $ | 26,036 | | 4.00 | % | | $ | 34,173 | | 5.25 | % | | $ | 32,546 | | 5.00 | % |
| | | | | | | | | | | | | | | | | | | | | | | | |
At December 31, 2016: | | | | | | | | | | | | | | | | | | | | | | | | |
| | | | | | | | | | | | | | | | | | | | | | | | |
Common Equity Tier 1 Capital | | $ | 63,057 | | 12.32 | % | | $ | 23,039 | | 4.50 | % | | $ | 26,239 | | 5.125 | % | | $ | 33,279 | | 6.50 | % |
| | | | | | | | | | | | | | | | | | | | | | | | |
Tier I Risk-Based Capital Ratio | | $ | 63,057 | | 12.32 | % | | $ | 30,719 | | 6.00 | % | | $ | 33,919 | | 6.625 | % | | $ | 40,959 | | 8.00 | % |
| | | | | | | | | | | | | | | | | | | | | | | | |
Total Risk-Based Capital Ratio | | $ | 65,883 | | 12.87 | % | | $ | 40,959 | | 8.00 | % | | $ | 44,159 | | 8.625 | % | | $ | 51,199 | | 10.00 | % |
| | | | | | | | | | | | | | | | | | | | | | | | |
Tier 1 Leverage Ratio | | $ | 63,057 | | 10.45 | % | | $ | 24,133 | | 4.00 | % | | $ | 27,904 | | 4.625 | % | | $ | 30,166 | | 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 received 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 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 $106 million at December 31, 2017. 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, 2017, we had $9 million in cash and due from banks, $22 million in interest-bearing deposits with banks and federal funds sold, and $56 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 the FHLB, which can be drawn upon when required. The Bank has a line of credit totaling approximately $163 million with the FHLB of which $65 million was available to be drawn on December 31, 2017 based on qualifying loans pledged as collateral. In addition, the Bank can pledge securities at the Reserve Bank and the 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 $38 million of securities pledged at the FHLB, $0.1 million of securities pledged at the Reserve Bank, and an additional $19 million of unpledged securities. Using these securities as collateral, the Bank could borrow approximately $43 million at December 31, 2017.
Additionally, the Bank has unsecured federal funds lines of credit totaling $8 million with two institutions and a $4 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 Federal Reserve Bank or to pledge unpledged securities to this institution before it could borrow against this line. The proceeds of the Company’s line of credit may be used for general corporate purposes. At December 31, 2017, there were outstanding balances of $10 million under the Bank’s FHLB line and of $0 under the Company’s other line of credit.
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 or strategy analysis 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, 2017, we were in a liability sensitive position over a one year measurement horizon. 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) | % | (15.0) | % | (10.0) | % | (5.0) | % | (5.0) | % | (10.0) | % | (15.0) | % | (20.0) | % |
December 31, 2017 | | (7.5) | % | (5.6) | % | (3.7) | % | (1.7) | % | (1.4) | % | N/A | | N/A | | N/A | |
December 31, 2016 | | (9.9) | % | (7.4) | % | (4.9) | % | (2.4) | % | (4.0) | % | N/A | | N/A | | N/A | |
As shown above, measures of net interest income at risk were slightly more favorable at December 31, 2017 than at December 31, 2016 at all interest rate shock levels over a 12 month modelling period. All measures remained within prescribed policy limits. The primary contributors to the more favorable position were additions and improvements to our 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, 2017 | | 7.2 | % | 6.5 | % | 5.1 | % | 3.9 | % | (16.0) | % | N/A | | N/A | | N/A | |
December 31, 2016 | | 5.1 | % | 4.8 | % | 3.9 | % | 3.2 | % | (15.1) | % | N/A | | N/A | | N/A | |
The EVE at risk increased slightly at December 31, 2017 when compared to December 31, 2016 in most interest rate shock levels. We evaluated the slightly below policy decrease at the (100) bp level and the declining rate scenario shown in the table above. Although we believe the likelihood of this scenario is extremely remote, we will continue to monitor our strategy and measure the impact of our adjustments to ensure they do not 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 at December 31, 2017:
| | | | | | | | | | | | | | | | |
| | Projected Maturity Date or Payment Period | |
| | Total | | Less than 1 year | | 1 - 3 years | | 3 - 5 years | | More than 5 years | |
Time Deposits (1) | | $ | 115,412,405 | | $ | 43,191,811 | | $ | 61,139,334 | | $ | 10,902,341 | | $ | 178,919 | |
Operating lease obligations (2) | | | 10,194,145 | | | 1,123,057 | | | 1,562,934 | | | 1,301,946 | | | 6,206,208 | |
Purchase obligations (3) | | | 443,000 | | | 364,000 | | | 79,000 | | | — | | | — | |
Total | | $ | 126,049,550 | | $ | 44,678,868 | | $ | 62,781,268 | | $ | 12,204,287 | | $ | 6,385,127 | |
| (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 and our financial systems service providers. |
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 at December 31, 2017:
| | | | |
| | December 31, 2017 | |
Loan commitments | | $ | 13,643,220 | |
Unused lines of credit | | | 92,732,676 | |
Standby letters of credit | | | 8,510,683 | |
Mortgage loan repurchase obligation | | | 1,399,750 | |
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 and other fees subject to repurchase were $1.8 million and $7.2 million at December 31, 2017 and 2016, 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 stockholders and Board of Directors of Bay Bancorp, Inc.
Opinion on the Financial Statements
We have audited the accompanying consolidated balance sheets of Bay Bancorp, Inc. and subsidiary (the “Company”) as of December 31, 2017 and 2016, and the related consolidated statements of income, comprehensive income, stockholders’ equity and cash flows for the years ended December 31, 2017 and 2016, and the related notes (collectively referred to as the “consolidated financial statements”). In our opinion, the consolidated financial statements present fairly, in all material respects, the financial position of the Company as of December 31, 2017 and 2016, and the results of their operations and their cash flows for the years then ended, in conformity with accounting principles generally accepted in the United States of America.
Basis for Opinion
These consolidated financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on the Company’s consolidated financial statements based on our audits. We are a public accounting firm registered with the Public Company Accounting Oversight Board (United States) (“PCAOB”) and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB.
We conducted our audits in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement whether due to error or fraud. The Company is not required to have, nor were we engaged to perform, an audit of its internal control over financial reporting. As part of our audits we are required to obtain an understanding of internal control over financial reporting 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.
Our audits included performing procedures to assess the risks of material misstatement of the financial statements, whether due to error or fraud, and performing procedures that respond to those risks. Such procedures included examining, on a test basis, evidence regarding the amounts and disclosures in the financial statements. Our audits also included evaluating the accounting principles used and significant estimates made by management, as well as evaluating the overall presentation of the financial statements.
We believe that our audits provide a reasonable basis for our opinion.
/s/ Dixon Hughes Goodman LLP
We have served as the Company’s auditor since 2015.
Gaithersburg, Maryland
March 28, 2018
BAY BANCORP, INC. AND SUBSIDIARY
CONSOLIDATED BALANCE SHEETS
| | | | | | | |
| | December 31, | |
| | | | | | | |
| | 2017 | | 2016 | |
ASSETS | | | | | | | |
Cash and due from banks | | $ | 9,316,482 | | $ | 7,591,685 | |
Interest bearing deposits with banks and federal funds sold | | | 22,249,796 | | | 32,435,771 | |
Total Cash and Cash Equivalents | | | 31,566,278 | | | 40,027,456 | |
| | | | | | | |
Investment securities available for sale, at fair value | | | 55,814,216 | | | 60,232,727 | |
Investment securities held to maturity, at amortized cost | | | 1,073,107 | | | 1,158,238 | |
Restricted equity securities, at cost | | | 1,302,295 | | | 1,823,195 | |
Loans held for sale | | | 1,097,160 | | | 1,613,497 | |
| | | | | | | |
Loans, net of deferred fees and costs | | | 542,250,292 | | | 487,103,713 | |
Less: Allowance for loan losses | | | (4,156,425) | | | (2,823,153) | |
Loans, net | | | 538,093,867 | | | 484,280,560 | |
| | | | | | | |
Real estate acquired through foreclosure | | | 991,615 | | | 1,224,939 | |
Premises and equipment, net | | | 3,306,025 | | | 3,882,343 | |
Bank owned life insurance | | | 16,205,352 | | | 15,729,302 | |
Core deposit intangibles | | | 2,241,127 | | | 3,030,309 | |
Deferred tax assets, net | | | 1,806,352 | | | 2,984,718 | |
Accrued interest receivable | | | 2,176,359 | | | 1,884,945 | |
Accrued taxes receivable | | | 2,469,620 | | | 1,153,102 | |
Prepaid expenses | | | 604,381 | | | 1,001,723 | |
Other assets | | | 225,170 | | | 276,540 | |
Total Assets | | $ | 658,972,924 | | $ | 620,303,594 | |
| | | | | | | |
LIABILITIES | | | | | | | |
Noninterest-bearing deposits | | $ | 134,617,261 | | $ | 111,378,694 | |
Interest-bearing deposits | | | 438,137,299 | | | 415,079,700 | |
Total Deposits | | | 572,754,560 | | | 526,458,394 | |
| | | | | | | |
Short-term borrowings | | | 10,000,000 | | | 20,000,000 | |
Defined benefit pension liability | | | 612,112 | | | 994,156 | |
Accrued expenses and other liabilities | | | 3,730,123 | | | 6,923,818 | |
Total Liabilities | | | 587,096,795 | | | 554,376,368 | |
| | | | | | | |
STOCKHOLDERS’ EQUITY | | | | | | | |
Common stock - par $1.00 per shares, authorized 20,000,000 shares, issued and outstanding 10,717,889 and 10,626,290 shares at December 31, 2017 and December 31, 2016, respectively. | | | 10,667,227 | | | 10,456,098 | |
Additional paid-in capital | | | 41,692,751 | | | 40,814,285 | |
Retained earnings | | | 19,180,657 | | | 14,426,969 | |
Accumulated other comprehensive income | | | 335,494 | | | 30,383 | |
Total controlling interest | | | 71,876,129 | | | 65,727,735 | |
Non-controlling interest | | | — | | | 199,491 | |
Total Stockholders' Equity | | | 71,876,129 | | | 65,927,226 | |
Total Liabilities and Stockholders' Equity | | $ | 658,972,924 | | $ | 620,303,594 | |
See accompanying notes to audited consolidated financial statements
BAY BANCORP, INC. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF INCOME
| | | | | | | |
| | Year Ended December 31, | |
| | 2017 | | 2016 | |
INTEREST INCOME | | | | | | | |
Interest and fees on loans | | $ | 25,975,924 | | $ | 21,668,074 | |
Interest on loans held for sale | | | 43,358 | | | 120,997 | |
Interest and dividends on securities | | | 1,492,003 | | | 1,034,090 | |
Interest on deposits with banks and federal funds sold | | | 375,735 | | | 204,270 | |
Total interest income | | | 27,887,020 | | | 23,027,431 | |
| | | | | | | |
INTEREST EXPENSE | | | | | | | |
Interest on deposits | | | 2,019,129 | | | 1,658,698 | |
Interest on federal funds purchased | | | 132 | | | 28 | |
Interest on short-term borrowings | | | 319,959 | | | 191,408 | |
Total interest expense | | | 2,339,220 | | | 1,850,134 | |
Net interest income | | | 25,547,800 | | | 21,177,297 | |
| | | | | | | |
Provision for loan losses | | | 1,656,983 | | | 1,389,533 | |
Net interest income after provision for loan losses | | | 23,890,817 | | | 19,787,764 | |
| | | | | | | |
NONINTEREST INCOME | | | | | | | |
Payment sponsorship fees | | | 3,039,162 | | | 2,524,101 | |
Mortgage banking fees and gains | | | 527,947 | | | 832,990 | |
Service charges on deposit accounts | | | 337,012 | | | 278,949 | |
Bargain purchase gain | | | — | | | 893,127 | |
(Loss) gain on securities | | | (59,377) | | | 680,982 | |
Other income | | | 2,745,720 | | | 783,447 | |
Total noninterest Income | | | 6,590,464 | | | 5,993,596 | |
| | | | | | | |
NONINTEREST EXPENSES | | | | | | | |
Salary and benefits | | | 12,413,164 | | | 11,301,774 | |
Occupancy and equipment expenses | | | 2,832,945 | | | 3,341,221 | |
Data processing and item processing services | | | 1,390,458 | | | 1,212,471 | |
Legal, accounting and other professional fees | | | 716,358 | | | 1,082,206 | |
Advertising and marketing related expenses | | | 408,147 | | | 378,924 | |
FDIC insurance costs | | | 311,063 | | | 464,616 | |
Foreclosed property expenses and REO sales, net | | | 200,596 | | | 474,652 | |
Loan collection costs | | | 78,547 | | | 106,361 | |
Core deposit intangible amortization | | | 789,182 | | | 790,876 | |
Merger related expenses | | | 439,055 | | | 1,758,337 | |
Other expenses | | | 2,059,701 | | | 2,274,970 | |
Total noninterest expenses | | | 21,639,216 | | | 23,186,408 | |
Income before income taxes | | | 8,842,065 | | | 2,594,952 | |
Income tax expense | | | 4,000,579 | | | 1,001,596 | |
NET INCOME FROM CONTINUING OPERATIONS | | | 4,841,486 | | | 1,593,356 | |
Net income from discontinued operations, net of tax | | | — | | | 366,034 | |
NET INCOME | | $ | 4,841,486 | | $ | 1,959,390 | |
Net income from discontinued operations attributable to non-controlling interest | | | — | | | 199,491 | |
Net income available to common stockholders | | $ | 4,841,486 | | $ | 1,759,899 | |
| | | | | | | |
Weighted average shares outstanding | | | | | | | |
Basic | | | 10,607,217 | | | 10,734,748 | |
Diluted | | | 10,740,982 | | | 10,860,153 | |
| | | | | | | |
Earnings per share | | | | | | | |
Basic | | $ | 0.46 | | $ | 0.16 | |
Diluted | | $ | 0.45 | | $ | 0.16 | |
| | | | | | | |
See accompanying notes to audited consolidated financial statements
BAY BANCORP, INC. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
| | | | | | | |
| | Year Ended December 31, | |
| | 2017 | | 2016 | |
Net income | | $ | 4,841,486 | | $ | 1,959,390 | |
| | | | | | | |
Other comprehensive income (loss): | | | | | | | |
| | | | | | | |
Net unrealized gain on securities available for sale: | | | | | | | |
Net unrealized gain on securities during the period | | | 105,426 | | | 102,065 | |
Reclassification adjustment for loss (gain) on securities included in net income | | | 59,377 | | | (680,982) | |
Income tax expense relating to items above | | | (78,783) | | | 207,841 | |
Net effect on other comprehensive income (loss) | | | 86,020 | | | (371,076) | |
| | | | | | | |
Unrealized gain (loss) on defined benefit pension plan | | | 335,716 | | | (284,206) | |
Income tax (expense) benefit relating to item above | | | (116,625) | | | 112,105 | |
Net effect on other comprehensive income (loss) | | | 219,091 | | | (172,101) | |
| | | | | | | |
Other comprehensive income (loss) | | | 305,111 | | | (543,177) | |
Comprehensive income | | | 5,146,597 | | | 1,416,213 | |
| | | | | | | |
Comprehensive income available to non-controlling interest | | | — | | | 199,491 | |
Comprehensive income available to common stockholders | | $ | 5,146,597 | | $ | 1,216,722 | |
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 | | Non-controlling | | | | |
| | Stock | | Capital | | Earnings | | Income (Loss) | | Interest | | Total | |
Balance December 31, 2015 | | $ | 11,062,932 | | $ | 43,378,927 | | $ | 12,667,070 | | $ | 573,560 | | $ | — | | $ | 67,682,489 | |
| | | | | | | | | | | | | | | | | | | |
Net income | | | — | | | — | | | 1,759,899 | | | — | | | 199,491 | | | 1,959,390 | |
Other comprehensive income (loss) | | | — | | | — | | | — | | | (543,177) | | | — | | | (543,177) | |
Stock-based compensation | | | — | | | 94,607 | | | — | | | — | | | — | | | 94,607 | |
Issuance of common stock under stock-based compensation plan and 401K match | | | 136,602 | | | 389,313 | | | — | | | — | | | — | | | 525,915 | |
Repurchase of common stock | | | (743,436) | | | (3,048,562) | | | — | | | — | | | — | | | (3,791,998) | |
Balance December 31, 2016 | | $ | 10,456,098 | | $ | 40,814,285 | | $ | 14,426,969 | | $ | 30,383 | | $ | 199,491 | | $ | 65,927,226 | |
| | | | | | | | | | | | | | | | | | | |
| | | | | | | | | | | | | | | | | | | |
| | | | | | | | | | | Accumulated | | | | | | |
| | | | | Additional | | | | | Other | | | | | | |
| | Common | | Paid-in | | Retained | | Comprehensive | | Non-controlling | | | | |
| | Stock | | Capital | | Earnings | | Income (Loss) | | Interest | | Total | |
Balance December 31, 2016 | | $ | 10,456,098 | | $ | 40,814,285 | | $ | 14,426,969 | | $ | 30,383 | | $ | 199,491 | | $ | 65,927,226 | |
| | | | | | | | | | | | | | | | | | | |
Net income | | | — | | | — | | | 4,841,486 | | | — | | | — | | | 4,841,486 | |
Other comprehensive income (loss) | | | — | | | — | | | (87,798) | | | 305,111 | | | — | | | 217,313 | |
Stock-based compensation | | | — | | | 263,168 | | | — | | | — | | | — | | | 263,168 | |
Sale of iReverse | | | — | | | — | | | — | | | — | | | (199,491) | | | (199,491) | |
Issuance of common stock under stock-based compensation plan | | | 211,129 | | | 615,298 | | | — | | | — | | | — | | | 826,427 | |
Balance December 31, 2017 | | $ | 10,667,227 | | $ | 41,692,751 | | $ | 19,180,657 | | $ | 335,494 | | $ | — | | $ | 71,876,129 | |
See accompanying notes to audited consolidated financial statements
BAY BANCORP, INC. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF CASH FLOWS
| | | | | | | |
| | Years Ended December 31, | |
| | 2017 | | 2016 | |
| | | | | | | |
Cash flows from operating activities: | | | | | | | |
Net income | | $ | 4,841,486 | | $ | 1,959,390 | |
Adjustments to reconcile net income to net cash provided by (used in) operating activities: | | | | | | | |
Depreciation and amortization of premises and equipment | | | 579,012 | | | 649,878 | |
Stock-based compensation | | | 263,168 | | | 94,607 | |
Amortization of investment premiums and discounts, net | | | 224,415 | | | 237,298 | |
Accretion of net discounts on loans | | | (2,626,987) | | | (1,894,976) | |
Amortization of core deposit intangibles | | | 789,182 | | | 790,876 | |
(Accretion) amortization of deposit discounts and premiums | | | (25,941) | | | 4,955 | |
Provision for loan losses | | | 1,656,983 | | | 1,389,533 | |
Increase in cash surrender value of bank owned life insurance | | | (476,050) | | | (117,950) | |
Bargain purchase gain | | | — | | | (893,127) | |
Loss (gain) on securities | | | 59,377 | | | (680,982) | |
Loss (gain) on sale and disposal of premises and equipment | | | 97,773 | | | (347,587) | |
Write down of real estate acquired through foreclosure | | | 158,842 | | | 308,536 | |
Gain on sale of real estate acquired through foreclosure | | | (86,587) | | | (34,940) | |
Origination of loans held for sale | | | (30,129,383) | | | (41,825,473) | |
Proceeds from sales of loans held for sale | | | 31,610,318 | | | 45,998,019 | |
Gains on sales of loans held for sale | | | (964,598) | | | (1,232,406) | |
Deferred income taxes | | | 748,953 | | | 58,785 | |
Net increase in accrued interest receivable | | | (291,414) | | | (86,412) | |
Net (increase) decrease in accrued taxes receivable | | | (1,316,518) | | | 1,622,135 | |
Net decrease (increase) in prepaid expenses and other assets | | | 448,712 | | | (8,981,750) | |
Net increase (decrease) in pension plan liability | | | 99,884 | | | (119,287) | |
Net decrease in accrued expenses and other liabilities | | | (3,393,186) | | | (355,050) | |
Net cash provided by (used in) operating activities - continuing operations | | | 2,267,441 | | | (3,455,928) | |
Net cash provided by operating activities - discontinued operations | | | — | | | 408,721 | |
Net cash provided by (used in) operating activities | | | 2,267,441 | | | (3,047,207) | |
| | | | | | | |
Cash flows from investing activities: | | | | | | | |
Acquisition, net of cash acquired | | | — | | | 103,889,228 | |
Purchases of investment securities available for sale | | | (8,808,580) | | | (18,429,993) | |
Redemptions and maturities of investment securities available for sale | | | 13,104,591 | | | 32,853,420 | |
Redemption and maturities of investment securities held to maturity | | | 88,638 | | | 435,566 | |
Net redemption of Federal Home Loan Bank Stock | | | 520,900 | | | 1,358,500 | |
Net increase in loans | | | (53,538,851) | | | (34,868,466) | |
Proceeds from sale of real estate acquired through foreclosure | | | 856,617 | | | 958,058 | |
Purchases of premises and equipment | | | (193,049) | | | (312,226) | |
Proceeds from sale of premises and equipment | | | 92,581 | | | 1,282,832 | |
Net cash (used in) provided by investing activities - continuing operations | | | (47,877,153) | | | 87,166,919 | |
Net cash provided by investing activities - discontinued operations | | | — | | | 151,943 | |
Net cash (used in) provided by investing activities | | | (47,877,153) | | | 87,318,862 | |
| | | | | | | |
| | | | | | | |
Cash flows from financing activities: | | | | | | | |
Net increase (decrease) in deposits | | | 46,322,107 | | | (43,091,338) | |
Net decrease in short-term borrowings | | | (10,000,000) | | | (32,300,000) | |
Repurchase of common stock | | | — | | | (3,791,998) | |
Issuance of common stock for 401K match | | | — | | | 68,189 | |
Issuance of common stock under stock-based compensation plans | | | 826,427 | | | 457,726 | |
Net cash provided by (used in) financing activities | | | 37,148,534 | | | (78,657,421) | |
| | | | | | | |
Net (decrease) increase in cash and cash equivalents | | | (8,461,178) | | | 5,614,234 | |
Cash and cash equivalents at beginning of period | | | 40,027,456 | | | 34,413,222 | |
Cash and cash equivalents at end of period | | $ | 31,566,278 | | $ | 40,027,456 | |
| | | | | | | |
Supplemental Disclosures of Cash Flow information: | | | | | | | |
Interest paid on deposits and borrowings | | $ | 2,362,896 | | $ | 1,849,933 | |
Net income tax paid (refunded) | | | 4,322,000 | | | (552,391) | |
| | | | | | | |
Non Cash activities: | | | | | | | |
Transfer of loans to real estate acquired through foreclosure | | $ | 695,548 | | $ | 996,860 | |
Transfer of loans held for sale to loan portfolio | | | — | | | 310,707 | |
| | | | | | | |
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 Bancorp’s books on the basis of its equity in the net assets of the Bank.
Reclassifications
Certain prior year amounts have been reclassified to conform to current period classifications.
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 July 8, 2016 merger of Hopkins Bancorp, Inc. with and into the Company and the related merger of Hopkins Federal Savings Bank with and into the Bank (collectively, the “Hopkins Merger”); 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, 2017 and 2016.
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 at December 31, 2017 and 2016. 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 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: (i) the length of time and the extent to which the fair value has been less than cost; (ii) the reasons for the decline in value; (iii) the financial position and access to capital of the issuer, including the current and future impact of any specific events; and (iv) 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, 2017 and 2016:
| | | | | | | |
| | 2017 | | 2016 | |
Federal Home Loan Bank | | $ | 983,300 | | $ | 1,504,200 | |
Visa Inc., Class B | | | 204,195 | | | 204,195 | |
Maryland Financial Bank | | | 49,800 | | | 49,800 | |
Atlantic Community Bankers Bank | | | 65,000 | | | 65,000 | |
Total restricted equity securities | | $ | 1,302,295 | | $ | 1,823,195 | |
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. The amortization of loan fees or costs is discontinued when a loan is placed on nonaccrual status. 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 Hopkins Merger and previous acquisitions and mergers 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 Financial Accounting Standards Board (the “FASB”) Accounting Standards Codification (“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 Federal Savings Bank, Carrollton Bank, and Hopkins Federal Savings Bank (“Hopkins Bank”) 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 expense.
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 Hopkins Merger 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. The amortization of deferred gains on sale and leaseback transactions are recorded as a reduction to rent expense.
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. The Company reviews intangibles on a periodic basis or whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable, in which case an impairment charge would be recorded in noninterest expense.
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 May 2014, the FASB issued Accounting Standards Update (“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 2016, the FASB deferred the effective date by one year from the date in the original guidance. The guidance is effective for fiscal years and interim periods beginning after December 15, 2017. The Company’s adoption of this item is not expected to have a material impact on its results of operations or financial condition.
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 does not expect this ASU to have a material impact on the Company’s consolidated financial statements, but does expect a change in the fair value of loans reported in Note 16 – Fair Value.
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 an 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 does not 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 reviewed the impact of the adoption and where the Company is a lessee, primarily for the Company’s ground leases and administrative office leases, the Company will be required to record a lease liability and a right of use asset on its Consolidated Balance Sheets at fair value upon adoption.
In June 2016, FASB issued ASU No. 2016-13 Financial Instruments-Credit Losses (Topic 326). The ASU improves financial reporting by requiring timelier recording of credit losses on loans and other financial instruments held by the Company. The ASU requires the Company to measure all expected credit losses for financial assets held at the
reporting date based on historical experience, current conditions, and reasonable and supportable forecasts. Many of the loss estimation techniques applied today will still be permitted, although the inputs to those techniques will change to reflect the full amount of expected credit losses. The Company will continue to use judgment to determine which loss estimation method is appropriate for their circumstances. The ASU requires enhanced disclosures to help investors and other financial statement users better understand significant estimates and judgments used in estimating credit losses, as well as the credit quality and underwriting standards of an organization's portfolio. These disclosures include qualitative and quantitative requirements that provide additional information about the amounts recorded in the financial statements. Additionally, the ASU amends the accounting for credit losses on available-for-sale debt securities and purchased financial assets with credit deterioration. The ASU will take effect for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2019. Early application will be permitted for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2018. The Company’s finance team is reviewing its procedures and researching additional software resources for measuring credit losses and the effect of the ASU on its consolidated balance sheets and consolidated statements of operations.
In August 2016, FASB issued ASU No. 2016-15, Statement of Cash Flows (Topic 230): Classification of Certain Cash Receipts and Cash Payments. This ASU addresses the appropriate classification of eight specific cash flow issues on the cash flow statement. Debt prepayment costs should be classified as an outflow for financing activities. Settlement of zero-coupon debt instruments divides the interest portion as an outflow for operating activities and the principal portion as an outflow for financing activities. Contingent consideration payments made after a business combination should be classified as outflows for financing and operating activities. Proceeds from the settlement of bank-owned life insurance policies should be classified as inflows from investing activities. Other specific areas are identified in the ASU as to the appropriate classification of the cash inflows or outflows. The amendments in this ASU are effective for fiscal years beginning after December 15, 2017, including interim periods within those fiscal years. Early adoption is permitted and must be applied using a retrospective transition method to each period presented. The Company's finance team is evaluating the impact of this pronouncement and researching additional software resources that could assist with the implementation.
In November 2016, FASB issued ASU No. 2016-18, “Statement of Cash Flows – Restricted Cash.” This ASU provides guidance on the presentation of restricted cash or restricted cash equivalents in the statement of cash flows and is effective for the first quarter of 2018. Earlier application is permitted. The Company does not expect this ASU to have a material impact on the Company’s consolidated financial statements.
In January 2017, the FASB issued ASU No. 2017-04, “Simplifying the Test for Goodwill Impairment.” The guidance removes Step 2 of the goodwill impairment test, which requires a hypothetical purchase price allocation. Goodwill impairment will now be the amount by which a reporting unit’s carrying value exceeds its fair value, not to exceed the carrying amount of goodwill. All other goodwill impairment guidance will remain largely unchanged. ASU No. 2017-04 is effective for interim and annual reporting periods beginning after December 15, 2019, applied prospectively. Early adoption is permitted for any impairment tests performed after January 1, 2017. The Company does not expect this ASU to have a material impact on the Company’s consolidated financial statements.
In March 2017, the FASB issued ASU No. 2017-07, “Improving the Presentation of Net Periodic Pension Cost and Net Periodic Postretirement Benefit Cost.” Under the new guidance, employers will present the service cost component of the net periodic benefit cost in the same income statement line item (e.g., Salaries and Benefits) as other employee compensation costs arising from services rendered during the period. In addition, only the service cost component will be eligible for capitalization in assets. Employers will present the other components separately (e.g., Other Noninterest Expense) from the line item that includes the service cost. ASU No. 2017-07 is effective for interim and annual reporting periods beginning after December 15, 2017. Early adoption is permitted, however, the Company has decided not to early adopt. Employers will apply the guidance on the presentation of the components of net periodic benefit cost in the income statement retrospectively. The guidance limiting the capitalization of net periodic benefit cost in assets to the service cost component will be applied prospectively. The Company expects to utilize the ASU’s practical expedient allowing entities to estimate amounts for comparative periods using the information previously disclosed in their pension and other postretirement benefit plan footnote. The Company does not expect this ASU to have a material impact on the Company’s consolidated financial statements.
In March 2017, the FASB issued ASU No. 2017-08, “Premium Amortization on Purchased Callable Debt Securities.” This ASU shortens the amortization period for the premium on certain purchased callable debt securities to the earliest call date. Today, entities generally amortize the premium over the contractual life of the security. The new
guidance does not change the accounting for purchased callable debt securities held at a discount; the discount continues to be amortized to maturity. ASU No. 2017-08 is effective for interim and annual reporting periods beginning after December 15, 2018; early adoption is permitted. The guidance calls for a modified retrospective transition approach under which a cumulative-effect adjustment will be made to retained earnings as of the beginning of the first reporting period in which the guidance is adopted. The Company continues to evaluate the provisions of ASU No. 2017-08 to determine the potential impact the new standard will have on the Company’s consolidated financial statements.
In May 2017, the FASB issued ASU No. 2017-09, “Stock Compensation, Scope of Modification Accounting.” This ASU clarifies when changes to the terms of conditions of a share-based payment award must be accounted for as modifications. Companies will apply the modification accounting guidance if the value, vesting conditions or classification of the award changes. The new guidance should reduce diversity in practice and result in fewer changes to the terms of an award being accounted for as modifications, as the guidance will allow companies to make certain non-substantive changes to awards without accounting for them as modifications. It does not change the accounting for modifications. ASU No. 2017-09 is effective for interim and annual reporting periods beginning after December 15, 2017; early adoption is permitted. ASU No. 2017-09 is not expected to have a material impact on the Company’s consolidated financial statements.
In July 2017, the FASB issued ASU No. 2017-11, “Earnings Per Share (Topic 260): Distinguishing Liabilities from Equity (Topic 480)” This ASU addresses narrow issues identified a result of the complexity associated with applying GAAP for certain financial instruments with characteristics of liabilities. ASU No. 2017-11 is effective for interim and annual reporting periods beginning after December 15, 2018; early adoption is permitted. ASU No. 2017-11 is not expected to have a material impact on the Company’s consolidated financial statements.
In August 2017, the FASB issued ASU No. 2017-12, “Derivatives and Hedging (Topic 815): Target Improvements to Accounting for Hedging Activities” This ASU’s objective is to improve the financial reporting of hedging relationships to better portray the economic results of an entity’s risk management activities in its financial statements. In addition to that main objective, the amendments in this update make certain targeted improvements to simplify the application of the hedge accounting guidance in current GAAP. ASU No. 2017-12 is effective for interim and annual reporting periods beginning after December 15, 2018; early adoption is permitted. The Company will evaluate the provisions of ASU No. 2017-12 to determine the potential impact the new standard will have on the Company’s consolidated financial statements.
In February 2018, the FASB issued ASU No. 2018-02, “Income Statement - Reporting Comprehensive Income (Topic 220): Reclassification of Certain Tax Effects from AOCI,” a revised guidance on the accounting for certain tax effects stranded in AOCI. U.S. GAAP requires the effects of changes in tax rates and laws on deferred tax balances to be recorded as a component of income tax expense from continuing operations in the period of enactment. For deferred tax assets and liabilities related to items in AOCI, this results in the tax effects of such changes being stranded in AOCI. The revised guidance provides an optional reclassification from AOCI to retained earnings for such stranded tax effects resulting from the reduction in the corporate income tax rate enacted by the Tax Act. The reclassification may also include such stranded tax effects resulting from other income tax effects of the Tax Act, such as the effect of the federal benefit of deducting state income taxes. Entities are provided the option to apply the guidance retrospectively or in the period of adoption. The guidance is effective for us on January 1, 2019, with early adoption permitted. The Company continues to evaluate the provisions of ASU No. 2018-02 to determine the potential impact the new standard will have on the Company’s consolidated financial statements.
NOTE 2 – DISCONTINUED OPERATIONS
From July 8, 2016 until March 31, 2017, the Bank had an investment in a reverse home loan mortgage brokerage firm named iReverse Home Loan, LLC (“iReverse”). The Bank owned 51% of iReverse and reported its non-controlling interest in iReverse separately in the consolidated balance sheet at December 31, 2016. The Company reported the income of iReverse attributable to the Bank on the consolidated statement of income for the year ended December 31, 2016 as discontinued operations. On March 31, 2017, the Bank sold this interest to the other owner of iReverse for $70,000. The Company reported no discontinued operations for the year ended December 31, 2017.
Discontinued operations for the year ended December 31, 2016 included noninterest income and noninterest expense related to iReverse. The net income from discontinued operations, net of taxes for the year
ended December, 2016 was $366,034, with $199,491 attributable to non-controlling interest and $166,543 attributable to common stockholders.
Summarized financial information for our discontinued operations related to iReverse was as follows:
| |
| December 31, 2016 |
ASSETS | |
Cash and cash equivalents | $ 1,394,265 |
Other assets | 47,760 |
Total assets | 1,442,025 |
| |
LIABILITIES | |
Accrued expenses and other liabilities | 1,034,902 |
Total liabilities | 1,034,902 |
Net assets of discontinued operations | $ 407,123 |
| |
| For the Year Ended |
| December 31, 2016 |
NONINTEREST INCOME | |
Mortgage brokerage operations | $ 3,088,523 |
Bargain purchase gain | 151,943 |
Total noninterest income | 3,240,466 |
| |
NONINTEREST EXPENSES | |
Salaries and employee benefits | 2,001,455 |
Occupancy and equipment expenses | 37,225 |
Legal, accounting and other professional fees | 9,497 |
Advertising and marketing related expenses | 233,321 |
Other expenses | 567,132 |
Total Noninterest Expenses | 2,848,630 |
Income before taxes | 391,836 |
Income tax expense | 25,802 |
Net income from discontinued operations | $ 366,034 |
Net income from discontinued operations attributable to non-controlling interest | $ 199,491 |
| |
Net income available to common stockholders | $ 166,543 |
| |
NOTE 3 – INVESTMENT SECURITIES
At December 31, 2017 and December 31, 2016, 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, 2017 | | cost | | Gains | | Losses | | Fair Value | |
U.S. government agency | | $ | 6,776,250 | | $ | 47,553 | | $ | (2,256) | | $ | 6,821,547 | |
U.S. treasury securities | | | 8,757,476 | | | — | | | (104,816) | | | 8,652,660 | |
Residential mortgage-backed securities | | | 31,581,368 | | | 148,493 | | | (332,024) | | | 31,397,837 | |
State and municipal | | | 2,565,599 | | | 1,063 | | | (2,015) | | | 2,564,647 | |
Corporate bonds | | | 6,249,939 | | | 112,606 | | | (3,045) | | | 6,359,500 | |
Total debt securities | | | 55,930,632 | | | 309,715 | | | (444,156) | | | 55,796,191 | |
Equity securities | | | 18,765 | | | — | | | (740) | | | 18,025 | |
Totals | | $ | 55,949,397 | | $ | 309,715 | | $ | (444,896) | | $ | 55,814,216 | |
| | | | | | | | | | | | | |
Held-to-Maturity | | Amortized | | Gross Unrealized | | Estimated | |
December 31, 2017 | | cost | | Gains | | Losses | | Fair Value | |
Residential mortgage-backed securities | | | 1,073,107 | | | | | | (12,701) | | | 1,060,406 | |
Total debt securities | | | 1,073,107 | | | — | | | (12,701) | | | 1,060,406 | |
Totals | | $ | 1,073,107 | | $ | — | | $ | (12,701) | | $ | 1,060,406 | |
| | | | | | | | | | | | | |
Available for Sale | | Amortized | | Gross Unrealized | | Estimated | |
December 31, 2016 | | cost | | Gains | | Losses | | Fair Value | |
U.S. government agency | | $ | 7,748,481 | | $ | 68,493 | | $ | (43,856) | | $ | 7,773,118 | |
U.S. treasury securities | | | 8,728,284 | | | 14,812 | | | (119,837) | | | 8,623,259 | |
Residential mortgage-backed securities | | | 30,952,601 | | | 197,495 | | | (336,615) | | | 30,813,481 | |
State and municipal | | | 2,638,214 | | | 2,421 | | | (3,355) | | | 2,637,280 | |
Corporate bonds | | | 10,372,549 | | | 1,647 | | | (45,741) | | | 10,328,455 | |
Total debt securities | | | 60,440,129 | | | 284,868 | | | (549,404) | | | 60,175,593 | |
Equity securities | | | 92,585 | | | 6,021 | | | (41,472) | | | 57,134 | |
Totals | | $ | 60,532,714 | | $ | 290,889 | | $ | (590,876) | | $ | 60,232,727 | |
| | | | | | | | | | | | | |
Held-to-Maturity | | Amortized | | Gross Unrealized | | Estimated | |
December 31, 2016 | | cost | | Gains | | Losses | | Fair Value | |
Residential mortgage-backed securities | | $ | 1,158,238 | | $ | — | | $ | (8,896) | | $ | 1,149,342 | |
Total debt securities | | | 1,158,238 | | | — | | | (8,896) | | | 1,149,342 | |
Totals | | $ | 1,158,238 | | $ | — | | $ | (8,896) | | $ | 1,149,342 | |
Unrealized losses segregated by length of impairment at December 31, 2017 and December 31, 2016 were as follows:
| | | | | | | | | | | | | | | | | | | |
| | Less than 12 months | | 12 months or longer | | Total | |
Available for Sale | | Fair | | Unrealized | | Fair | | Unrealized | | Fair | | Unrealized | |
December 31, 2017 | | Value | | Losses | | Value | | Losses | | Value | | Losses | |
U.S. government agency | | $ | — | | $ | — | | $ | 997,480 | | $ | (2,256) | | $ | 997,480 | | $ | (2,256) | |
U.S. treasury securities | | | 5,861,490 | | | (25,801) | | | 2,791,170 | | | (79,015) | | | 8,652,660 | | | (104,816) | |
Residential mortgage-backed securities | | | 2,495,139 | | | (17,648) | | | 12,259,611 | | | (314,376) | | | 14,754,750 | | | (332,024) | |
State and municipals | | | 1,716,573 | | | (1,738) | | | 324,834 | | | (277) | | | 2,041,407 | | | (2,015) | |
Corporate bonds | | | 3,496,955 | | | (3,045) | | | — | | | — | | | 3,496,955 | | | (3,045) | |
Total debt securities | | | 13,570,157 | | | (48,232) | | | 16,373,095 | | | (395,924) | | | 29,943,252 | | | (444,156) | |
Equity securities | | | — | | | — | | | 18,765 | | | (740) | | | 18,765 | | | (740) | |
Totals | | $ | 13,570,157 | | $ | (48,232) | | $ | 16,391,860 | | $ | (396,664) | | $ | 29,962,017 | | $ | (444,896) | |
| | | | | | | | | | | | | | | | | | | |
| | Less than 12 months | | 12 months or longer | | Total | |
Held-to-Maturity | | Fair | | Unrealized | | Fair | | Unrealized | | Fair | | Unrealized | |
December 31, 2017 | | Value | | Losses | | Value | | Losses | | Value | | Losses | |
Residential mortgage-backed securities | | | 1,060,406 | | | (12,701) | | | — | | | — | | | 1,060,406 | | | (12,701) | |
Total debt securities | | $ | 1,060,406 | | $ | (12,701) | | $ | — | | $ | — | | $ | 1,060,406 | | $ | (12,701) | |
| | | | | | | | | | | | | | | | | | | |
| | | | | | | | | | | | | | | | | | | |
| | Less than 12 months | | 12 months or longer | | Total | |
Available for Sale | | Fair | | Unrealized | | Fair | | Unrealized | | Fair | | Unrealized | |
December 31, 2016 | | Value | | Losses | | Value | | Losses | | Value | | Losses | |
U.S. government agency | | $ | 3,983,930 | | $ | (43,856) | | $ | — | | $ | — | | $ | 3,983,930 | | $ | (43,856) | |
U.S. treasury securities | | | 5,645,640 | | | (119,837) | | | — | | | — | | | 5,645,640 | | | (119,837) | |
Residential mortgage-backed securities | | | 17,368,416 | | | (315,284) | | | 563,545 | | | (21,331) | | | 17,931,961 | | | (336,615) | |
State and municipals | | | 1,042,964 | | | (3,355) | | | — | | | — | | | 1,042,964 | | | (3,355) | |
Corporate bonds | | | 7,973,405 | | | (45,741) | | | — | | | — | | | 7,973,405 | | | (45,741) | |
Total debt securities | | | 36,014,355 | | | (528,073) | | | 563,545 | | | (21,331) | | | 36,577,900 | | | (549,404) | |
Equity securities | | | — | | | — | | | 25,180 | | | (41,472) | | | 25,180 | | | (41,472) | |
Totals | | $ | 36,014,355 | | $ | (528,073) | | $ | 588,725 | | $ | (62,803) | | $ | 36,603,080 | | $ | (590,876) | |
| | | | | | | | | | | | | | | | | | | |
| | Less than 12 months | | 12 months or longer | | Total | |
Held-to-Maturity | | Fair | | Unrealized | | Fair | | Unrealized | | Fair | | Unrealized | |
December 31, 2016 | | Value | | Losses | | Value | | Losses | | Value | | Losses | |
Residential mortgage-backed securities | | | 1,149,342 | | | (8,896) | | | — | | | — | | | 1,149,342 | | | (8,896) | |
Total debt securities | | $ | 1,149,342 | | $ | (8,896) | | $ | — | | $ | — | | $ | 1,149,342 | | $ | (8,896) | |
| | | | | | | | | | | | | | | | | | | |
At December 31, 2017, unrealized losses in the Company’s portfolio of debt securities of $444,156 in the aggregate were related to 71 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, 2017, unrealized losses in the Company’s portfolio of equity securities of $740 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, 2016, unrealized losses in the Company’s portfolio of debt securities of $549,404 in the aggregate were related to 73 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, 2016, unrealized losses in the Company’s portfolio of equity securities of $41,472 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.
Except for U.S. Agency securities, there was no outstanding balance of any single issuer which exceeded 10% of stockholders’ equity at December 31, 2017 or 2016.
No investment securities held by the Company at December 31, 2017 and December 31, 2016 were subject to a write-down due to credit related other-than-temporary impairment.
Contractual maturities of debt securities at December 31, 2017 and 2016 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.
| | | | | | | | | | | | | | |
| | 2017 | | 2016 | | |
| | Amortized | | Fair | | Amortized | | Fair | | |
| | Cost | | Value | | Cost | | Value | | |
Available for sale | | | | | | | | | | | | | | |
Within one year | | $ | 5,543,158 | | $ | 5,537,907 | | $ | 6,122,743 | | $ | 6,100,576 | | |
Over one to five years | | | 7,971,926 | | | 8,027,149 | | | 12,570,847 | | | 12,642,656 | | |
Over five to ten years | | | 10,834,180 | | | 10,833,298 | | | 7,765,282 | | | 7,627,060 | | |
Over ten years | | | — | | | — | | | 3,028,656 | | | 2,991,820 | | |
Residential mortgage-backed securities | | | 31,581,368 | | | 31,397,837 | | | 30,952,601 | | | 30,813,481 | | |
Totals | | $ | 55,930,632 | | $ | 55,796,191 | | $ | 60,440,129 | | $ | 60,175,593 | | |
| | | | | | | | | | | | | | |
| | 2017 | | 2016 | | |
| | Amortized | | Fair | | Amortized | | Fair | | |
| | Cost | | Value | | Cost | | Value | | |
Held to maturity | | | | | | | | | | | | | | |
Residential mortgage-backed securities | | | 1,073,107 | | | 1,060,406 | | | 1,158,238 | | | 1,149,342 | | |
Totals | | $ | 1,073,107 | | $ | 1,060,406 | | $ | 1,158,238 | | $ | 1,149,342 | | |
| | | | | | | | | | | | | | |
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, 2017, there were 16 sales of investment securities available for sale for a gain of $610. During the year ended December 31, 2016, there were six sales of investment securities available for sale for a gain of $420,280.
At December 31, 2017, securities with an amortized cost of $38,238,595 (fair value of $38,122,102) were pledged as collateral for potential borrowing from the Federal Home Loan Bank of Atlanta (the “FHLB”) and the Federal Reserve Bank of Richmond (the “Reserve Bank”). At December 31, 2016, securities with an amortized cost of $10,479,133 (fair value of $10,604,335) 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, | | December 31, | |
| | 2017 | | 2016 | |
Commercial & Industrial | | $ | 79,776,508 | | $ | 67,234,642 | |
Commercial Real Estate | | | 234,097,013 | | | 205,495,337 | |
Residential Real Estate | | | 145,568,138 | | | 153,368,115 | |
Home Equity Line of Credit | | | 33,810,692 | | | 33,256,012 | |
Land | | | 5,805,203 | | | 5,870,999 | |
Construction | | | 40,482,660 | | | 19,804,912 | |
Consumer & Other | | | 2,710,078 | | | 2,073,696 | |
Total Loans | | | 542,250,292 | | | 487,103,713 | |
Less: Allowance for Loan Losses | | | (4,156,425) | | | (2,823,153) | |
Net Loans | | $ | 538,093,867 | | $ | 484,280,560 | |
At December 31, 2017 and December 31, 2016, loans not considered to have deteriorated credit quality at acquisition had a total remaining unamortized discount of $2,955,938 and $3,793,033, respectively, and carrying values of $146,647,976 and $187,483,532, 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 separated 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, 2017 and 2016, Commercial Real Estate – Investor loans had a total balance of $153,282,836 and $138,527,163, respectively. At December 31, 2017 and December 31, 2016, Commercial Real Estate – Owner Occupied loans had a total balance of $80,814,177 and $66,968,174, 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 a 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, 2017 and 2016, Residential Real Estate – Investor loans had a total balance of $43,770,327 and $44,787,039, respectively. At December 31, 2017 and 2016, Residential Real Estate – Owner Occupied loans had a total balance of $101,797,811 and $108,581,076, 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 purchased credit impaired (“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, troubled debt restructurings (“TDRs”), and PCI loans where cash flows have deteriorated from those forecasted at 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, 2017:
| | | | | | | | | | | | | | | | | | | | | | | | | |
| | Commercial | | Commercial | | Residential | | Home Equity | | | | | | | | Consumer | | | | |
| | & Industrial | | Real Estate | | Real Estate | | Line of Credit | | Land | | Construction | | & Other | | Total | |
Allowance for loan losses: | | | | | | | | | | | | | | | | | | | | | | | | | |
Beginning balance | | $ | 369,857 | | $ | 1,082,855 | | $ | 1,043,778 | | $ | 184,296 | | $ | 19,159 | | $ | 111,503 | | $ | 11,705 | | $ | 2,823,153 | |
Charge-offs | | | — | | | — | | | (559,369) | | | — | | | — | | | (15,593) | | | (14,999) | | | (589,961) | |
Recoveries (1) | | | 375 | | | — | | | 167,350 | | | — | | | 98,091 | | | — | | | 434 | | | 266,250 | |
Provision | | | 207,470 | | | 575,948 | | | 664,973 | | | 61,865 | | | (76,262) | | | 200,223 | | | 22,766 | | | 1,656,983 | |
Ending balance | | $ | 577,702 | | $ | 1,658,803 | | $ | 1,316,732 | | $ | 246,161 | | $ | 40,988 | | $ | 296,133 | | $ | 19,906 | | $ | 4,156,425 | |
| | | | | | | | | | | | | | | | | | | | | | | | | |
The following table presents loans and the related allowance for loan losses, by loan portfolio segment, at December 31, 2017:
| | | | | | | | | | | | | | | | | | | | | | | | | |
| | 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 | | $ | — | | $ | 7,199 | | $ | 345,105 | | $ | — | | $ | — | | $ | — | | $ | — | | $ | 352,304 | |
Ending balance: | | | | | | | | | | | | | | | | | | | | | | | | | |
collectively evaluated | | | | | | | | | | | | | | | | | | | | | | | | | |
for impairment | | | 577,702 | | | 1,651,604 | | | 971,627 | | | 246,161 | | | 40,988 | | | 296,133 | | | 19,906 | | | 3,804,121 | |
Totals | | $ | 577,702 | | $ | 1,658,803 | | $ | 1,316,732 | | $ | 246,161 | | $ | 40,988 | | $ | 296,133 | | $ | 19,906 | | $ | 4,156,425 | |
| | | | | | | | | | | | | | | | | | | | | | | | | |
Loans: | | | | | | | | | | | | | | | | | | | | | | | | | |
Ending balance: | | | | | | | | | | | | | | | | | | | | | | | | | |
individually evaluated | | | | | | | | | | | | | | | | | | | | | | | | | |
for impairment | | $ | 993,924 | | $ | 166,323 | | $ | 4,855,341 | | $ | 71,367 | | $ | 59,544 | | $ | — | | $ | 15,052 | | $ | 6,161,551 | |
Ending balance: | | | | | | | | | | | | | | | | | | | | | | | | | |
collectively evaluated | | | | | | | | | | | | | | | | | | | | | | | | | |
for impairment | | | 78,212,088 | | | 223,601,941 | | | 131,543,430 | | | 33,326,502 | | | 5,549,152 | | | 40,091,892 | | | 2,695,026 | | | 515,020,031 | |
Ending balance: loans | | | | | | | | | | | | | | | | | | | | | | | | | |
acquired with deteriorated | | | | | | | | | | | | | | | | | | | | | | | | | |
credit quality (2) | | | 570,496 | | | 10,328,749 | | | 9,169,367 | | | 412,823 | | | 196,507 | | | 390,768 | | | — | | | 21,068,710 | |
Totals | | $ | 79,776,508 | | $ | 234,097,013 | | $ | 145,568,138 | | $ | 33,810,692 | | $ | 5,805,203 | | $ | 40,482,660 | | $ | 2,710,078 | | $ | 542,250,292 | |
| | | | | | | | | | | | | | | | | | | | | | | | | |
| (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 $57,600 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, 2016:
| | | | | | | | | | | | | | | | | | | | | | | | | |
| | Commercial | | Commercial | | Residential | | Home Equity | | | | | | | | Consumer | | | | |
| | & Industrial | | Real Estate | | Real Estate | | Line of Credit | | Land | | Construction | | & Other | | Total | |
Allowance for loan losses: | | | | | | | | | | | | | | | | | | | | | | | | | |
Beginning balance | | $ | 210,798 | | $ | 727,869 | | $ | 593,084 | | $ | 157,043 | | $ | 15,713 | | $ | 62,967 | | $ | 5,535 | | $ | 1,773,009 | |
Charge-offs | | | — | | | — | | | (385,069) | | | (5,203) | | | — | | | — | | | (455) | | | (390,727) | |
Recoveries (1) | | | — | | | — | | | 51,338 | | | — | | | — | | | — | | | — | | | 51,338 | |
Provision | | | 159,059 | | | 354,986 | | | 784,425 | | | 32,456 | | | 3,446 | | | 48,536 | | | 6,625 | | | 1,389,533 | |
Ending balance | | $ | 369,857 | | $ | 1,082,855 | | $ | 1,043,778 | | $ | 184,296 | | $ | 19,159 | | $ | 111,503 | | $ | 11,705 | | $ | 2,823,153 | |
| | | | | | | | | | | | | | | | | | | | | | | | | |
The following table presents loans and the related allowance for loan losses, by loan portfolio segment, at December 31, 2016:
| | | | | | | | | | | | | | | | | | | | | | | | | |
| | 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 | | $ | — | | $ | — | | $ | 270,526 | | $ | — | | $ | — | | $ | — | | $ | — | | $ | 270,526 | |
Ending balance: | | | | | | | | | | | | | | | | | | | | | | | | | |
collectively evaluated | | | | | | | | | | | | | | | | | | | | | | | | | |
for impairment | | | 369,857 | | | 1,082,855 | | | 773,252 | | | 184,296 | | | 19,159 | | | 111,503 | | | 11,705 | | | 2,552,627 | |
Totals | | $ | 369,857 | | $ | 1,082,855 | | $ | 1,043,778 | | $ | 184,296 | | $ | 19,159 | | $ | 111,503 | | $ | 11,705 | | $ | 2,823,153 | |
| | | | | | | | | | | | | | | | | | | | | | | | | |
Loans: | | | | | | | | | | | | | | | | | | | | | | | | | |
Ending balance: | | | | | | | | | | | | | | | | | | | | | | | | | |
individually evaluated | | | | | | | | | | | | | | | | | | | | | | | | | |
for impairment | | $ | 641,774 | | $ | 277,515 | | $ | 4,521,110 | | $ | 55,552 | | $ | — | | $ | — | | $ | 5,798 | | $ | 5,501,749 | |
Ending balance: | | | | | | | | | | | | | | | | | | | | | | | | | |
collectively evaluated | | | | | | | | | | | | | | | | | | | | | | | | | |
for impairment | | | 65,341,316 | | | 191,303,934 | | | 136,607,497 | | | 32,558,837 | | | 3,384,741 | | | 19,698,823 | | | 2,067,898 | | | 450,963,046 | |
Ending balance: loans | | | | | | | | | | | | | | | | | | | | | | | | | |
acquired with deteriorated | | | | | | | | | | | | | | | | | | | | | | | | | |
credit quality(2) | | | 1,251,552 | | | 13,913,888 | | | 12,239,508 | | | 641,623 | | | 2,486,258 | | | 106,089 | | | — | | | 30,638,918 | |
Totals | | $ | 67,234,642 | | $ | 205,495,337 | | $ | 153,368,115 | | $ | 33,256,012 | | $ | 5,870,999 | | $ | 19,804,912 | | $ | 2,073,696 | | $ | 487,103,713 | |
| | | | | | | | | | | | | | | | | | | | | | | | | |
| (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 $98,154 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, at December 31, 2017:
| | | | | | | | | | | | | | | | |
| | | | | | | | | | | For the Year Ended | |
| | At December 31, 2017 | | December 31, 2017 | |
| | | | | Unpaid | | | | | Average | | Interest | |
| | Recorded | | Principal | | Related | | Recorded | | Income (loss) | |
| | Investment | | Balance | | Allowance | | Investment | | Recognized (1) | |
With no related allowance recorded: | | | | | | | | | | | | | | | | |
Commercial & Industrial | | $ | 993,924 | | $ | 1,078,072 | | $ | — | | $ | 1,103,381 | | $ | 37,642 | |
Residential Real Estate - Investor | | | 781,838 | | | 926,422 | | | — | | | 1,006,252 | | | 4,954 | |
Residential Real Estate - Owner occupied | | | 3,418,617 | | | 3,627,184 | | | — | | | 3,815,332 | | | 116,759 | |
Land | | | 59,544 | | | 63,118 | | | — | | | 62,103 | | | 275 | |
Home Equity Line of Credit | | | 71,367 | | | 101,073 | | | — | | | 91,486 | | | (168) | |
Consumer & Other | | | 15,052 | | | 198,457 | | | — | | | 107,871 | | | (16) | |
| | | | | | | | | | | | | | | | |
With an allowance recorded: | | | | | | | | | | | | | | | | |
Commercial Real Estate - Owner occupied | | | 166,323 | | | 166,063 | | | 7,199 | | | 121,088 | | | (18) | |
Residential Real Estate - Investor | | | 339,381 | | | 356,269 | | | 188,473 | | | 357,006 | | | 9,208 | |
Residential Real Estate - Owner occupied | | | 543,102 | | | 518,739 | | | 156,632 | | | 560,296 | | | 21,307 | |
| | | | | | | | | | | | | | | | |
Total | | | 6,389,148 | | | 7,035,397 | | | 352,304 | | | 7,224,815 | | | 189,943 | |
| | | | | | | | | | | | | | | | |
Total impaired loans: | | | | | | | | | | | | | | | | |
Commercial & Industrial | | $ | 993,924 | | $ | 1,078,072 | | $ | — | | $ | 1,103,381 | | $ | 37,642 | |
Commercial Real Estate | | | 166,323 | | | 166,063 | | | 7,199 | | | 121,088 | | | (18) | |
Residential Real Estate | | | 5,082,938 | | | 5,428,614 | | | 345,105 | | | 5,738,886 | | | 152,228 | |
Land | | | 59,544 | | | 63,118 | | | — | | | 62,103 | | | 275 | |
Home Equity Line of Credit | | | 71,367 | | | 101,073 | | | — | | | 91,486 | | | (168) | |
Consumer & Other | | | 15,052 | | | 198,457 | | | — | | | 107,871 | | | (16) | |
Total | | $ | 6,389,148 | | $ | 7,035,397 | | $ | 352,304 | | $ | 7,224,815 | | $ | 189,943 | |
| (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, at December 31, 2016:
| | | | | | | | | | | | | | | | |
| | | | | | | | | | | For the year ended | |
| | At December 31, 2016 | | December 31, 2016 | |
| | | | | Unpaid | | Average | | Average | | | | |
| | Recorded | | Principal | | Related | | Recorded | | Income (loss) | |
| | Investment | | Balance | | Allowance | | Investment | | Recognized (1) | |
With no related allowance recorded: | | | | | | | | | | | | | | | | |
Commercial & Industrial | | $ | 641,774 | | $ | 739,128 | | $ | — | | $ | 804,938 | | $ | 79,886 | |
Commercial Real Estate - Investor | | | 277,515 | | | 277,515 | | | — | | | 294,053 | | | — | |
Residential Real Estate - Investor | | | 785,500 | | | 890,719 | | | — | | | 994,674 | | | 11,748 | |
Residential Real Estate - Owner occupied | | | 3,008,832 | | | 3,196,027 | | | — | | | 3,225,912 | | | 103,916 | |
Home Equity Line of Credit | | | 55,552 | | | 85,470 | | | — | | | 73,026 | | | (68) | |
Consumer & Other | | | 5,798 | | | 189,204 | | | — | | | 97,501 | | | — | |
| | | | | | | | | | | | | | | | |
With an allowance recorded: | | | | | | | | | | | | | | | | |
Residential Real Estate - Investor | | | 790,537 | | | 813,087 | | | 268,537 | | | 832,508 | | | 5,920 | |
Residential Real Estate - Owner occupied | | | 159,028 | | | 159,028 | | | 1,989 | | | 160,102 | | | — | |
| | | | | | | | | | | | | | | | |
Total | | | 5,724,536 | | | 6,350,178 | | | 270,526 | | | 6,482,714 | | | 201,402 | |
| | | | | | | | | | | | | | | | |
Total impaired loans: | | | | | | | | | | | | | | | | |
Commercial & Industrial | | $ | 641,774 | | $ | 739,128 | | $ | — | | $ | 804,938 | | $ | 79,886 | |
Commercial Real Estate | | | 277,515 | | | 277,515 | | | — | | | 294,053 | | | — | |
Residential Real Estate | | | 4,743,897 | | | 5,058,861 | | | 270,526 | | | 5,213,196 | | | 121,584 | |
Home Equity Line of Credit | | | 55,552 | | | 85,470 | | | — | | | 73,026 | | | (68) | |
Construction | | | — | | | — | | | — | | | — | | | — | |
Consumer & Other | | | 5,798 | | | 189,204 | | | — | | | 97,501 | | | — | |
Total | | $ | 5,724,536 | | $ | 6,350,178 | | $ | 270,526 | | $ | 6,482,714 | | $ | 201,402 | |
| (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 at December 31, 2017:
| | | | | | | | | | | | | | | | |
| | Risk Rating | |
| | Pass | | Special Mention | | Substandard | | Doubtful | | Total | |
Commercial & Industrial | | $ | 75,620,689 | | $ | 83,890 | | $ | 4,071,929 | | $ | — | | $ | 79,776,508 | |
Commercial Real Estate - Investor | | | 150,280,526 | | | — | | | 3,002,310 | | | — | | | 153,282,836 | |
Commercial Real Estate - Owner Occupied | | | 78,630,032 | | | 957,887 | | | 1,226,258 | | | — | | | 80,814,177 | |
Residential Real Estate - Investor | | | 38,837,947 | | | 228,251 | | | 4,704,129 | | | — | | | 43,770,327 | |
Residential Real Estate - Owner Occupied | | | 96,354,867 | | | — | | | 5,442,944 | | | — | | | 101,797,811 | |
Home Equity Line of Credit | | | 33,757,501 | | | — | | | 53,191 | | | — | | | 33,810,692 | |
Land | | | 5,638,879 | | | — | | | 166,324 | | | — | | | 5,805,203 | |
Construction | | | 40,057,287 | | | — | | | 425,373 | | | — | | | 40,482,660 | |
Consumer & Other | | | 2,695,026 | | | — | | | 15,052 | | | — | | | 2,710,078 | |
Total | | $ | 521,872,754 | | $ | 1,270,028 | | $ | 19,107,510 | | $ | — | | $ | 542,250,292 | |
The following table provides information with respect to the Company's credit quality indicators by class of the loan portfolio at December 31, 2016:
| | | | | | | | | | | | | | | | |
| | Risk Rating | |
| | Pass | | Special Mention | | Substandard | | Doubtful | | Total | |
Commercial & Industrial | | $ | 63,961,379 | | $ | 688,595 | | $ | 2,584,668 | | $ | — | | $ | 67,234,642 | |
Commercial Real Estate - Investor | | | 134,601,346 | | | 2,958,695 | | | 967,122 | | | — | | | 138,527,163 | |
Commercial Real Estate - Owner Occupied | | | 64,761,020 | | | 1,126,705 | | | 1,080,449 | | | — | | | 66,968,174 | |
Residential Real Estate - Investor | | | 36,905,288 | | | 240,700 | | | 7,641,052 | | | — | | | 44,787,040 | |
Residential Real Estate - Owner Occupied | | | 102,367,880 | | | — | | | 6,213,195 | | | — | | | 108,581,075 | |
Home Equity Line of Credit | | | 32,969,668 | | | — | | | 286,344 | | | — | | | 33,256,012 | |
Land | | | 3,513,607 | | | — | | | 2,357,392 | | | — | | | 5,870,999 | |
Construction | | | 19,698,823 | | | — | | | 106,089 | | | — | | | 19,804,912 | |
Consumer & Other | | | 2,067,898 | | | — | | | 5,798 | | | — | | | 2,073,696 | |
Total | | $ | 460,846,909 | | $ | 5,014,695 | | $ | 21,242,109 | | $ | — | | $ | 487,103,713 | |
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 at December 31, 2017. 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 | | $ | 274,824 | | $ | 14,898 | | $ | — | | $ | 289,722 | | $ | 78,128,185 | | $ | 788,104 | | $ | 79,206,011 | |
Commercial Real Estate - Investor | | | — | | | 156,821 | | | — | | | 156,821 | | | 145,317,680 | | | 166,323 | | | 145,640,824 | |
Commercial Real Estate - Owner Occupied | | | 213,257 | | | — | | | — | | | 213,257 | | | 77,914,184 | | | — | | | 78,127,441 | |
Residential Real Estate - Investor | | | 547,855 | | | — | | | — | | | 547,855 | | | 35,708,675 | | | 893,623 | | | 37,150,153 | |
Residential Real Estate - Owner Occupied | | | 686,522 | | | 485,810 | | | — | | | 1,172,332 | | | 94,260,908 | | | 3,815,378 | | | 99,248,618 | |
Home Equity Line of Credit | | | 181,414 | | | 11,182 | | | — | | | 192,596 | | | 33,133,906 | | | 71,367 | | | 33,397,869 | |
Land | | | — | | | — | | | — | | | — | | | 5,549,151 | | | 59,544 | | | 5,608,695 | |
Construction | | | 165,876 | | | — | | | — | | | 165,876 | | | 39,926,017 | | | — | | | 40,091,893 | |
Consumer & Other | | | 12,830 | | | — | | | — | | | 12,830 | | | 2,682,196 | | | 15,052 | | | 2,710,078 | |
Total | | $ | 2,082,578 | | $ | 668,711 | | $ | — | | $ | 2,751,289 | | $ | 512,620,902 | | $ | 5,809,391 | | $ | 521,181,582 | |
| | | | | | | | | | | | | | | | | | | | | | |
Purchased credit impaired loans | | | | | | | | | | | | | | | | | | | | | 21,068,710 | |
Total Loans | | | | | | | | | | | | | | | | | | | | $ | 542,250,292 | |
The following table presents the classes of the loan portfolio summarized by the aging categories of performing loans and nonaccrual loans at December 31, 2016. 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 | | $ | 17,737 | | $ | — | | $ | — | | $ | 17,737 | | $ | 65,582,550 | | $ | 382,802 | | $ | 65,983,089 | |
Commercial Real Estate - Investor | | | — | | | — | | | — | | | — | | | 129,751,253 | | | 277,515 | | | 130,028,768 | |
Commercial Real Estate - Owner Occupied | | | 139,670 | | | 149,119 | | | — | | | 288,789 | | | 61,263,891 | | | — | | | 61,552,680 | |
Residential Real Estate - Investor | | | 702,856 | | | — | | | — | | | 702,856 | | | 34,114,611 | | | 1,260,961 | | | 36,078,428 | |
Residential Real Estate - Owner Occupied | | | 2,933,983 | | | 373,168 | | | — | | | 3,307,151 | | | 98,724,320 | | | 3,018,710 | | | 105,050,181 | |
Home Equity Line of Credit | | | 136,387 | | | — | | | — | | | 136,387 | | | 32,422,450 | | | 55,552 | | | 32,614,389 | |
Land | | | — | | | — | | | — | | | — | | | 3,384,741 | | | — | | | 3,384,741 | |
Construction | | | 173,105 | | | — | | | — | | | 173,105 | | | 19,525,718 | | | — | | | 19,698,823 | |
Consumer & Other | | | — | | | — | | | — | | | — | | | 2,067,898 | | | 5,798 | | | 2,073,696 | |
Total | | $ | 4,103,738 | | $ | 522,287 | | $ | — | | $ | 4,626,025 | | $ | 446,837,432 | | $ | 5,001,338 | | $ | 456,464,795 | |
| | | | | | | | | | | | | | | | | | | | | | |
Purchased credit impaired loans | | | | | | | | | | | | | | | | | | | | | 30,638,918 | |
Total Loans | | | | | | | | | | | | | | | | | | | | $ | 487,103,713 | |
Troubled Debt Restructurings
The restructuring of a loan constitutes a 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, 2017 and December 31, 2016:
| | | | | | | | | | | | | | | | | |
| | Year Ended December 31, 2017 | | Year Ended December 31, 2016 | |
| | | | 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: | | | | | | | | | | | | | | | | | |
Residential Real Estate - Investor | | - | | $ | - | | $ | - | | 1 | | $ | 35,672 | | $ | 35,672 | |
Residential Real Estate - Owner Occupied | | 3 | | | 729,535 | | | 729,535 | | 2 | | | 363,504 | | | 363,504 | |
Totals | | 3 | | $ | 729,535 | | $ | 729,535 | | 3 | | $ | 399,176 | | $ | 399,176 | |
| | | | | | | | | | | | | | | | | |
For the year ended December 31, 2017, there were three loans modified as TDRs. The restructuring of a Residential Real Estate – Owner Occupied loan lowered the interest rate by 2% to 5.50%, lowered the monthly payment and reduced fees. The restructuring of a Residential Real Estate - Owner Occupied loan deferred payments for six months. The restructuring of a Residential Real Estate - Owner Occupied loan extended the maturity date by 11 years and reduced the rate to 3.85%. These three TDR loans were on nonaccrual at December 31, 2017.
For the year ended December 31, 2016, there were three loans modified as TDRs. The restructuring of a Residential Real Estate - Investor loan extended the maturity date by three years, lowered the interest rate by 4.75% to 3.00%, lowered the monthly payment and added past due interest to the principal balance. The restructuring of a Residential Real Estate - Owner Occupied loan extended the loan by 13 years with a fixed rate 20-year term and added fees and past due interest to the principal balance. The restructuring of a Residential Real Estate - Owner Occupied loan lowered the monthly payment to interest and escrow only for 11 months, one month payment deferment, and extended the maturity date by one month. These three TDR loans were on nonaccrual at December 31, 2016.
None of the loans modified as a TDR during the previous 12 months were in default of its modified terms at December 31, 2017. At December 31, 2017 and 2016, the Bank had $2,228,270 and $1,824,206 in loans identified as TDRs, respectively, of which $1,876,109 and $1,323,975, respectively, were on nonaccrual status.
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 at 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 at 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, 2017 | | December 31, 2016 | |
Commercial & Industrial | | $ | 570,496 | | $ | 1,251,552 | |
Commercial Real Estate | | | 10,328,749 | | | 13,913,888 | |
Residential Real Estate | | | 9,169,367 | | | 12,239,507 | |
Home Equity Line of Credit | | | 412,823 | | | 641,623 | |
Land | | | 196,507 | | | 2,486,259 | |
Construction | | | 390,768 | | | 106,089 | |
Total Loans | | $ | 21,068,710 | | $ | 30,638,918 | |
The contractual amount outstanding for these loans totaled $23,656,094 and $34,915,206 at December 31, 2017 and December 31, 2016, respectively.
The following table reflects activity in the accretable discount for these loans for the years ended December 31, 2017 and 2016:
| | | | | | |
| | | | | | |
| | 2017 | | 2016 |
Balance at beginning of period | | $ | 1,315,319 | | $ | 275,730 |
Acquired through Hopkins Acquisition | | | — | | | 1,239,532 |
Reclassification from nonaccretable difference | | | 1,390,954 | | | 968,006 |
Accretion into interest income | | | (1,498,801) | | | (1,064,967) |
Disposals | | | (271,674) | | | (102,982) |
Balance at end of period | | $ | 935,798 | | $ | 1,315,319 |
The following table reflects activity in the allowance for these loans for the years ended December 31, 2017 and 2016:
| | | | | | |
| | | | | | |
| | 2017 | | 2016 |
Balance at beginning of period | | $ | 77,175 | | $ | — |
Charge-offs | | | (119,403) | | | (48,164) |
Recoveries | | | 227,074 | | | 9,112 |
Provision for loan losses | | | (96,198) | | | 116,227 |
Balance at end of period | | $ | 88,648 | | $ | 77,175 |
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, 2017 and 2016:
| | | | | | | |
| | Year Ended December 31, | |
| | 2017 | | 2016 | |
Balance at beginning of period | | $ | 1,224,939 | | $ | 1,459,732 | |
New transfers from loans | | | 695,548 | | | 996,860 | |
Sales | | | (770,030) | | | (923,117) | |
Write-downs | | | (158,842) | | | (308,536) | |
Balance at end of period | | $ | 991,615 | | $ | 1,224,939 | |
At December 31, 2017, the balance of real estate acquired through foreclosure included 10 1-4 family residential properties and two land parcels with a carrying value of $704,201 and $287,414, respectively. There were 18 1-4 family residential estate loans with a carrying value of $1,182,736 that were in the process of foreclosure.
At December 31, 2016, the balance of real estate acquired through foreclosure included 13 1-4 family residential properties and four land parcels with a carrying value of $903,900 and $321,039, respectively. There were 22 1-4 family residential estate loans with a carrying value of $1,520,775 that were in the process of foreclosure.
NOTE 7 – PREMISES AND EQUIPMENT
The components of premises and equipment at December 31, 2017 and 2016 are as follows:
| | | | | | | | | | |
| | | | | | | | Useful Life |
| | 2017 | | 2016 | | (in years) |
Land | | $ | 775,000 | | $ | 829,800 | | | | |
Buildings and improvements | | | 690,768 | | | 742,152 | | 10 | — | 40 |
Leasehold improvements | | | 2,635,804 | | | 2,589,493 | | 10 | — | 25 |
Furniture, fixtures and equipment | | | 1,415,956 | | | 1,826,404 | | 3 | — | 10 |
Software | | | 432,171 | | | 520,172 | | 3 | — | 10 |
| | | 5,949,699 | | | 6,508,021 | | | | |
Accumulated depreciation and amortization | | | (2,643,674) | | | (2,625,678) | | | | |
Net premises and equipment | | $ | 3,306,025 | | $ | 3,882,343 | | | | |
| | | | | | | | | | |
Depreciation and amortization expense for premises and equipment amounted to $579,012 and $649,878 for the years ended December 31, 2017 and 2016, respectively.
The Company leases six 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 two properties with a branch at each location.
Rent expense applicable to operating leases for the years ended December 31, 2017 and 2016 was $1,171,670 and $1,506,093 respectively.
In connection with the disposition of certain real estate in 2016, we entered into a sale leaseback transaction. The lease is classified as operating lease and the gain realized on the sale leaseback transaction has been deferred and will be credited to rent expense over the initial lease term. The deferred gain totaled $370,202 and $462,753 at December 31, 2017 and 2016, respectively, reflected in the accompanying Consolidated Balance Sheets under the caption Accrued expenses and other liabilities.
At December 31, 2017, 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 | |
2018 | | $ | 1,123,057 | |
2019 | | | 872,097 | |
2020 | | | 690,837 | |
2021 | | | 685,554 | |
2022 | | | 616,392 | |
Thereafter | | | 6,206,208 | |
Total minimum lease payments | | $ | 10,194,145 | |
NOTE 8 – CORE DEPOSIT INTANGIBLE ASSETS
The Company's core deposit intangible assets at December 31, 2017 had a remaining weighted average amortization period of approximately 2.4 years. The following table presents the changes in the net book value of core deposit intangible assets for the years ended December 31, 2017 and 2016:
| | | | | | |
| | | | | | |
| | 2017 | | 2016 |
Balance at beginning of period | | $ | 3,030,309 | | $ | 2,624,184 |
Additions from the Hopkins Merger | | | — | | | 1,197,001 |
Amortization expense | | | (789,182) | | | (790,876) |
Balance, at end of period | | $ | 2,241,127 | | $ | 3,030,309 |
The following table presents the gross carrying amount, accumulated amortization, and net carrying amount of core deposit intangible assets at December 31, 2017 and December 31, 2016:
| | | | | | | |
| | 2017 | | 2016 | |
Gross carrying amount | | $ | 6,775,211 | | $ | 6,775,211 | |
Accumulated amortization | | | (4,534,084) | | | (3,744,902) | |
Net carrying amount | | $ | 2,241,127 | | $ | 3,030,309 | |
The following table sets forth the future amortization expense for the Company’s core deposit intangible assets at December 31, 2017:
| | | | |
Twelve months ending December 31: | | Amount | |
2018 | | | 616,111 | |
2019 | | | 540,682 | |
2020 | | | 488,027 | |
2021 | | | 380,430 | |
2022 | | | 156,511 | |
Subsequent years | | | 59,366 | |
Total | | $ | 2,241,127 | |
NOTE 9 – DEPOSITS
The following table presents the composition of deposits at December 31, 2017 and 2016:
| | | | | | | |
| | December 31, 2017 | | December 31, 2016 | |
Noninterest-bearing deposits | | $ | 134,617,261 | | $ | 111,378,694 | |
Interest-bearing deposits: | | | | | | | |
Checking | | | 65,077,405 | | | 58,482,158 | |
Savings | | | 107,112,529 | | | 120,376,229 | |
Money market | | | 150,534,960 | | | 109,550,925 | |
Total interest-bearing checking, savings and money market deposits | | | 322,724,894 | | | 288,409,312 | |
| | | | | | | |
Time deposits $100,000 and below | | | 60,970,287 | | | 72,021,712 | |
Time deposits above $100,000 and below $250,000 | | | 40,537,390 | | | 42,849,544 | |
Time deposits above $250,000 | | | 13,904,728 | | | 11,799,132 | |
Total time deposits | | | 115,412,405 | | | 126,670,388 | |
Total interest-bearing deposits | | | 438,137,299 | | | 415,079,700 | |
Total Deposits | | $ | 572,754,560 | | $ | 526,458,394 | |
| | | | | | | |
The following table sets forth the maturity distribution for the Company’s time deposits at December 31, 2017:
| | | | |
| | Amount | |
Maturing within one year | | $ | 43,191,811 | |
Maturing over one to two years | | | 55,286,196 | |
Maturing over two to three years | | | 5,853,138 | |
Maturing over three to four years | | | 6,155,419 | |
Maturing over four to five years | | | 4,746,922 | |
Maturing over five years | | | 178,919 | |
Total Time Deposits | | $ | 115,412,405 | |
Interest expense on deposits for the years ended December 31, 2017 and 2016 is as follows:
| | | | | | | |
| | Year Ended December 31, | |
| | 2017 | | 2016 | |
Interest-bearing checking | | $ | 81,809 | | $ | 56,682 | |
Savings | | | 399,929 | | | 265,551 | |
Money market | | | 492,063 | | | 264,108 | |
Total interest-bearing checking, savings and money market deposits | | | 973,801 | | | 586,341 | |
| | | | | | | |
Time deposits $100,000 and below | | | 514,201 | | | 480,316 | |
Time deposits above $100,000 and below $250,000 | | | 405,463 | | | 480,768 | |
Time deposits above $250,000 | | | 125,664 | | | 111,273 | |
Total time deposits | | | 1,045,328 | | | 1,072,357 | |
Total Interest Expense | | $ | 2,019,129 | | $ | 1,658,698 | |
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, 2017, CDARS and ICS deposits were $0 and $15.0 million, respectively. At December 31, 2016, CDARS and ICS deposits were $0.6 million and $10.5 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.
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 $13.9 million and $11.8 million at December 31, 2017 and 2016, respectively.
NOTE 10 – BORROWINGS
Borrowings at December 31, 2017 and 2016 consisted of the following:
| | | | |
| | December 31, 2017 | |
Federal Home Loan Bank Advances | | | | |
Due January, 2018, Fixed Rate 1.41% | | $ | 10,000,000 | |
Total | | $ | 10,000,000 | |
At December 31, 2017 | | | | |
Weighted average interest rate at year end: | | | | |
Federal Home Loan Bank short term advance | | | 1.41 | % |
Maximum amount outstanding at month end during the year: | | | | |
Federal Home Loan Bank overnight advance | | $ | 27,000,000 | |
Federal Home Loan Bank short term advances | | $ | 24,000,000 | |
Average amount outstanding during the year: | | | | |
Federal Home Loan Bank overnight advance | | $ | 11,924,658 | |
Federal Home Loan Bank short term advances | | $ | 16,751,781 | |
Weighted average interest rate during the year: | | | | |
Federal Home Loan Bank overnight advance | | | 1.17 | % |
Federal Home Loan Bank short term advances | | | 1.08 | % |
| | | | |
At December 31, 2016 | | | | |
Federal Home Loan Bank Advances | | | | |
Due December, 2017, Variable Rate 0.84% | | $ | 20,000,000 | |
Total | | $ | 20,000,000 | |
| | | | |
| | | | |
Weighted average interest rate at year end: | | | | |
Federal Home Loan Bank overnight advance | | | 0.80 | % |
Maximum amount outstanding at month end during the year: | | | | |
Federal Home Loan Bank overnight advance | | $ | 38,100,000 | |
Federal Home Loan Bank short term advances | | $ | 59,400,000 | |
Atlantic Community Bankers Bank advances | | $ | 1,975,000 | |
Average amount outstanding during the year: | | | | |
Federal Home Loan Bank overnight advance | | $ | 10,343,989 | |
Federal Home Loan Bank short term advances | | $ | 13,057,104 | |
Atlantic Community Bankers Bank advances | | $ | 1,208,538 | |
Weighted average interest rate during the year: | | | | |
Federal Home Loan Bank overnight advance | | | 0.77 | % |
Federal Home Loan Bank short term advances | | | 0.48 | % |
Atlantic Community Bankers Bank advances | | | 4.13 | % |
Interest expense on FHLB advances and other borrowed funds for the years ended December 31, 2017 and 2016 were $319,959 and $191,408, respectively.
The Company had no long-term borrowings at December 31, 2017.
NOTE 11 – STOCK-BASED COMPENSATION
The Bay Bancorp, Inc. 2015 Equity Compensation Plan (the “2015 Plan”) was adopted by the Company’s Board of Directors in March 2015 and approved by the Company’s 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.
An aggregate of 100,000 shares of common stock were reserved for issuance under awards granted under the 2015 Plan. The 2015 Plan provides that 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. At December 31, 2017, option awards with respect to 30,000 shares were outstanding under the 2015 Plan.
The Company assumed the Jefferson Bancorp, Inc. 2010 Stock Option Plan (the “Jefferson Plan”) in 2013 when it merged with Jefferson. The Jefferson Plan was approved by Jefferson’s Board of Directors in September 2010 and adopted by its stockholders in April 2011. 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 is administered by the Board’s Compensation Committee. The Jefferson Plan authorized the issuance of up to 577,642 shares of common stock (as adjusted for the Jefferson Merger’s 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 10-year terms. Options relating to a total of 71,544 shares of common stock were outstanding at December 31, 2017.
The Carrollton Bancorp 2007 Equity Plan (the “Carrollton Plan” and, together with the 2015 Plan and the Jefferson Plan, the “Equity Plans”) was adopted by the Board of Directors of Carrollton Bancorp in March 2007 and approved by the stockholders of Carrollton Bancorp in April 2007. The Carrollton Plan is a broad-based plan that permits the grant of stock options, stock appreciation rights, stock awards and performance units. The Carrollton Plan reserved 500,000 shares of common stock for issuance. Options relating to a total of 80,000 shares of common stock were outstanding at December 31, 2017.
.
Stock Options
The following weighted average assumptions were used for options granted during the years ended December 31, 2017 and 2016:
| | | | | | |
| | 2017 | | 2016 |
Dividend yield | | — | % | | — | % |
Expected life | | 6.5 | years | | 6.5 | years |
Expected volatility | | 25.9 | % | | 18.9 | % |
Risk-free interest rate | | 2.14 | % | | 1.64 | % |
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 years ended December 31, 2017 and 2016:
| | | | | | | | | | | | | | |
| | | | Weighted | | | Weighted | | | | | | |
| | | | Average | | | Average | | Weighted Average | | Aggregate | |
| | Stock Options | | Exercise | | | Grant Date | | Remaining | | Intrinsic | |
| | Outstanding | | Price | | | Fair Value | | Contractual Life (years) | | Value | |
Outstanding at December 31, 2015 | | 495,832 | | $ | 5.17 | | $ | — | | 6.3 | | $ | — | |
Granted | | 55,000 | | | 5.12 | | | 1.18 | | | | | — | |
Exercised | | (95,434) | | | 4.78 | | | | | | | | — | |
Forfeited or expired | | (67,768) | | | 4.76 | | | | | | | | — | |
Outstanding at December 31, 2016 | | 387,630 | | $ | 5.32 | | $ | 1.79 | | 6.1 | | $ | 624,823 | |
| | | | | | | | | | | | | | |
Exercisable at December 31, 2016 | | 273,149 | | $ | 5.34 | | $ | 1.96 | | 5.1 | | $ | 467,126 | |
| | | | | | | | | | | | | | |
Outstanding at December 31, 2016 | | 387,630 | | $ | 5.32 | | $ | 1.79 | | 6.1 | | | 624,823 | |
Granted | | 20,000 | | | 7.15 | | | 2.30 | | | | | — | |
Exercised | | (175,306) | | | 4.92 | | | 1.71 | | | | | — | |
Forfeited or expired | | (50,780) | | | 4.49 | | | 1.24 | | | | | — | |
Outstanding at December 31, 2017 | | 181,544 | | $ | 5.19 | | $ | 2.08 | | 6.1 | | $ | 1,276,415 | |
| | | | | | | | | | | | | | |
Exercisable at December 31, 2017 | | 122,544 | | $ | 4.99 | | $ | 2.24 | | 4.9 | | $ | 886,760 | |
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. The Company has an incentive stock award program covering substantially all full-time employees. At December 31, 2017, the number of outstanding restricted shares of common stock held by non-employee directors and full-time employees was 13,250 and 37,412, respectively.
A summary of the activity for the Company’s restricted stock for the period indicated is presented in the following table:
| | | | | |
| | | | Weighted- |
| | | | Average Grant |
| | Shares | | Date value |
Restricted stock at December 31, 2015 | | 15,296 | | $ | 5.23 |
Granted | | 77,760 | | | 4.84 |
Vested | | (26,963) | | | 5.04 |
Restricted stock at December 31, 2016 | | 66,093 | | $ | 4.85 |
Granted | | 26,252 | | $ | 7.04 |
Vested | | (35,822) | | | 5.13 |
Cancelled, forfeited or expired | | (5,861) | | | 5.15 |
Restricted stock at December 31, 2017 | | 50,662 | | $ | 6.24 |
| | | | | |
Stock-based compensation expense
Stock-based compensation expense is recognized on a straight-line basis over the related service period and is recorded in noninterest expense. Unrecognized stock-based compensation expense attributable to option shares was $69,317 at December 31, 2017. This amount is expected to be recognized over a remaining weighted average period of approximately 2.7 years. Unrecognized stock-based compensation expense attributable to restricted shares was $192,929
at December 31, 2017. This amount is expected to be recognized over a remaining weighted average period of approximately 1.3 years. A summary of stock-based compensation expense is presented in the following table:
| | | | | |
| For the year ended December 31, |
| | 2017 | | | 2016 |
| | | | | |
Restricted shares | $ | 218,090 | | $ | 79,999 |
Option shares | | 45,078 | | | 14,608 |
Total | $ | 263,168 | | $ | 94,607 |
| | | | | |
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
| | | | | | | |
| | 2017 | | 2016 | |
Change in Benefit Obligation | | | | | | | |
Benefit obligation at beginning of year | | $ | 7,481,112 | | $ | 10,627,480 | |
Service cost | | | 72,667 | | | 72,809 | |
Interest cost | | | 272,040 | | | 418,980 | |
Actuarial loss | | | 248,067 | | | 1,304,080 | |
Settlement/curtailment | | | — | | | (1,166,707) | |
Disbursements made | | | (538,702) | | | (3,775,530) | |
Benefit obligation at end of year | | | 7,535,184 | | | 7,481,112 | |
Change in Plan Assets | | | | | | | |
Fair value of plan assets at beginning of year | | | 6,486,956 | | | 9,798,243 | |
Actual return on plan assets | | | 974,818 | | | 464,243 | |
Disbursements made | | | (538,702) | | | (3,775,530) | |
Fair value of plan assets at end of year | | | 6,923,072 | | | 6,486,956 | |
Funded Status at End of Year | | $ | (612,112) | | $ | (994,156) | |
The accumulated benefit obligation was $7,535,184 and $7,481,112 at December 31, 2017 and 2016, respectively.
The amount recognized on the consolidated balance sheet as defined benefit pension liability was $612,112 and $994,156 at December 31, 2017 and 2016, respectively.
The amount recognized in accumulated other comprehensive income (loss) (net of taxes) was $219,091 and ($172,101) at December 31, 2017 and 2016, respectively.
Components of Net Periodic Pension Cost and Other Amounts Recognized in Other Comprehensive Income
| | | | | | | |
| | | | | | | |
Net Periodic Pension Benefit | | 2017 | | 2016 | |
Service cost | | $ | 72,667 | | $ | 72,809 | |
Interest cost | | | 272,040 | | | 418,980 | |
Expected return on plan assets | | | (420,583) | | | (606,779) | |
Settlement/curtailment | | | — | | | (60,194) | |
Net periodic pension benefit | | | (75,876) | | | (175,184) | |
| | | | | | | |
Other Changes in Plan Assets and Benefit Obligations | | | | | | | |
Net loss (gain) for the period | | | (274) | | | 284,206 | |
Amortization of prior service cost | | | — | | | — | |
Amortization of net transition liability | | | — | | | — | |
Amortization of net gain | | | — | | | — | |
Total recognized in other comprehensive income | | | (274) | | | 284,206 | |
Total recognized in net periodic pension cost and other comprehensive income | | $ | (76,150) | | $ | 109,022 | |
Additional Information
The weighted-average assumptions used in the actuarial computation of the Pension Plan’s benefit obligations were as follows:
| | | | | |
| | 2017 | | 2016 | |
Discount rates | | 3.36 | % | 3.81 | % |
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:
| | | | | |
| | 2017 | | 2016 | |
Discount rates (a) | | 3.81 | % | 4.14/3.38 | % |
Expected rate on plan assets | | 6.40 | % | 6.60 | % |
Rate of compensation increase | | NA | | NA | |
(a)The discount rate from 1/1/16 to 10/31/16 was 4.14%. The discount rate from 11/1/16 to 12/31/16 was 3.38%.
The target and actual allocations expressed as a percentage of the Pension Plan’s assets at December 31, 2017 and 2016 were as follows:
| | | | | |
December 31, 2017 | | Target | | Actual | |
Equity securities | | 40-65 | % | 60 | % |
Debt securities | | 35-60 | % | 40 | % |
Total | | 100 | % | 100 | % |
| | | | | |
December 31, 2016 | | | | | |
Equity securities | | Target | | Actual | |
Debt securities | | 40-65 | % | 58 | % |
Total | | 35-60 | % | 42 | % |
| | 100 | % | 100 | % |
Estimated future benefit payments are as follows:
| | | | |
Periods ending December 31: | | Amount | |
2018 | | $ | 475,908 | |
2019 | | | 470,582 | |
2020 | | | 476,848 | |
2021 | | | 464,097 | |
2022 | | | 471,472 | |
2021-2025 | | | 2,165,192 | |
There was no required minimum amount of contribution to be made by the Company to the Pension Plan during 2017.
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, 2017 and 2016.
| | | | | | | | | | | | | |
| | | | | Quoted Prices in | | | | | | | |
| | | | | Active markets for | | Significant Other | | Significant Other | |
| | Total as of December 31, | | Identical Assets | | Observable Inputs | | Unobservable Inputs | |
Asset Category | | 2017 | | (Level 1) | | (Level 2) | | (Level 3) | |
Equity Securities – Pooled Separate Account: | | | | | | | | | | | | | |
Large-cap | | $ | 1,477,280 | | $ | — | | $ | 1,477,280 | | $ | — | |
Mixed-cap | | | 1,484,258 | | | — | | | 1,484,258 | | | | |
Small-cap | | | 621,352 | | | — | | | 621,352 | | | — | |
International | | | 623,790 | | | — | | | 623,790 | | | — | |
Guaranteed Deposit | | | 2,716,392 | | | — | | | 2,716,392 | | | — | |
Total | | $ | 6,923,072 | | $ | — | | $ | 6,923,072 | | $ | — | |
| | | | | | | | | | | | | |
| | | | | Quoted Prices in | | | | | | | |
| | | | | Active markets for | | Significant Other | | Significant Other | |
| | Total as of December 31, | | Identical Assets | | Observable Inputs | | Unobservable Inputs | |
Asset Category | | 2016 | | (Level 1) | | (Level 2) | | (Level 3) | |
Equity Securities - Pooled Separate Account: | | | | | | | | | | | | | |
Large-cap | | $ | 1,389,382 | | $ | — | | $ | 1,389,382 | | $ | — | |
Mixed-cap | | | 1,284,601 | | $ | — | | | 1,284,601 | | | — | |
Small-cap | | | 580,881 | | | — | | | 580,881 | | | — | |
International | | | 533,581 | | | — | | | 533,581 | | | — | |
Guaranteed Deposit | | | 2,698,511 | | | — | | | 2,698,511 | | | — | |
Total | | $ | 6,486,956 | | $ | — | | $ | 6,486,956 | | $ | — | |
At December 31, 2017, the plan’s assets totaled $6.9 million, an increase of $0.4 million from December 31, 2016 balance of $6.5 million. The plan was amended to allow a lump sum window for the terminated vested participants, which ran from July 1, 2016 to September 15, 2016. Lump sums were paid out on November 1, 2016. This window gave terminated employees the opportunity to elect a single lump sum payment in lieu of any future pension benefits. One hundred participants accepted the Company’s offer and $3.3 million in lump sums were paid from the plan.
401(k) Plan
The Company has a 401(k) profit sharing plan covering substantially all full-time employees. For 2015, the Company made a discretionary employer matching contribution that was paid in shares of the Company’s common stock, in an amount equal to 50% of a participant’s contributions made between July 1, 2015 and December 31, 2015 capped at 2% of his or her compensation for 2015. These contributions were made in 2016. For 2016, the Company made a discretionary employer matching contribution, paid in cash in 2017, in an amount equal to 50% of employee participant’s annual contributions, capped at 3% of his or her compensation for 2016. For 2017, the Company’s board of directors approved a discretionary employer matching contribution, to be paid in cash in 2018, in an amount equal to 50% of employee participant’s annual contributions, capped at 3% of his or her compensation for 2017. The expense associated with this plan during the years ended December 31, 2017 and 2016 was $153,625 and $165,570, respectively.
NOTE 13 – INCOME TAXES
The components of income tax expense (benefit) are as follows for the years ended December 31, 2017 and 2016:
| | | | | | | |
| | 2017 | | 2016 | |
Current income tax expense: | | | | | | | |
Federal | | $ | 2,289,816 | | $ | 721,291 | |
State | | | 680,330 | | | 221,520 | |
Total current tax benefit | | | 2,970,146 | | | 942,811 | |
| | | | | | | |
Deferred income tax expense (benefit): | | | | | | | |
Federal | | | 973,618 | | | 59,820 | |
State | | | 56,815 | | | (1,035) | |
Total deferred tax expense | | | 1,030,433 | | | 58,785 | |
| | | | | | | |
Total income tax expense (benefit) | | $ | 4,000,579 | | $ | 1,001,596 | |
The income tax expense component table above for 2016 does not include $25,802 of income tax expense related to discontinued operations.
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, | |
| | 2017 | | 2016 | |
| | | | | Percentage of | | | | | Percentage of | |
| | Amount | | Pretax Income | | Amount | | Pretax Income | |
Income tax expense at federal statutory rate | | $ | 3,006,302 | | 34 | % | $ | 923,881 | | 34 | % |
Increase (decrease) resulting from: | | | | | | | | | | | |
Tax exempt income | | | (10,040) | | (0.1) | % | | (13,029) | | (0.5) | % |
Bank owned life insurance | | | (161,857) | | (1.8) | % | | (40,103) | | (1.5) | % |
State income taxes, net of federal income tax benefit | | | 486,516 | | 5.5 | % | | 145,520 | | 5.4 | % |
Incentive stock options | | | (115,286) | | (1.3) | % | | (4,754) | | (0.2) | % |
Nondeductible expenses | | | 78,381 | | 0.8 | % | | (9,919) | | (0.3) | % |
Write-down of deferred tax assets | | | 625,217 | | 7.1 | % | | — | | — | % |
Nondeductible merger costs | | | 91,346 | | 1.0 | % | | — | | — | % |
Total income tax expense and effective tax rate | | $ | 4,000,579 | | 45.2 | % | $ | 1,001,596 | | 36.9 | % |
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, 2017 and 2016 are as follows:
| | | | | | | |
| | 2017 | | 2016 | |
Deferred tax assets | | | | | | | |
Bad debts | | $ | 1,143,744 | | $ | 1,113,593 | |
Equity security impairment loss | | | 141,863 | | | 179,692 | |
Net unrealized losses on available for sale securities | | | 37,851 | | | 97,723 | |
Deferred compensation | | | 100,765 | | | 161,346 | |
Nonaccrual loan interest income | | | 156,894 | | | 227,816 | |
Stock based compensation plans | | | 84,349 | | | 95,687 | |
Accrued pension expense | | | 273,834 | | | 410,097 | |
Real estate acquired through foreclosure | | | 79,698 | | | 169,298 | |
Purchase accounting adjustment - loans | | | 310,848 | | | 1,123,763 | |
AMT credit carryforwards | | | 176,049 | | | 169,796 | |
NOL carryforwards | | | 544,334 | | | 709,539 | |
Subtotal | | | 3,050,229 | | | 4,458,350 | |
Less: Valuation allowance | | | (146,354) | | | (90,528) | |
Total deferred tax assets | | | 2,903,875 | | | 4,367,822 | |
| | | | | | | |
Deferred tax liabilities: | | | | | | | |
Core deposit intangibles | | | 616,702 | | | 1,195,305 | |
Depreciation and amortization | | | 21,565 | | | 12,730 | |
Deferred loan fees and costs | | | 228,814 | | | — | |
Net unrealized gain on pension plan assets | | | 175,675 | | | 151,544 | |
Other | | | 54,767 | | | 23,525 | |
Total deferred tax liabilities | | | 1,097,523 | | | 1,383,104 | |
Net Deferred Tax Asset | | $ | 1,806,352 | | $ | 2,984,718 | |
| | | | | | | |
The bargain purchase gain recognized in 2016 was the result of the Hopkins Merger, which was an all cash merger that was treated as an asset purchase and, thus, a taxable transaction. Therefore, there was no impact from the Hopkins Merger on the effective tax rate for 2016.
At December 31, 2017 and 2016, the Company had federal net operating loss carryforwards of $0.9 million and $1.2 million, respectively, which begin to expire in 2033. As a result of the Jefferson Merger, $0.8 million of these net operating losses are subject to an annual limitation of $0.35 million. At December 31, 2017 and 2016, the Company had state net operating loss carryforwards of $5.5 million and $5.3 million, respectively, which begin to expire in 2033. At December 31, 2017, there was a valuation allowance of approximately $146,000 and $91,000 respectively, 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 at December 31, 2017, with the exception of the items noted above.
At December 31, 2017 and 2016, 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. In 2016 the Company concluded its audit by the Internal Revenue Service for the 2011 and 2013 tax years.
The result of the audits produced no changes to the tax liability for either year. The Company is no longer subject to examination by taxing authorities in these jurisdictions for the years before 2013.
The Tax Cuts and Jobs Act (the “Tax Act”) was enacted on December 22, 2017. The Tax Act reduces the maximum U.S. federal corporate tax rate from 35% to 21%. At December 31, 2017, the Company completed its accounting estimates for the tax effects of enactment of the Tax Act which were provisional and will be trued up through the filing of the Company’s 2017 tax return.
As described below, the Company has made a reasonable estimate of the effects on our existing deferred
tax balances as of December 31, 2017. The Company revalued all of its deferred tax assets and liabilities based
on the rates at which they are expected to reverse in the future. The Company recognized a tax expense of $625,000 in the Company’s tax provision for the year ended December 31, 2017 related to adjusting its net deferred tax balance to reflect the new corporate tax rate.
A reconciliation of income tax provision for the year ended December 31, 2017 is as follows:
| | | |
Income tax expense at the companies 34% rate | | $ | 3,006,302 |
See reconciliation of federal tax rate to effective tax rate above | | | 369,060 |
Income tax expense due to re-measurement of net deferred tax assets | | | 625,217 |
Total Income Tax Provision/Benefit | | $ | 4,000,579 |
| | | |
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. The reclassification adjustments included in the table below represent realized gains or losses on available for sale securities and are included in the consolidated statements of income within noninterest income within the caption “Gain on securities sold”. 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 on | | | | | |
| | Investments Available | | Defined Benefit | | | |
| | for Sale | | Pension Plan | | Total | |
Balance at December 31, 2016 | | $ | (202,262) | | $ | 232,645 | | $ | 30,383 | |
Other comprehensive income: | | | | | | | | | | |
Other comprehensive income before reclassification adjustments | | | 50,323 | | | 219,091 | | | 269,414 | |
Amounts reclassified from comprehensive income | | | 35,697 | | | - | | | 35,697 | |
Other comprehensive income | | | 86,020 | | | 219,091 | | | 305,111 | |
Balance at December 31, 2017 | | $ | (116,242) | | $ | 451,736 | | $ | 335,494 | |
| | | | | | | | | | |
| | Unrealized Gains on | | | | | |
| | Investments Available | | Defined Benefit | | | |
| | for Sale | | Pension Plan | | Total | |
Balance at December 31, 2015 | | $ | 168,814 | | $ | 404,746 | | $ | 573,560 | |
Other comprehensive loss: | | | | | | | | | | |
Other comprehensive loss before reclassification adjustments | | | 47,319 | | | (172,101) | | | (124,782) | |
Amounts reclassified from comprehensive loss | | | (418,395) | | | - | | | (418,395) | |
Other comprehensive loss | | | (371,076) | | | (172,101) | | | (543,177) | |
Balance at December 31, 2016 | | $ | (202,262) | | $ | 232,645 | | $ | 30,383 | |
| | | | | | | | | | |
| | Before Tax Amount | | Tax (Expense) Benefit | | Net of Tax Amount | |
For the year ended December 31, 2017 | | | | | | | | | | |
Other comprehensive income: | | | | | | | | | | |
Unrealized gain on AFS debt securities: | | | | | | | | | | |
Gross AFS securities gain (loss) | | $ | 105,426 | | $ | (55,103) | | $ | 50,323 | |
Reclassification adjustments | | | 59,377 | | | (23,680) | | | 35,697 | |
Net income (loss) recognized in other comprehensive income | | | 164,803 | | | (78,783) | | | 86,020 | |
Defined benefit pension plan adjustments: | | | | | | | | | | |
Net actuarial income (loss) | | | 335,716 | | | (116,625) | | | 219,091 | |
Net income recognized in other comprehensive income | | | 335,716 | | | (116,625) | | | 219,091 | |
Other comprehensive income (loss) | | $ | 500,519 | | $ | (195,408) | | $ | 305,111 | |
| | | | | | | | | | |
| | | Before Tax Amount | | | Tax (Expense) Benefit | | | Net of Tax Amount | |
For the year ended December 31, 2016 | | | | | | | | | | |
Other comprehensive loss: | | | | | | | | | | |
Unrealized gain on AFS debt securities: | | | | | | | | | | |
Gross AFS securities gain (loss) | | $ | 102,065 | | $ | (54,746) | | $ | 47,319 | |
Reclassification adjustments | | | (680,982) | | | 262,587 | | | (418,395) | |
Net (loss) income recognized in other comprehensive loss | | | (578,917) | | | 207,841 | | | (371,076) | |
Defined benefit pension plan adjustments: | | | | | | | | | | |
Net actuarial (loss) income | | | (284,206) | | | 112,105 | | | (172,101) | |
Net loss recognized in other comprehensive loss | | | (284,206) | | | 112,105 | | | (172,101) | |
Other comprehensive (loss) income | | $ | (863,123) | | $ | 319,946 | | $ | (543,177) | |
| | | | | | | | | | |
NOTE 15 – NET INCOME PER COMMON SHARE
The calculation of net income per common share for the years ended December 31, 2017 and 2016 are as follows:
| | | | | | | |
| | Year ended December 31, | |
| | 2017 | | 2016 | |
Basic earnings per share: | | | | | | | |
Net income available to common stockholders | | $ | 4,841,486 | | $ | 1,759,899 | |
Weighted average shares outstanding | | | 10,607,217 | | | 10,734,748 | |
Net income per share - basic | | $ | 0.46 | | $ | 0.16 | |
| | | | | | | |
Diluted earnings per share: | | | | | | | |
Net income available to common stockholders | | $ | 4,841,486 | | $ | 1,759,899 | |
Weighted average shares outstanding | | | 10,607,217 | | | 10,734,748 | |
Dilutive potential shares | | | 133,765 | | | 125,405 | |
Total diluted average shares outstanding | | | 10,740,982 | | | 10,860,153 | |
Net income per share - diluted | | $ | 0.45 | | $ | 0.16 | |
| | | | | | | |
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:
| | | | | | | |
| | 2017 | | 2016 | |
Beginning Balance | | $ | 14,133,013 | | $ | 9,676,890 | |
Additions | | | 637,946 | | | 4,775,903 | |
Repayments | | | (566,738) | | | (319,780) | |
Ending Balance | | $ | 14,204,221 | | $ | 14,133,013 | |
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 at December 31, 2017 and 2016 were $14,904,299 and $8,081,410, respectively.
A principal for a commercial real estate services company, through which the Bank entered into a third-party lease agreement for the Bank’s Lutherville offices and branch in 2010, became a director of the Company and the Bank on April 19, 2013. The Bank paid approximately $113,965 in 2017 and $120,107 in 2016 as lease payments for the office and branch facilities. In addition, the Bank paid approximately $130,260 to the real estate services company in 2016 primarily for 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 a cost sharing agreement for services to be performed by one of the Bank’s employees. The managing member reimbursed the Bank for $21,200 for services performed on its behalf in 2016.
In July 2014, the Company entered into an agreement with its largest stockholder whereby the stockholder will provide management and advisory services to the Company and the Bank. The Bank paid $68,750 to the stockholder during 2017 and $111,250 during 2016.
In 2017, the Company’s board of directors engaged Hovde Group LLC (“Hovde Group”) to provide investment banking services in connection with the proposed merger (the “Merger”) with Old Line Bancshares, Inc. (“Old Line Bancshares”). Steven D. Hovde, who serves on the boards of directors of the Company and the Bank, is the Chairman and Chief Executive Officer of Hovde Group. In 2017, pursuant to the engagement letter, Hovde Group received a $100,000 fairness opinion fee and was reimbursed for related expenses totaling $12,904 in 2017. Hovde Group will receive a completion fee equal to 1.0% of the transaction value, subject to the consummation of the Merger. For this purpose, the transaction value will include the aggregate Merger consideration plus the aggregate amount of cash paid in exchange for any Company stock option that remains unexercised as of the effective time of the Merger. The opinion fee will be credited in full toward the portion of the completion fee that will become payable to Hovde Group upon the consummation of the Merger. The Agreement and Plan of Merger, dated as of September 27, 2017, between the Company and Old Line Bancshares (the “Merger Agreement”) requires Old Line Bancshares to pay the Company a termination fee of $5,076,000 if the Merger Agreement is terminated under certain circumstances. In that event, Hovde Group will be entitled to $761,400, or 15% of that termination fee.
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, 2017 | | December 31, 2016 | |
Loan commitments | | $ | 13,643,220 | | $ | 7,729,629 | |
Unused lines of credit | | | 92,732,676 | | | 93,883,713 | |
Standby letters of credit | | | 8,510,683 | | | 8,424,706 | |
Mortgage loan repurchase obligations | | | 1,399,750 | | | 7,177,755 | |
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.
Shortly after the consummation of the Hopkins Merger, on September 20, 2016, Alvin M. Lapidus, the former Chairman of Hopkins, and Lois F. Lapidus, his wife, filed a lawsuit against Bay Bank in the United States District Court, District of Maryland, in which they alleged that a former employee of Hopkins Bank embezzled approximately $1.45 million from their deposit accounts at Hopkins Bank prior to the Hopkins Merger. On September 27, 2017, in settlement of this litigation, the Bank agreed to pay $1,417,608 to Mr. and Mrs. Lapidus and they agreed to dismiss the lawsuit with prejudice. The settlement agreement contains a full release of claims by Mr. and Mrs. Lapidus as to Bay Bank and its predecessors and successors, including Hopkins Federal Savings Bank. On September 26, 2017, the Bank received insurance proceeds in the amount of $1,442,609 in connection with that settlement, which represent the settlement amount, less the Bank’s $75,000 insurance deductible, plus $100,000 for reimbursable audit expenses. The Bank previously received $100,000 in insurance proceeds for reimbursable claims expense.
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 and other fees subject to repurchase were $1.8 million and $7.2 million at December 31, 2017 and 2016, respectively. Management does not expect losses resulting from repurchase requests to be material to reported financial results.
Proposed Merger: On September 27, 2017, the Company and Old Line Bancshares, the parent company of Old Line Bank, entered into the Merger Agreement, pursuant to which the Company will merge with and into Old Line Bancshares, with Old Line Bancshares as the surviving corporation. The Merger Agreement, which has been approved by the boards of directors of both companies, provides that each outstanding share of the Company’s common stock will be converted into the right to receive a number of shares of common stock of Old Line, with the exact exchange ratio to be determined prior to closing. Immediately following the Merger, the Bank will be merged with and into Old Line Bank, with Old Line bank as the surviving depository institution (the “Bank Merger”).
Consummation of the Merger is subject to certain conditions, including, among others, the approval of the Merger by the stockholders of Old Line Bancshares and the Company and the receipt of required regulatory approvals.
The stockholders of the Company and of Old Line Bancshares approved the Merger at special meetings thereof held on March 28, 2018. The Federal Reserve approved the Merger and related transactions on March 2, 2018, the FDIC approved the Bank Merger on March 6, 2018, and the Maryland Commissioner of Financial Regulation approved the Bank Merger on March 9, 2018.
On December 14, 2017, Adam Franchi, both individually and on behalf of a putative class of the Company’s stockholders, filed a complaint in the United States District Court for the District of Maryland against the Company, its directors and Old Line Bancshares (the “Litigation”). The complaint alleges that the version of the joint proxy statement/prospectus that was filed with the SEC on November 22, 2017 omitted certain material information in violation of Section 14(a) of the Exchange Act and Rule 14a-9 promulgated thereunder and asks the court to, among other things, enjoin the parties from proceeding with the Merger unless and until they revise the joint proxy statement/prospectus so that it includes the information that is alleged to have been omitted therefrom. In the event that the parties fail to do so and nevertheless proceed with the merger, the complaint asks the court to set aside the Merger or award rescissory damages. On February 14, 2018, without admitting any violation of law, Old Line Bancshares filed an amended joint proxy statement/prospectus with the SEC, and Mr. Franchi thereafter agreed to dismiss with prejudice all of his claims, but only as to himself and without prejudice to any other member of the putative class of stockholders. On March 28, 2018, the parties to the Litigation entered into a Stipulation and Proposed Order of Dismissal that, if approved by the court, will resolve all issues raised in the Litigation except for a claim for attorneys’ fees.
The Merger Agreement includes customary representations, warranties and covenants of the parties. The Merger Agreement contains termination rights of the Company and Old Line Bancshares and further provides that we will be required to pay Old Line Bancshares a termination fee of $5,076,000 if the Merger Agreement is terminated under specified circumstances set forth therein.
We expect the Merger to close on or about April 18, 2018, although this date is subject to change. For additional information regarding our pending Merger, please see as our definitive proxy statement filed with the Securities and Exchange Commission on February 14, 2018.
You should keep in mind that discussions in this report that refer to the Company’s business, operations and risks in the future refer to the Company as a stand-alone entity up to the closing of the pending Merger or if the Merger does not close, and that these considerations will be different with respect to the combined company after the closing of the Merger.
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, 2017.
The tables below present the recorded amount of assets measured at fair value on a recurring basis at December 31, 2017 and 2016:
| | | | | | | | | | | | | |
| | | | | | Significant Other | | Significant Other | |
| | Carrying Value | | Quoted Prices | | Observable Inputs | | Unobservable | |
December 31, 2017 | | (Fair Value) | | (Level 1) | | (Level 2) | | Inputs (Level 3) | |
U.S. government agency | | $ | 6,821,547 | | $ | — | | $ | 6,821,547 | | $ | — | |
U.S. treasury securities | | | 8,652,660 | | | — | | | 8,652,660 | | | — | |
Residential mortgage-backed securities | | | 31,397,837 | | | — | | | 31,397,837 | | | — | |
State and municipal | | | 2,564,647 | | | — | | | 2,564,647 | | | — | |
Corporate obligations | | | 6,359,500 | | | — | | | 6,359,500 | | | — | |
Equity securities | | | 18,025 | | | 18,025 | | | — | | | — | |
| | $ | 55,814,216 | | $ | 18,025 | | $ | 55,796,191 | | $ | — | |
| | | | | | | | | | | | | |
| | | | | | Significant Other | | Significant Other | |
| | Carrying Value | | Quoted Prices | | Observable Inputs | | Unobservable | |
December 31, 2016 | | (Fair Value) | | (Level 1) | | (Level 2) | | Inputs (Level 3) | |
U.S. government agency | | $ | 7,773,118 | | $ | — | | $ | 7,773,118 | | $ | — | |
U.S. treasury securities | | | 8,623,259 | | | — | | | 8,623,259 | | | — | |
Residential mortgage-backed securities | | | 30,813,481 | | | — | | | 30,813,481 | | | — | |
State and municipal | | | 2,637,280 | | | — | | | 2,637,280 | | | — | |
Corporate obligations | | | 10,328,455 | | | — | | | 10,328,455 | | | — | |
Equity securities | | | 57,134 | | | 57,134 | | | — | | | — | |
| | $ | 60,232,727 | | $ | 57,134 | | $ | 60,175,593 | | $ | — | |
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, 2017 and 2016.
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 at December 31, 2017 and 2016:
| | | | | | | | | | | | | |
| | | | | | | | Significant Other | | Significant Other | |
| | Carrying Value | | Quoted Prices | | Observable Inputs | | Unobservable | |
December 31, 2017 | | (Fair Value) | | (Level 1) | | (Level 2) | | Inputs (Level 3) | |
Impaired loans | | $ | 925,107 | | $ | — | | $ | — | | $ | 925,107 | |
Real estate acquired through foreclosure | | | 991,615 | | | — | | | — | | | 991,615 | |
| | $ | 1,916,722 | | $ | — | | $ | — | | | 1,916,722 | |
| | | | | | | | | | | | | |
| | | | | | | | Significant Other | | Significant Other | |
| | Carrying Value | | Quoted Prices | | Observable Inputs | | Unobservable | |
December 31, 2016 | | (Fair Value) | | (Level 1) | | (Level 2) | | Inputs (Level 3) | |
Impaired loans | | $ | 819,877 | | $ | — | | $ | — | | $ | 819,877 | |
Real estate acquired through foreclosure | | | 1,224,939 | | | — | | | — | | | 1,224,939 | |
| | $ | 2,044,816 | | $ | — | | $ | — | | | 2,044,816 | |
| | | | | | | | | | | | |
| | | Quantitative Information about Level 3 Fair Value Measurements |
December 31, 2017 | | | Fair Value | | | Valuation Technique | | | Unobservable Input | | | Range |
Impaired loans | | $ | 925,107 | | | Appraisal of collateral (1) | | | Appraisal adjustments (2) | | | 0% - 10% |
| | | | | | | | | | | | |
Real estate acquired through foreclosure | | $ | 991,615 | | | 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, 2016 | | | Fair Value | | | Valuation Technique | | | Unobservable Input | | | Range |
Impaired loans | | $ | 819,877 | | $ | Appraisal of collateral (1) | | | Appraisal adjustments (2) | | | 0% - 10% |
| | | | | | | | | | | | |
Real estate acquired through foreclosure | | $ | 1,224,939 | | | 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, 2017 and 2016 is made in accordance with the requirements of ASC Topic 820:
| | | | | | | | | | | | | | |
| | Level in Fair | | December 31, 2017 | | December 31, 2016 | |
| | Value | | Carrying | | Estimated fair | | Carrying | | Estimated fair | |
| | Hierarchy | | Amount | | value | | Amount | | value | |
Financial assets: | | | | | | | | | | | | | | |
Cash and cash equivalents | | Level 1 | | $ | 31,566,278 | | $ | 31,566,278 | | $ | 40,027,456 | | 40,027,456 | |
Investment securities available for sale (debt) | | Level 2 | | | 55,796,191 | | | 55,796,191 | | | 60,175,593 | | 60,175,593 | |
Investment securities available for sale (equity) | | Level 1 | | | 18,025 | | | 18,025 | | | 57,134 | | 57,134 | |
Investment securities held to maturity (debt) | | Level 2 | | | 1,073,107 | | | 1,060,406 | | | 1,158,238 | | 1,149,342 | |
Restricted equity securities | | Level 2 | | | 1,302,295 | | | 1,302,295 | | | 1,823,195 | | 1,823,195 | |
Loans held for sale | | Level 2 | | | 1,097,160 | | | 1,097,160 | | | 1,613,497 | | 1,613,497 | |
Loans, net of allowance | | Level 3 | | | 538,093,867 | | | 535,626,867 | | | 484,280,560 | | 487,325,072 | |
Accrued interest receivable | | Level 2 | | | 2,176,359 | | | 2,176,359 | | | 1,884,945 | | 1,884,945 | |
| | | | | | | | | | | | | | |
Financial liabilities: | | | | | | | | | | | | | | |
Deposits | | Level 3 | | | 572,754,560 | | | 571,409,560 | | | 526,458,394 | | 526,119,460 | |
Accrued interest payable | | Level 2 | | | 18,671 | | | 18,671 | | | 16,406 | | 16,406 | |
Borrowings | | Level 2 | | | 10,000,000 | | | 10,000,000 | | | 20,000,000 | | 20,000,000 | |
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 Office of the Comptroller of the Currency (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 “well capitalized” is 5%, but an individual institution could be required to maintain a higher level. In connection with the merger of Carrollton Bank with and into the Bank, 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. In 2016, the OCC reduced the required leverage ratio for the Bank to at least 8.5%. 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, 2017 and December 31, 2016. 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, 2017 and December 31, 2016 under the regulatory capital rules in effect at each date. The capital levels of the Bank at December 31, 2017 also exceeded the minimum capital requirements shown in the table below including the currently applicable Conservation Buffer of 1.25%. Since December 31, 2017, 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 | |
| | | | | | | | | | | | | | Minimum Capital | | | Capitalized Under | |
| | | | | | | | Minimum | | | Requirements with | | | Prompt Corrective | |
| | Actual | | | Capital Requirements | | | Conservation Buffer | | | Action Provisions | |
| | Amount | | Ratio | | | Amount | | Ratio | | | Amount | | Ratio | | | Amount | | Ratio | |
At December 31, 2017: | | | | | | | | | | | | | | | | | | | | | | | | |
| | | | | | | | | | | | | | | | | | | | | | | | |
Common Equity Tier 1 Capital | | $ | 68,579 | | 12.11 | % | | $ | 25,476 | | 4.50 | % | | $ | 32,553 | | 5.75 | % | | $ | 36,799 | | 6.50 | % |
| | | | | | | | | | | | | | | | | | | | | | | | |
Tier I Risk-Based Capital Ratio | | $ | 68,579 | | 12.11 | % | | $ | 33,968 | | 6.00 | % | | $ | 41,045 | | 7.25 | % | | $ | 45,291 | | 8.00 | % |
| | | | | | | | | | | | | | | | | | | | | | | | |
Total Risk-Based Capital Ratio | | $ | 72,735 | | 12.85 | % | | $ | 45,291 | | 8.00 | % | | $ | 52,367 | | 9.25 | % | | $ | 56,613 | | 10.00 | % |
| | | | | | | | | | | | | | | | | | | | | | | | |
Tier 1 Leverage Ratio | | $ | 68,579 | | 10.54 | % | | $ | 26,036 | | 4.00 | % | | $ | 34,173 | | 5.25 | % | | $ | 32,546 | | 5.00 | % |
| | | | | | | | | | | | | | | | | | | | | | | | |
At December 31, 2016: | | | | | | | | | | | | | | | | | | | | | | | | |
| | | | | | | | | | | | | | | | | | | | | | | | |
Common Equity Tier 1 Capital | | $ | 63,057 | | 12.32 | % | | $ | 23,039 | | 4.50 | % | | $ | 26,239 | | 5.125 | % | | $ | 33,279 | | 6.50 | % |
| | | | | | | | | | | | | | | | | | | | | | | | |
Tier I Risk-Based Capital Ratio | | $ | 63,057 | | 12.32 | % | | $ | 30,719 | | 6.00 | % | | $ | 33,919 | | 6.625 | % | | $ | 40,959 | | 8.00 | % |
| | | | | | | | | | | | | | | | | | | | | | | | |
Total Risk-Based Capital Ratio | | $ | 65,883 | | 12.87 | % | | $ | 40,959 | | 8.00 | % | | $ | 44,159 | | 8.625 | % | | $ | 51,199 | | 10.00 | % |
| | | | | | | | | | | | | | | | | | | | | | | | |
Tier 1 Leverage Ratio | | $ | 63,057 | | 10.45 | % | | $ | 24,133 | | 4.00 | % | | $ | 27,904 | | 4.625 | % | | $ | 30,166 | | 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 received 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 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 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, 2017 and 2016.
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, 2017, 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, | |
| | 2017 | | 2016 | |
ASSETS | | | | | | | |
Cash and cash equivalents | | $ | 834,299 | | $ | 219,250 | |
Investment securities available for sale, at fair value | | | 67,825 | | | 87,080 | |
Investment in subsidiary | | | 71,037,263 | | | 65,294,348 | |
Other assets | | | 196,860 | | | 332,692 | |
Total Assets | | $ | 72,136,247 | | $ | 65,933,370 | |
| | | | | | | |
LIABILITIES | | | | | | | |
Accrued expenses and other liabilities | | | 260,118 | | | 6,144 | |
Total Liabilities | | | 260,118 | | | 6,144 | |
| | | | | | | |
STOCKHOLDERS’ EQUITY | | | | | | | |
Common stock | | | 10,667,227 | | | 10,456,098 | |
Additional paid-in capital | | | 41,692,751 | | | 40,814,285 | |
Retained earnings | | | 19,180,657 | | | 14,426,969 | |
Accumulated other comprehensive income | | | 335,494 | | | 30,383 | |
Stockholders' Equity - controlling interest | | | 71,876,129 | | | 65,727,735 | |
Stockholders' Equity - non-controlling interest | | | — | | | 199,491 | |
Total Stockholders' Equity | | | 71,876,129 | | | 65,927,226 | |
Total Liabilities and Stockholders' Equity | | $ | 72,136,247 | | $ | 65,933,370 | |
| | | | | | | |
| | Years Ended December 31, | |
| | 2017 | | 2016 | |
Income: | | | | | | | |
Interest and dividends on deposits and investment securities | | $ | 1,887 | | $ | 203 | |
Other (loss) income | | | (59,967) | | | 120 | |
Total Income | | | (58,080) | | | 323 | |
| | | | | | | |
Expenses: | | | | | | | |
Interest on short-term borrowings | | | 635 | | | 49,850 | |
Merger related expenses | | | 289,512 | | | — | |
Other noninterest expenses | | | 235,488 | | | 334,323 | |
Total Expenses | | | 525,635 | | | 384,173 | |
| | | | | | | |
Loss before income taxes and equity in undistributed net income of subsidiary | | | (583,715) | | | (383,850) | |
Income tax benefit | | | (198,463) | | | (188,352) | |
Loss before equity in undistributed net income of subsidiary | | | (385,252) | | | (195,498) | |
Equity in undistributed net income of subsidiary | | | 5,226,738 | | | 1,788,854 | |
NET INCOME FROM CONTINUING OPERATIONS, NET OF TAXES | | $ | 4,841,486 | | $ | 1,593,356 | |
Net income from discontinued operations, net of taxes | | | — | | | 366,034 | |
NET INCOME | | $ | 4,841,486 | | $ | 1,959,390 | |
Net income from discontinued operations attributable to non-controlling interest | | | — | | | 199,491 | |
NET INCOME AVAILABLE TO COMMON STOCKHOLDERS | | $ | 4,841,486 | | $ | 1,759,899 | |
| | | | | | | |
| | Years Ended December 31, | |
| | 2017 | | 2016 | |
Cash flows from operating activities: | | | | | | | |
Net income | | $ | 4,841,486 | | $ | 1,959,390 | |
Adjustments to reconcile net income to net cash (used in) provided by operating activities: | | | | | | | |
Equity in undistributed net income of subsidiary | | | (5,226,738) | | | (1,788,854) | |
Net decrease (increase) in accrued interest receivable and other assets | | | 216,786 | | | (322,268) | |
Net increase (decrease) in intercompany accounts payable | | | 62,819 | | | (51,961) | |
Net decrease in accrued taxes | | | (182,397) | | | (88,911) | |
Net increase in accrued expenses and other liabilities | | | 57,411 | | | 373,057 | |
Net cash (used in) provided by operating activities - continuing operations | | | (230,633) | | | 80,453 | |
Net cash used in operating activities - discontinued operations | | | — | | | (366,034) | |
Net cash used in operating activities | | | (230,633) | | | (285,581) | |
| | | | | | | |
Cash flows from investing activities: | | | | | | | |
Acquisition, net of cash acquired | | | — | | | 4,000,000 | |
Additional equity investment in subsidiary | | | 19,255 | | | — | |
Net cash provided by investing activities - continuing operations | | | 19,255 | | | 4,000,000 | |
Net cash used in investing activities - discontinued operations | | | — | | | (20,000) | |
Net cash provided by investing activities | | | 19,255 | | | 3,980,000 | |
| | | | | | | |
Cash flows from financing activities: | | | | | | | |
Proceeds from issuance of common stock | | | — | | | (3,791,998) | |
Repurchase of common stock | | | — | | | 471,932 | |
Issuance of common stock under stock-based compensation plan | | | 826,427 | | | 53,983 | |
Proceeds from short term borrowings | | | — | | | (300,000) | |
Net cash provided by (used in) financing activities | | | 826,427 | | | (3,566,083) | |
| | | | | | | |
Net increase in cash and cash equivalents | | | 615,049 | | | 128,336 | |
Cash and cash equivalents at beginning of period | | | 219,250 | | | 90,914 | |
Cash and cash equivalents at end of period | | $ | 834,299 | | $ | 219,250 | |
| | | | | | | |
NOTE 21 – QUARTERLY FINANCIAL RESULTS (UNAUDITED)
| | | | | | | | | | | | | |
| | Year Ended December 31, 2017 | |
| | First Quarter | | Second Quarter | | Third Quarter | | Fourth Quarter | |
Interest income | | $ | 6,355,586 | | $ | 6,898,258 | | $ | 7,240,039 | | $ | 7,393,137 | |
Interest expense | | | 516,054 | | | 553,017 | | | 626,338 | | | 643,811 | |
Net interest income | | | 5,839,532 | | | 6,345,241 | | | 6,613,701 | | | 6,749,326 | |
Provision for loan losses | | | 440,521 | | | 522,323 | | | 313,963 | | | 380,176 | |
Net interest income after provision for loan losses | | | 5,399,011 | | | 5,822,918 | | | 6,299,738 | | | 6,369,150 | |
Noninterest income | | | 1,326,364 | | | 1,352,670 | | | 2,657,789 | | | 1,253,641 | |
Noninterest expenses | | | 5,181,562 | | | 5,203,596 | | | 5,300,630 | | | 5,953,428 | |
Income before income taxes | | | 1,543,813 | | | 1,971,992 | | | 3,656,897 | | | 1,669,363 | |
Income taxes | | | 587,005 | | | 746,633 | | | 1,458,061 | | | 1,208,880 | |
Net Income | | $ | 956,808 | | $ | 1,225,359 | | $ | 2,198,836 | | $ | 460,483 | |
| | | | | | | | | | | | | |
Net income per share-basic | | $ | 0.09 | | $ | 0.12 | | $ | 0.21 | | $ | 0.04 | |
Net income per share-diluted | | $ | 0.09 | | $ | 0.11 | | $ | 0.20 | | $ | 0.04 | |
| | | | | | | | | | | | | |
| | Year Ended December 31, 2016 | |
| | First Quarter | | Second Quarter | | Third Quarter | | Fourth Quarter | |
Interest income | | $ | 5,114,415 | | $ | 5,251,498 | | $ | 6,280,326 | | $ | 6,381,192 | |
Interest expense | | | 372,972 | | | 372,292 | | | 588,265 | | | 516,605 | |
Net interest income | | | 4,741,443 | | | 4,879,206 | | | 5,692,061 | | | 5,864,587 | |
Provision for loan losses | | | 298,000 | | | 357,533 | | | 360,000 | | | 374,000 | |
Net interest income after provision for loan losses | | | 4,443,443 | | | 4,521,673 | | | 5,332,061 | | | 5,490,587 | |
Bargain purchase gain | | | — | | | — | | | 1,034,456 | | | (141,329) | |
Other noninterest income | | | 1,191,077 | | | 1,325,003 | | | 1,367,464 | | | 1,216,925 | |
Total noninterest income | | | 1,191,077 | | | 1,325,003 | | | 2,401,920 | | | 1,075,596 | |
Noninterest expenses | | | 5,329,997 | | | 5,105,975 | | | 7,036,215 | | | 5,714,221 | |
Income before income taxes | | | 304,523 | | | 740,701 | | | 697,766 | | | 851,962 | |
Income taxes | | | 118,124 | | | 291,597 | | | 277,733 | | | 314,142 | |
Net income from continuing operations, net of taxes | | | 186,399 | | | 449,104 | | | 420,033 | | | 537,820 | |
Net income from discontinued operations, net of taxes | | | — | | | — | | | 92,405 | | | 273,629 | |
Net income from discontinued operations attributable to non-controlling interest | | | — | | | — | | | 138,212 | | | 61,279 | |
Net income available to common stockholders | | $ | 186,399 | | $ | 449,104 | | $ | 374,226 | | $ | 750,170 | |
| | | | | | | | | | | | | |
Net income per share - basic | | $ | 0.02 | | $ | 0.04 | | $ | 0.04 | | $ | 0.07 | |
Net income per share - diluted | | $ | 0.02 | | $ | 0.04 | | $ | 0.03 | | $ | 0.07 | |
(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 March 28, 2018, the Merger was approved by the stockholders of the Company and of Old Line Bancshares. Pursuant to the terms of the Equity Plans and also to satisfy the Company’s obligations under the Merger Agreement with respect to the treatment of stock options in the Merger, the Compensation Committee of the Company’s Board of Directors accelerated, effective March 28, 2018, the vesting of (i) options to purchase a total of 47,000 shares of common stock and (ii) restricted stock awards relating to 29,095 shares of common stock that were granted under the 2015 Plan. Pursuant to the terms of the Carrollton Plan, the restricted stock awards granted under that plan (relating to 14,708 shares) will vest at the effective time of the Merger.
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 at December 31, 2017 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, 2017, 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 at December 31, 2017. 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 at December 31, 2017, in relation to criteria for effective internal control over financial reporting as described in “2013 Internal Control — Integrated Framework,” issued by the Committee of Sponsoring Organizations of the Treadway Commission. Based on this assessment and on the foregoing criteria, management has concluded that, at December 31, 2017, Bay Bancorp, Inc.’s internal control over financial reporting is effective.
| | | |
Dated: March 28, 2018 | | | |
| | | |
/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
BOARD OF DIRECTORS
The number of directors constituting the Company’s Board of Directors is currently set at nine. The Board of Directors, by resolution approved a majority vote thereof, may alter the number of directors from time to time. Information regarding the Company’s directors, including their names, ages, their principal occupations and business experience during the last five years, and their qualifications to serve as directors is set forth below.
Pierre A. Abushacra, 50. Pierre graduated from George Washington University’s School of Business with a major in Finance in 1988 after which he worked in Washington DC in private banking for 4 years. In 1992, Pierre founded Firehook Bakery as a sourdough bread bakery and café in Old Town Alexandria. Firehook currently operates a wholesale bakery, 10 company owned and operated cafes in the Washington DC metro area and distributes packaged baked goods nationally to conventional supermarkets and natural food stores. Pierre manages his family real estate investment & management company, Kapa Property Company, which owns and manages office, retail and warehouse properties in Washington DC and Northern Virginia. Pierre has placed a high value on community involvement and support for entrepreneurship. He is a member of the Young Presidents Organization US Capital Chapter, Entrepreneur Organization Washington DC Chapter, and a board member of the Cleveland Park Business Association and Dupont Circle Business Improvement District. Mr. Abushacra, who serves on the Board’s Audit Committee and Director's loan committee, has served as a director of the Company since 2015. Mr. Abushacra, who serves on the Board’s Audit Committee and Nominating and Corporate Governance Committee (the “Nominating Committee”), has served as a director of the Company since 2015.
The Board of Directors believes that Mr. Abushacra’s qualifications for serving as a director include his entrepreneurial background and experience as a business owner within the target market for the Bank.
Robert J. Aumiller, 69. Mr. Aumiller is the past President of Mackenzie Commercial Real Estate Services, LLC, a commercial real estate brokerage where he served for over 30 years. Mr. Aumiller currently serves as Executive Vice President of Mackenzie Ventures. LLC, the holding company of all of the Mackenzie subsidiaries. Mr. Aumiller acts as Project Team Leader and oversees and participates in all facets of the operation of the company and has been a licensed real estate broker for more than 25 years. Mr. Aumiller also has significant commercial development experience, having been involved in build-to-suit projects and equity participations and acquisitions, as well as services relating to site selection, marketing and feasibility analysis, building design and construction, financing, and management of various industrial, medical and office facilities. Mr. Aumiller is also an attorney who, prior to joining Mackenzie in 1984, was engaged in private practice representing various real estate investors and developers. Prior to that time, Mr. Aumiller was an Assistant Attorney General for the State of Maryland and, among other clients, represented the Maryland Real Estate and Banking Commissions and served as counsel to the Maryland State Department of Assessments and Taxation. Mr. Aumiller is past president of the Maryland Chapter of NAIOP and has lectured both locally and nationally on build-to-suit development and the development process. Mr. Aumiller, who serves as Chairman of the ALCO committee and also serves on the Board’s Nominating Committee and Compensation Committee, has served as a director of the Company since 2001 and of the Bank since April 19, 2013. Between 2001 and April 19, 2013, he served as a director of Carrollton Bank, which merged into the Bank on April 19, 2013 in connection with the Jefferson Merger on that date.
The Board of Directors believes that Mr. Aumiller’s qualifications for serving as a director include his experience as both a commercial and residential developer, which gives him valuable insight into the sector in which we originate a large portion of our loans, as well as his entrepreneurial, financial and operational expertise.
Steven K. Breeden, 59. Mr. Breeden is a principal in Security Development Corporation, a diversified real estate development company located in Howard County, Maryland. Mr. Breeden has been with Security Development since 1980, where his work has involved financial analysis of commercial and residential real estate projects, economic modeling and daily project monitoring. He is responsible for the company’s banking relationships. Mr. Breeden holds a Master’s
degree in Finance from Loyola University and BS in Economics and Business from Carnegie Mellon University. Mr. Breeden, who serves on the Board’s Audit Committee and Chairman of the Compensation Committee, has served as a director of the Company since 1995 and of the Bank since April 19, 2013. Between 1995 and April 19, 2013, he served as a director of Carrollton Bank.
The Board of Directors believes that Mr. Breeden’s qualifications for serving as a director include his knowledge of the Bank’s business and operations as a result of his years of service as a director of the Company and the Bank and his extensive understanding of the local real estate industry and market involvement gained from his more than 30 years of experience in most aspects of real estate development, with a concentration in complex financing, of residential and commercial projects throughout the Baltimore area.
Mark M. Caplan, 59. Mr. Caplan is a Baltimore native who has been very active in real estate investment and management as well as equipment and vehicle financing in the region. He is the President and CEO of the Time Group, a real estate equity firm where he has worked since 1980. Time Group has interests in approximately 6,000 units in multi-family, manufactured housing, and senior living. He is also a founder and is currently the Chairman of the WPM Real Estate Group, a manager of multi-family properties as well as other property types currently comprising in excess of 17,000 units. In addition to his real estate activities, Mr. Caplan is the Chairman of Madison Capital, an independent vehicle and equipment financing firm he founded in 1984. Mr. Caplan was previously on the Board of Sterling Bank & Trust which was sold to Carroll County Bank & Trust in the late 1990s. Mr. Caplan is active in the non-for-profit community in Baltimore, having served on the Boards of The Walters Art Museum, The Bryn Mawr School, The Gilman School, Center Stage and St. Ignatius Loyola Academy. Mr. Caplan is a graduate of Johns Hopkins University where he received his Bachelor of Arts degree in Social & Behavioral Sciences and received his Master of Business Administration from the Columbia Business School. Mr. Caplan serves on the Board’s Compensation Committee and he also serves on the Board’s ALCO Committee. Mr. Caplan has served as a director of the Company since April 19, 2013 and of the Bank since April 2012.
The Board of Directors believes that Mr. Caplan’s qualifications for serving as a director include his experience investing in real estate, general management experience, as well as credit experience lending to businesses in the mid-Atlantic region.
Harold “Hal” Hackerman, 66. Mr. Hackerman is a director and President of the Audit, Accounting, and Consulting Firm of Ellin & Tucker, Chartered, a regional accounting firm headquartered in Baltimore. Mr. Hackerman has been with Ellin & Tucker since 1984. During his accounting career, he has had responsibility for both publicly traded and closely held businesses. His industry expertise includes wholesale distribution, manufacturing, not-for-profit, fast-food, brokerage, real estate, and construction organizations. In addition, Mr. Hackerman has extensive experience in mergers and acquisitions, assisting companies in financially troubled situations and bankruptcies representing debtors, unsecured creditors, and secured lenders. He is a graduate of Fairleigh Dickinson University where he earned a Bachelor of Science degree. Mr. Hackerman, serves as Chairman of the Nominating Committee and on the Board’s Audit Committee and Executive Committee. Mr. Hackerman has been a director of the Company since 2002 and of the Bank since April 19, 2013 and is currently the Lead Independent Director. Between 2002 and April 19, 2013, he served as a director of Carrollton Bank.
The Board of Directors believes that Mr. Hackerman’s extensive public accounting experience, which has given him a thorough understanding of financial regulations applicable to the Company and the Bank, and his valuable insight as to accounting-related matters, such as internal controls, makes him an appropriate choice to serve as a director.
Eric D. Hovde, age 53. Mr. Hovde is an active entrepreneur who has started and manages numerous business enterprises. Mr. Hovde is the Chairman and Chief Executive Officer of H Bancorp LLC, a $1.8 billion private bank holding company with banking operations on both the east and the west coasts. Additionally, he serves as Chief Exec Officer and co-owner of Hovde Properties, LLC, a real estate development and management company where he oversees management of the company and all large development projects. Mr. Hovde also founded and previously managed Hovde Financial, an investment banking company, and Hovde Capital, an asset management company. Throughout his career he has served as a director on numerous bank boards and currently serves as the Chief Executive Officer of Sunwest Bank in Orange County, California. Additionally, Mr. Hovde is a significant stockholder and board member of ePlus, Inc., a leading value-added reseller and lessor of technology products and services that common stock of which is listed on the NASDAQ Stock Market and registered with the SEC under Section 12(b) of the Exchange Act. Mr. Hovde, along with his brother, Steve, created and funds the Hovde Foundation, an organization that actively supports two central missions – clinical research to find a cure for Multiple Sclerosis and charitable relief for children in desperate need. The Foundation has established Hovde Houses throughout many countries around the world. He earned his degrees in Economics and International Relations at the University of Wisconsin. Mr. Hovde is the Chairman of Bay Bancorp and Bay Bank and serves as the
Chairman of the Executive Committee and on the Board’s Asset/Liability & Investment Committee. He has served as a director of Bay Bancorp and Bay Bank since September 25, 2013.
The Board of Directors believes that Mr. Hovde’s qualifications for serving as a director include his experience and background managing diverse financial organizations and serving on the boards of diverse organizations. In addition, as the founder of Hovde Financial, an investment banking firm focused on mergers and acquisitions, Mr. Hovde provides valuable insight to the Company with his knowledge and experience in that area.
Steven D. Hovde, age 62. Mr. Hovde is the Chairman and Chief Executive Officer of Hovde Group, a leading financial services and investment banking firm that provides a full-service suite of investment banking, capital raising, and financial advisory services focused exclusively on the banking and thrift industry. Mr. Hovde co-founded Hovde Group in 1987 with his brother, Eric D. Hovde, who also serves on the boards of directors of the Company and the Bank. Before co-founding Hovde Group, Mr. Hovde was Regional General Counsel and Vice President of a national commercial real estate development firm, Vantage Companies. Previous to that, Mr. Hovde served as an attorney with a 200-member law firm based in Chicago, Rudnick & Wolfe, which is today DLA Piper, specializing in real estate law. Prior to that, Mr. Hovde practiced accounting in Chicago as a Certified Public Accountant with one of the former “Big Eight” public accounting firms, Touche Ross LLP, which is today Deloitte & Touche LLP. Mr. Hovde has served on the Boards of the Company and the Bank since June 2016 and also serves on the Board’s Nominating Committee and Compensation Committee.
The Board of Directors believes that Mr. Hovde’s qualifications for serving as a director include his experience and background managing diverse financial organizations and serving on the boards of diverse organizations. In addition, as the founder of Hovde Financial, an investment banking firm focused on mergers and acquisitions, Mr. Hovde provides valuable insight to the Company with his knowledge and experience in that area.
Charles L. Maskell Jr, age 58. Mr. Maskell began his career as a CPA in a public accounting firm in 1982 and for over 15 years had been Managing Director and Partner for accounting, audit and consulting services firms. He is a founder and the Managing Director of Chesapeake Corporate Advisors, LLC, a middle market investment bank and corporate advisory firm, a position he has held since December 2005. In this role Mr. Maskell provides emerging and middle market companies with business strategy, valuations, and mergers and acquisitions services. Mr. Maskell regularly consults with clients regarding divestitures, acquisitions and mergers conducting both strategic and fair market value engagements. From January 1998 through November 2005, Mr. Maskell was Managing Director – Consulting Services with RSM McGladrey, Inc., a national business consulting, accounting and tax firm with focus on middle market companies currently known as McGladrey, LLC. Mr. Maskell is a Certified Business Appraiser through The Institute of Business Appraisers and is certified in Mergers and Acquisitions through the Alliance of Merger and Acquisition Advisors. He also served as Chairman and Member of the Loyola University – Maryland Sellinger School of Business Board of Sponsors and is currently a member of the Board of Trustees of Mercy Medical Center. Mr. Maskell, who serves as Chairman of the Board’s Audit Committee and serves on the Board’s Executive Committee, has served as a director of the Company since April 19, 2013 and of the Bank since May 2012.
The Board of Directors believes that Mr. Maskell’s qualifications for serving as a director include his experience in public accounting and corporate advisory work, which gives him informed insight into lending in the small and middle market businesses as well as experience in the financial reporting and corporate governance required by the Bank.
Joseph J. Thomas, 54. Mr. Thomas has served as a Director of the Bank since its founding in 2010 and Chairman of the Company from April 2013 until December 2014 when he became President and CEO of the Company and the Bank. Mr. Thomas was previously Managing Director of Hovde Private Equity Advisors and Financial Services Partners Fund I, a private equity fund dedicated to investing in financial services companies and community banks. Previously, Mr. Thomas enjoyed a distinguished 20-year career with Wachovia Corporation. Mr. Thomas was Managing Director and Head of Financial Institutions Investment Banking for Wachovia Securities. In this role, he was responsible for all mergers and acquisitions, equity capital markets, private equity, fixed income and corporate banking activities with U.S. banks, asset management firms, insurance companies, and specialty finance clients. Over the course of his career at Wachovia, Mr. Thomas held a range of corporate finance, capital markets and investment management positions. Mr. Thomas holds a Masters of Business Administration degree from Fuqua School of Business at Duke University and a Bachelor of Arts degree from the University of Virginia. In addition, Mr. Thomas is a Chartered Financial Analyst and a member of the CFA Society of Washington, DC and a National Association of Corporate Directors Governance Fellow. Mr. Thomas also serves on the Federal Delegate Board of the Independent Community Bankers of America.
The Board of Directors believes that Mr. Thomas’ qualifications for serving as a director include his experience in the banking industry for nearly 30 years in a variety of capacities, including as founding Chairman of Jefferson Bancorp
and as a director of several community banks, and his achievement of various designations as a financial services industry expert.
AUDIT COMMITTEE
The Board of Directors has a separately-designated standing Audit Committee established in accordance with Section 3(a)(58)(A) of the Exchange Act. The Audit Committee is composed of Charles L. Maskell, Jr., Chairman, Steven K. Breeden, Pierre A. Abushacra and Harold I. Hackerman. The Board of Directors has determined that Mr. Hackerman qualifies as an “audit committee financial expert” as defined in Item 407(d)(5) of the SEC’s Regulation S-K.
EXECUTIVE OFFICERS AND SIGNIFICANT EMPLOYEES
Information regarding the Company’s executive officers is set forth below:
Joseph J. Thomas – Mr. Thomas, age 54 serves as the CEO of the Company and the Bank. Additional information about Mr. Thomas is set forth above.
Larry D. Pickett – Mr. Pickett, age 56, has been Executive Vice President – Chief Financial Officer of the Company and the Bank since January 2, 2014. Between August 2008 and his appointment by the Bank and the Company, Mr. Pickett served as the Vice President of Financial Planning, Profitability and Analysis for Susquehanna Bancshares, Inc., located in Lititz, Pennsylvania. In this position, Mr. Pickett was responsible for the financial operations of the $18 billion regional banking organization. His responsibilities included strategic planning, budgeting, forecasting, balance sheet management, evaluation of bank and branch acquisition opportunities and monthly/quarterly narration of bank financial performance and projected performance. He was also responsible for supplying divisional, regional, business line, customer and officer profitability and was a member of the Corporate Asset Liability Committee. Prior to that, between March 2006 and August 2008, Mr. Pickett was the Chief Financial and Chief Risk Officer of Susquehanna Bank in Hunt Valley, Maryland, a $3 billion community bank, where he was responsible for budgeting, forecasting and strategic planning, oversaw the bank's credit division, was a voting member of loan committee, and served as the chairman of the bank's ALCO, Audit and Pricing Committees. He was also responsible for the implementation and ongoing management of Susquehanna Bank's Sarbanes-Oxley Act compliance program.
Information about the Bank’s executive officers, other than Messrs. Thomas and Pickett, is set forth below.
James W. Kirschner - Mr. Kirschner, age 55, has served as Senior Vice President and Chief Credit Officer of the Bank since January 2011. He has more than 30 years’ experience in banking and distressed investing having previously worked for Bank of America, Beltway Capital Management, and FirstCity Crestone. His current responsibilities include the management of the Credit Administration function and Special Assets Group of the Bank. He has been a member of the Bank’s loan committee since 2011. He has extensive experience with credit underwriting, lending, and loan work-out.
Deanna L. Lintz – Mrs. Lintz, age 49, has served as Executive Vice President and Chief Banking Officer since August 2015. Mrs. Lintz joined the bank in March 2007 as Senior Vice President, Branch Administration. She currently manages Branch Administration, Business Banking, Treasury Management, Facilities, Corporate Security and Deposit Operations. Prior to joining the bank, Mrs. Lintz worked at Provident Bank and M&T Bank between 2004 and 2007 as a Business Banking Relationship Manager. Mrs. Lintz started her banking career with Maryland National Bank in 1990 where she worked in their Retail Finance Division. She continued with the bank, through their transition to NationsBank and now Bank of America in their Retail Division as Regional Sales Manager where she managed the sales and service activities for over 20 Banking Centers, and as a Client Manager in their Premier Banking Division managing a $150 million portfolio.
CODE OF ETHICS
The Company has adopted a code of ethics that applies to all its directors and officers, and a copy of the code of ethics will be provided to any person, without charge, upon written request to Bay Bancorp, Inc., Attention: Corporate Secretary, 7151 Columbia Gateway Drive, Suite A, Columbia, Maryland 21046. There have been no material changes in the procedures previously disclosed by which stockholders may recommend nominees to the Company’s Board of Directors.
SECTION 16(a) BENEFICIAL OWNERSHIP REPORTING COMPLIANCE
Pursuant to Section 16(a) of the Exchange Act and the rules promulgated thereunder, the Company’s executive officers and directors and persons who beneficially own more than 10% of the outstanding shares of the Company’s common stock are required to file certain reports regarding their ownership of common stock with the SEC. Based solely on a review of copies of such reports furnished to the Company, or written representations that no reports were required, the Company believes that all such persons timely filed all reports required to be filed by Section 16(a) during the year ended December 31, 2017.
ITEM 11. EXECUTIVE COMPENSATION
DIRECTOR COMPENSATION
The following table sets forth the compensation paid to or earned by each person who served as a director of the Company during the year ended December 31, 2017 and is not also a “named executive officer” (as defined below under the heading “Executive Compensation”). Directors received compensation solely in their capacities as directors of the Bank and did not receive any additional fees for their service as directors of the Company. Information regarding compensation paid to or earned by directors who are also named executive officers is presented in the Summary
Compensation Table that appears below in the section entitled, “Executive Compensation”.
| | | | | |
| | | | | |
Name | Fees earned or paid in cash ($) | Stock awards ($) (1) (2) | Option awards ($) (2) | All other compensation ($) | Total ($) |
Pierre A. Abushacra | 14,250 | 9,938 | - | - | 24,188 |
Robert J. Aumiller | 13,200 | 9,938 | - | - | 23,138 |
Steven K. Breeden | 14,450 | 9,938 | - | - | 24,388 |
Mark M. Caplan | 12,300 | 9,938 | - | - | 22,238 |
Harold I. Hackerman | 13,250 | 9,938 | - | - | 23,188 |
Eric D. Hovde | 29,000 | 29,813 | - | - | 58,813 |
Steven D. Hovde | 21,750 | 9,938 | - | - | 31,688 |
Charles L. Maskell, Jr. | 17,350 | 9,938 | - | - | 27,288 |
Michael Chiaramonte | 3,250 | - | - | - | 3,250 |
Notes:
| (1) | | Amounts in this column represent the grant date fair value of 1,325 shares of restricted Common stock granted in 2017, computed in accordance with Financial Standards Accounting Board Accounting Standards Codification Topic 718 (“Topic 718”). See Note 11 to the audited financial statements presented in Item 8 of Part II of this annual report regarding assumptions underlying valuation of equity awards. |
| (2) | | Outstanding equity awards held by directors as of December 31, 2017 are as follows: Mr. Aumiller, 1,325 shares of restricted Common Stock; Mr. Breeden, 1,325 shares of restricted Common Stock; Mr. Caplan, options to purchase 11,109 shares of Common Stock and 1,325 shares of restricted Common Stock; Mr. Hackerman, 1,325 shares of restricted Common Stock; Mr. Eric D. Hovde, 3,975 shares of restricted Common Stock; Mr. Maskell, options to purchase 11,109 shares of Common Stock and 1,325 shares of restricted Common Stock; Mr. Steven D. Hovde, 1,325 shares of restricted Common Stock; and Mr. Abushacra, 1,325 shares of restricted Common Stock. |
The director compensation program in effect for 2017 provided that directors who were not employees of the Company or the Bank were to receive (i) a monthly retainer fee of $1,000, except for the Chairman of the Audit Committee who received a monthly retainer fee of $1,250 and the Chairman of the Board who received a monthly retainer of $2,500, and (ii) a formal committee meeting attendance fee, whether attending the meeting in person or telephonically, of $250 per eligible committee, with the exception of the Committee Chair who received $300 per eligible committee, to be capped at twelve (12) meetings per year. In addition, if the Company’s then-effective equity compensation plans had sufficient shares reserved for issuance, then each non-employee director who was serving on the date of the 2017 Annual Meeting of Stockholders was to receive a grant of restricted shares of Common Stock, having a fair market value of $10,000 as of the
grant date and subject to a one year vesting period. Each such director received a grant of 1,325 shares of restricted Common Stock with the Chairman receiving 3,975 shares.
The Compensation Committee has the authority and resources necessary to engage its own legal and/or consultants, including to obtain advice, assistance or direction with respect to executive compensation and benefits. During 2017, neither the Compensation Committee nor management engaged a compensation consultant to provide assistance with respect to the determination or recommendation of the amount or form of executive or director compensation.
Overview of Compensation Program
The Company’s executive compensation program is designed to:
| · | | Align the financial interests of the executive officers with the long-term interests of the Company’s stockholders; |
| · | | Attract and retain high performing executive officers to lead the Company to greater levels of profitability; and |
| · | | Motivate and incent executive officers to attain the Company’s earnings and performance goals. The compensation program for the Company’s executive officers has four primary components: |
| · | | annual cash incentive awards; |
| · | | equity-based awards; and |
| · | | employee benefits and perquisites. |
Based on the analysis provided by Board Advisory, as such, it was determined that executive compensation was generally reasonable relative to market peers for base, total cash and total compensation.
Our compensation philosophy is to pay conservatively competitive base salaries based on individual experience, Company and individual performance, and personal contributions to the organization and its goals. Short-term incentives, generally payable in cash, and long-term incentives, generally provided through equity-based awards, are targeted to be competitive but depend more heavily upon Company performance than does base pay. Total compensation and accountability are intended to increase with position and responsibility.
The Company recognizes that executives have significant influence on the overall financial results of the Company and aligns the financial interests of the executive officers with the long-term interests of the stockholders by using equity-based awards that increase in value as stockholder value increases and by choosing financial measures and goals for cash incentive compensation that are based on the key measures that drive the financial performance of the Company.
Base Salary
We believe that competitive base salaries are necessary to attract and retain high performing executive officers. In determining base salaries, the Compensation Committee considers the executive’s qualifications and experience, scope of responsibilities and future potential, the goals and objectives established for the executive and the executive’s past performance, as well as competitive salary practices at other financial institutions.
Annual Incentive Plan
All of our named executive officers participated in our bonus plan. The bonus plan encourages executive officers to work together as a team to achieve specific annual financial goals. The bonus plan is designed to motivate our executive officers to achieve strategic goals, strengthen links between pay and the performance of the Company and align management’s interests more closely with the interests of the stockholders.
The plan is designed to pay out a cash and stock award based on pre-established key performance criteria that must be met before payouts may be made. The key performance indicators are:
| · | | Growth as measured by net loan growth; |
| · | | Overall risk management performance; and |
| · | | Other individual personal performance. |
Incentives are calculated based on budget and business plan goals as measured by the key performance indicators. The 2017 budget was approved by the Board of Directors at the March 2017 meeting and was the basis for the 2017 incentive plan goals.
Equity Plans
The Company and the Bank try to closely align the financial interests of the executive officers with the long-term interests of our stockholders through, among other things, long-term compensation arrangements, which take the form of equity-based awards. Most recently, these awards have been made under the 2007 Plan, the Jefferson Plan and the 2015 Equity Plan. The Company’s Board of Directors and its Compensation Committee administer these plans.
At the 2007 Annual Meeting of Stockholders, the Company’s stockholders approved the Carrollton Bancorp 2007 Equity Plan (the “Carrollton Plan”) and provides for a variety of award types, such as stock options, restricted stock, stock appreciation rights, restricted performance stock, unrestricted stock and performance unit awards, all of which increase in value as the value of the Common Stock increases. Up to 500,000 shares of Common Stock were reserved for issuance under the Carrollton Plan.
Prior to the Jefferson Merger, Jefferson granted options to purchase shares of its common stock under the Jefferson Bancorp, Inc. 2010 Stock Option Plan (the “Jefferson Plan”), which was assumed by the Company in connection with the Jefferson Merger. Each option granted under the Jefferson Plan that was outstanding at the time of the Jefferson Merger was also assumed by the Company and was converted into an option to purchase that number of shares of the Company’s common stock equal to the product of the shares of Jefferson common stock subject to the option and 2.2217, which was the exchange ratio in the Jefferson Merger. After giving effect to the Jefferson Merger, the Jefferson Plan reserved 559,868 shares of Common Stock for issuance. Except for a change in the administrator of the Jefferson Plan (from Jefferson’s Compensation Committee to the Company’s Compensation Committee), all such options remain subject to the same terms and conditions, including vesting, that applied under the Jefferson Plan immediately prior to the Jefferson Merger.
The Bay Bancorp, Inc. 2015 Equity Compensation Plan (the “2015 Plan” and together with the Carrollton Plan and the Jefferson Plan, the “Equity Plans”) was approved by stockholders at the 2015 Annual Meeting and permits the grant of stock options, stock awards and other stock-based awards. The 2015 Equity 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 Equity Plan. The aggregate number of shares of Common Stock that may be issued or transferred under the 2015 Equity Plan is 100,000, and the aggregate number of shares that may be issued or transferred pursuant to options intended to qualify as incentive stock options within the meaning of Section 422 of the Code 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.
Each of the foregoing plans provides for adjustments to the number of shares subject to the adjustments in the number and type of shares that remain available under the plans and of shares that are subject to outstanding awards in the event of any change in the number or kind of shares of Common Stock outstanding by reason of any change in the Company’s capitalization, or by reason of any, merger, reorganization or consolidation. Also, in the event of a merger, reorganization or consolidation in which the Company will not be the surviving corporation or in which the Company will survive but will experience a change in control, or in the case where the Company sells all or substantially all of its assets to another entity, each of the plans provides for acceleration of the exercisability or payment of outstanding awards and, generally, for the assumption or replacement by the surviving corporation of any stock option that is not exercised prior to the effective time of the transaction.
401(k) Plan
The Company has a contributory retirement savings plan qualifying under Section 401(k) of the Code (the “Thrift Plan”). Effective February 1, 2017, eligible employees can join the plan on the first of the month following their date of hire. Participants are eligible for discretionary employer matching contributions on the first day of the quarter following one year of employment. For 2016, we made a discretionary employer matching contribution in cash, in an amount equal to 50% of a participants contributions during 2016 capped at 2% of his or her compensation for 2016. These contributions were made in 2017. For 2017, we intend to make a discretionary employer matching contribution, to be paid in cash, in an amount equal to 50% of employee participant’s annual contributions, capped at 3% of his or her compensation for 2017.
Summary of Executive Compensation
The discussion that follows provides information about compensation awarded to, earned by, or paid to the following persons during 2017 and 2016: (i) the Company’s principal executive officer; (ii) any other person who served as the Company’s principal executive officer at any time during 2017, (iii) the Company’s two most highly compensated executive officers other than the principal executive officer who were serving as such as of December 31, 2017 and whose total compensation for 2017 (excluding above-market and preferential earnings on nonqualified deferred compensation) exceeded $100,000, and (iv) up to two additional individuals for whom disclosure would have been provided pursuant to the foregoing item (iii) had they been serving as executive officers of the Company as of December 31, 2017 (all of the foregoing persons are referred to as the “named executive officers”). For this purpose, the term “executive officer” includes any executive officer of the Bank who performs a policy making function for the Company.
The Company has determined that, for purposes of this Proxy Statement, the named executive officers are Joseph J. Thomas, Larry D. Pickett and James W. Kirschner, as well as Michael F. Croxson who left the Company on July 28, 2017.
The following table sets forth the compensation earned by or awarded to the Company’s named executive officers in 2017 and 2016:
| | | | | | | | |
| | | | | | | | |
Summary Compensation Table |
| Year | Salary | Bonus | Stock awards | Option awards | Nonequity incentive plan compensation | All other compensation | Total |
Name and principal position | | ($) | ($) | ($)(2) | ($)(2) | ($)(3) | ($)(4) | ($) |
Joseph J. Thomas | 2017 | 311,539 | 47,162 | 10,703 | - | 41,179 | 28,592 | 439,175 |
President & CEO (1) | 2016 | 300,600 | 45,548 | 6,848 | - | - | 28,448 | 381,444 |
| | | | | | | | |
Larry D. Pickett | 2017 | 240,000 | 19,200 | 72,339 | - | 13,535 | 9,390 | 354,464 |
Executive VP & CFO | 2016 | 225,173 | 15,527 | 44,415 | - | - | 9,240 | 294,355 |
| | | | | | | | |
James W. Kirschner | 2017 | 167,693 | 20,769 | 18,594 | - | 4,782 | 7,087 | 218,925 |
Senior VP-Chief Credit Officer | 2016 | 142,885 | 25,000 | - | - | - | 5,727 | 173,612 |
| | | | | | | | |
Mike F. Croxson | 2017 | 122,885 | 35,174 | - | 17,500 | - | 403 | 175,962 |
Former Executive VP-Chief Administration Officer | 2016 | 92,308 | 10,219 | - | - | - | 230 | 102,757 |
| | | | | | | | |
| | | | | | | | |
Notes:
| (1) | | Mr. Thomas also serves as a director of the Company and the Bank but receives no separate remuneration for such service. |
| (2) | | Amounts reflect the aggregate grant date fair value of the restricted stock or stock options computed in accordance with Topic 718. See Note 11 to the audited financial statements contained in this annual report regarding the assumptions underlying valuation of equity awards. |
| (3) | | The amounts reflect awards paid under the Annual Incentive Plan. |
| (4) | | For Mr. Thomas, the amounts include (i) an auto allowance of $19,802 for 2017 and $19,808 for 2016, (ii) imputed income relating to the group term life insurance premiums paid on his behalf in the amount of $690 for 2017 and 2016 (iii) employer matching contributions to his Thrift Plan account in the amount of $8,100 for 2017, which will be made in March 2018 and paid in cash, and $7,950 for 2016. For Mr. Pickett, the amounts include, (i) imputed income relating to the group term life insurance premiums paid on his behalf in the amount of $1,290 for 2017 and 2016, and (ii) employer matching contributions to his Thrift Plan account in the amount of $8,100 for 2017 which will be made in March 2018 and paid in cash, and $7,950 for 2016. For Mr. Kirschner, the amounts include imputed income relating to the group term life insurance premiums paid on his behalf in the amount of $1,290 for 2017 and $690 in 2016 and employer matching contributions to his Thrift Plan account in the amount of $5,797 for 2017, which will be made in March 2018 and paid in cash, and $5,037 for 2016. For Mr. Croxson, the amounts include imputed income relating to the group term life insurance premiums paid on his behalf in the amount of $403 for 2017 and $230 for 2016. |
Employment Arrangements
Joseph J. Thomas
Mr. Thomas entered into an employment agreement with the Company and the Bank on April 14, 2017 (the
“Thomas Agreement”). The Thomas Agreement provides for an initial one-year term, with successive one-year renewal terms unless either party provides the other party with 90 days’ prior written notice of its intention to not renew the term of Agreement upon its normal expiration. The Thomas Agreement initially set Mr. Thomas’ annual base salary level at $315,000, subject to periodic review, and provides that he will be eligible to participate in such equity compensation, bonus, incentive and other executive compensation programs as may be made available to senior management of the Company from time to time. The employee benefits to be provided pursuant to the Thomas Agreement include a monthly automobile allowance, four weeks of paid vacation, a minimum of $315,000 in group term life insurance coverage and such other employee benefits as may be made available from time to time to similarly-situated executive officers of the Employer.
The Thomas Agreement provides that, upon the termination of Mr. Thomas’ employment for any reason, he will be entitled to receive all unpaid compensation and benefits that have accrued through the date of termination. If, during a term, his employment is terminated because of his death or disability, then the Thomas Agreement provides that Mr. Thomas will be entitled to also receive the cash value of any unused vacation and the pro-rated portion of the cash-based performance bonus that he would have earned for the year in which the termination occurs had his employment not ended. If, during a term, Mr. Thomas is terminated without “Cause” (as defined in the Thomas Agreement) or if Mr. Thomas terminates his employment for “Good Reason” (as defined in the Thomas Agreement), then (i) he will receive the cash value of any unused vacation, (ii) he will receive, as severance, continued base salary at his then-current rate for 12 months following termination, (iii) he will have the right to continue his participation in the Company’s health, dental and life insurance benefit plans during the period that the severance is paid, the costs of which will be paid by the Bank, and (iv) any unvested equity awards that he holds will immediately vest and become payable or exercisable pursuant to their terms. If, however, a termination without “Cause” or for “Good Reason” occurs within three months before or 12 months after (the “Protection Period”) a “Change in Control” (as defined in the Thomas Agreement), or if Mr. Thomas’ employment ends during the Protection Period because the Employer has elected not to renew the term of the Thomas Agreement upon its normal expiration, then, in lieu of the severance and benefits described in items (ii) and (iii) above, respectively (but in addition to the benefits described in items (i) and (iv) above), Mr. Thomas will be entitled to a lump sum change-in-control severance payment equal to 2.0 times his then-current base salary rate and he will have the right to continue his participation in the Company’s health, dental and life insurance benefit plans for a period of 12 months, the costs of which will be paid by the Bank. The Thomas Agreement provides that if the Employer determines that the aggregate present value of that portion of this change in control severance payment that is considered “Contingent Payments” (as defined in the Thomas Agreement) and all other “Contingent Payments” payable to Mr. Thomas exceeds 2.99 times his “Base Amount” (as defined in the Thomas Agreement), such that the excise tax under Section 4999 of the Internal Revenue Code of 1986, as amended, would otherwise be triggered, then the change in control severance payment will be reduced to the extent necessary to avoid the imposition of that excise tax. If Mr. Thomas’ employment ends because the Company has elected not to renew the term of Thomas Agreement upon its normal expiration and that termination does not occur during the Protection Period, then Mr. Thomas will be entitled to receive continued base salary payments for three months following the date of termination. Except for the accrued but unpaid compensation and benefits payable in the case of any termination, the cash value of unused vacation payable in the event of Mr. Thomas’ death or disability and the pro-rated bonus payable upon Mr. Thomas’ death, the payment of all the foregoing amounts is conditioned upon Mr. Thomas’ execution, delivery and non-revocation of a Separation Agreement in substantially the form attached to the Thomas Agreement and, in certain cases, his compliance with certain notice and other requirements.
The Thomas Agreement provides that, for 12 months following the termination of his employment for any reason, Mr. Thomas may not, directly or indirectly, (i) compete with the Bank or its affiliates from or at any place in the State of Maryland that is located within 60 miles of his most-recently designated employment location at the Bank, (ii) solicit the Bank’s business relationships, or (iii) solicit, engage or hire any of the Bank’s independent contractors or employees. In addition to the foregoing, the Thomas Agreement contains representations and warranties by Mr. Thomas, covenants regarding confidentiality of Bank information and the return of Bank property upon termination, and other provisions that are customary for this type of employment agreement.
Larry D. Pickett
Mr. Pickett entered into an Employment Agreement with the Bank (the “Pickett Agreement”) dated January 2, 2014, which provides for (i) the payment of an annual salary of $240,000, (ii) eligibility to receive an annual cash performance bonus of up to 25% of his then-current annual salary level, (iii) eligibility to receive an annual stock performance bonus of up to 20% of his then-current annual salary level, to be paid in shares of Common Stock, (iv) the grant of an option to purchase
50,000 shares of Common Stock, of which 20% vested as of the grant date and the remaining portion will vest at the rate of 20% per year, (v) $300,000 in group term life insurance coverage, and (vi) participation in the Bank's standard employee benefit plans. In 2016, Mr. Pickett was awarded 25,000 shares of restricted stock to vest over a period of three years, the first of which vested upon the date of the grant. Beginning in 2016, Mr. Pickett will receive at least 10% of base pay in annual long-term incentive grants. Mr. Pickett’s entitlement to the cash performance bonus and stock performance bonus will be determined based on the degree to which criteria relating to both the Bank's performance as a whole and his individual performance are satisfied. These criteria will be established from time to time by the Compensation Committee of the Bank’s Board of Directors. The term of the agreement is for one year and will automatically renew for successive one-year terms unless either party delivers written notice to the other party at least 90 days prior to the current term's expiration date of an intention not to renew the employment relationship. Mr. Pickett’s employment may be terminated prior to the expiration of its then-current term by either Mr. Pickett or the Bank upon notice of such termination to the other party. If the Bank terminates the employment without “Cause” (as defined in the Pickett Agreement) and not because of Mr. Pickett’s death or disability or in connection with a “Change in Control” (as defined in the Pickett Agreement), or if Mr. Pickett terminates his employment for “Good Reason” (as defined in the Pickett Agreement) other than in connection with a Change in Control, then (i) subject to his execution, delivery and non-revocation of a general release and the satisfaction of certain other conditions, Mr. Pickett will be entitled to cash severance equal to six months’ base salary, which will be paid in six equal monthly installments and (ii) he will be entitled to continue his participation in the Bank’s medical plan during the period that the severance is paid. If the Bank experiences a Change in Control and Mr. Pickett’s employment is terminated within 180 days of such Change in Control by the Bank without Cause and not because of his death or disability or by Mr. Pickett for Good Reason, then (i) subject to his execution, delivery and non-revocation of a general release and the satisfaction of certain other conditions, Mr. Pickett will be entitled to receive a lump sum cash severance payment equal to 100% of his then-current base salary, (ii) he will be entitled to continue his participation in the Bank’s medical plan for 12 months after the termination of his employment, and (iii) the unvested portion of all outstanding stock options held by Mr. Pickett will automatically vest and become exercisable in accordance with the terms of those option awards. Except in the case of a termination by the Bank for Cause, the termination of Mr. Pickett’s employment will also entitle him to receive a cash payment representing the value of his accrued but unused vacation days.
The Pickett Agreement provides that, for 12 months following the termination of his employment for any reason, Mr. Pickett may not, directly or indirectly, solicit the Bank’s business relationships, solicit, engage or hire any of the Bank’s independent contractors or employees, or urge any person to reduce such person’s business with the Bank.
James W. Kirschner and Mike F. Croxson
Mr. Kirschner is not a party to any employment agreement with the Company or the Bank, and neither was Mr. Croxson while he was employed by the Bank. Both were employed on an at-will basis. Under the terms of his employment arrangement, Mr. Kirschner is entitled to an annual salary of $168,000. During 2017, Mr. Croxson was entitled to receive an annual salary of $213,000. In addition to base salaries paid in 2017, Messrs. Kirschner and Croxson were eligible to participate in the Thrift Plan and the Equity Plans, and to participate in and/or receive benefits that the Company and/or the Bank made available to all eligible employees generally, including health, dental and vision insurance, long-term disability insurance, and group term life insurance.
Potential Payments Upon Termination of Employment as of December 31, 2017
The table below represents the lump sum maximum amounts that the named executive officers would have been eligible to receive under their respective employment arrangements upon a change in control or if their employment were to be terminated under one of the various scenarios described below as of December 31, 2017. Benefits payable under the Company’s defined benefit/pension plan or Thrift Plan are not included. As noted above, Messrs. Thomas and Pickett will be entitled to certain benefits if their employment with the Company and the Bank are terminated under certain circumstances following a “Change in Control”. The proposed Merger with Old Line Bancshares will constitute a Change in Control for purposes of both Mr. Thomas’ and Mr. Pickett’s employment agreements, and Old Line Bancshares agreed in the Merger Agreement to pay any amount that may become payable to any Company employees under existing employment agreements in connection with the Merger. Accordingly, if payable, such compensation will be paid by Old Line Bancshares after consummation of the Merger. The amounts reported under “Termination without Cause of for Good Reason following a Change in Control” reflect such golden parachute compensation.
| | | | | | | | | |
| | | | | | Termination | | Termination | |
| | | | | | without Cause or | | without Cause or | |
| | | | Termination | | for Good Reason | | for Good Reason | |
| | Quit/termination | | due to death | | - No Change in | | following a Change | |
�� | | for cause | | or disability | | Control | | in Control | |
Name | | ($) | | ($) | | ($)(1) | | ($)(1) | |
Joseph J. Thomas | | - | | 94,399 | | 340,349 | | 655,349 | |
| | | | | | | | | |
Larry D. Pickett | | - | | - | | 131,301 | | 251,301 | |
| | | | | | | | | |
James W. Kirschner | | - | | - | | - | | - | |
| | | | | | | | | |
Mike F. Croxson | | - | | - | | - | | - | |
Note:
| (1) | | The amounts shown for Mr. Thomas and Mr. Pickett include $19,291 and $6,686, respectively, in estimated perquisites and other benefits related to the continuation of health insurance and life insurance plans for 12 months following the termination of employment. |
Equity Compensation Awards
The following table shows all outstanding equity awards held by the named executive officers as of December 31, 2017.
Outstanding Equity Awards at 2017 Fiscal Year-End
| | | | | | |
Name | Option Awards | Stock Awards |
| Number of securities underlying unexercised options (#) exercisable | Number of securities underlying unexercised options (#) unexercisable | Option exercise price ($) | Option expiration date | Number of shares or units of stock that have not vested (#) | Market value of shares or units of stock that have not vested ($) |
Joseph J. Thomas | - | - | - | - | 9,426 | 59,707 |
| | | | | | |
Larry D. Pickett | 40,000 | 10,000 | 5.15 | 01/02/2024 | 14,029 | 80,809 |
| | | | | | |
James W. Kirschner | 16,663 | - | 4.50 | 01/24/2021 | 5,382 | 29,878 |
| 11,000 | - | 4.75 | 07/29/2024 | | |
Mike F. Croxson | - | - | - | - | - | - |
| | | | | | |
Tax and Accounting Implications
Under Section 162(m) of the Code, the Company’s federal income tax deductions may be limited to the extent that total compensation paid in any taxable year to a “covered employee” exceeds $1,000,000. None of the Company’s “covered employees” received compensation in excess of this limit on deductibility.
Section 409A of the Code imposes certain restrictions on the manner and timing of distributions to participants who are “key employees” of the Company under non-qualified deferred compensation plans and arrangements, including a prohibition against paying benefits to a key executive for six months following his or her separation from service. If nonqualified deferred compensation subject to Section 409A does not comply with Section 409A, then the compensation is taxable in the first year that it is not subject to a substantial risk of forfeiture. In such case, the employee is subject to regular federal income tax, interest and an additional federal income tax of 20% of the compensation includible in income.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS
EQUITY COMPENSATION PLAN INFORMATION
The following table contains information about the Equity Plans at December 31, 2017:
| | | | | | | | |
| | | | | | 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 | | 181,544 | | $ | 5.19 | | 85,525 | |
Equity compensation plans not approved by security holders | | — | | | — | | — | |
Total | | 181,544 | | $ | 5.19 | | 85,525 | |
Note:
| (1) | | In addition to stock options and stock appreciation rights, the Carrollton Plan and the 2015 Plan permit the grant of stock awards of various types and performance units. At December 31, 2017, restricted stock awards relating to 50,662 shares were outstanding that are not included in the number shown in column (a) Under the Carrollton Plan (i) 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 Carrollton Plan (ii) subject to the anti-dilution provisions of the Carrollton 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. Under the 2015 Plan, a participant may not be awarded, in any calendar year, grants covering more than 20,000 shares of common stock. |
BENEFICIAL OWNERSHIP OF THE COMMON STOCK
The following table sets forth, as of March 26, 2018, certain information concerning shares of the Common Stock beneficially owned by: (i) each of the named executive officers; (ii) each of the current directors and director nominees of the Company; (iii) all directors and executive officers of the Company as a group; and (iv) each other person that we believe beneficially owns in excess of 5% of the outstanding shares of Common Stock. Generally, a person “beneficially owns” shares if he or she has or shares with others the right to vote those shares or to invest (or dispose of) those shares, or if he or she has the right to acquire such voting or investment rights, within 60 days (such as by exercising stock options or similar rights). The percentages were calculated based on 10,717,889 issued and outstanding shares of Common Stock, plus, for each named person, any shares that such person may acquire within 60 days of March 26, 2018. Except as otherwise noted, the address of each person named below is the address of the Company.
| | | |
| Amount and Nature of Beneficial Ownership | | Percent of Class (%) |
Directors and Named Executive Officers | | | |
Pierre A. Abushacra | 31,603 | | * |
Robert J. Aumiller | 17,783 | (1) | * |
Steven K. Breeden | 95,953 | (2) | * |
Mark M. Caplan | 158,968 | (3) | 1.5 |
Mike F. Croxson | 5,000 | | * |
Harold I. Hackerman | 21,345 | | * |
Eric D. Hovde | 2,991,019 | (4) | 27.9 |
Steven D. Hovde | 128,930 | (5) | 1.2 |
James W. Kirschner | 35,378 | (6) | * |
Charles L. Maskell, Jr. | 21,865 | (7) | * |
Larry D. Pickett | 81,486 | (8) | * |
Joseph J. Thomas | 279,410 | | 2.6 |
All Directors and Officers as a Group (12 persons) | 3,840,168 | | 35.8 |
| | | |
Persons Who Beneficially Own More than 5% of the Class | | | |
Context BH Capital Management, LP | 906,358 | (9) | 8.5 |
RMB Capital Holdings, LLC | 1,008,686 | (10) | 9.4 |
H Bancorp LLC | 2,775,690 | (11) | 25.9 |
| | | |
| | | |
Notes:
*Less than 1%
| (1) | | Includes 13,733 shares owned jointly with spouse. |
| (2) | | Includes 66,701 shares owned jointly with spouse. |
| (3) | | Includes 11,109 shares subject to fully vested and exercisable options to purchase shares. |
| (4) | | Includes the 2,775,690 shares reported below for H Bancorp, as Mr. Hovde has sole voting and investment discretion with respect to such shares, and 28,572 shares held by The Eric D. and Steven D. Hovde Foundation (the “Foundation”), as Eric D. Hovde is a co- trustee and shares voting and investment discretion with respect to such shares. The shares held by the Hovde Foundation are also reported for Steven D. Hovde. |
| (5) | | The shares are held by the Hovde Foundation. Eric D. Hovde and Steven D. Hovde are co-trustees of the foundation and thereby share voting and investment discretion with respect to the shares. These shares are also included in the amount reported for Eric D. Hovde. |
| (6) | | Includes 27,663 shares subject to fully vested and exercisable options. |
| (7) | | Includes 11,109 shares subject to fully vested and exercisable options. |
| (8) | | Includes 50,000 shares subject to fully vested and exercisable options. |
| (9) | | The information is based on the Schedule 13G/A filed with the SEC on February 13, 2018 by Context BH Capital Management, LP. The Fund’s address is 401 City Avenue, Suite 800, Bala Cynwyd, Pennsylvania 19004. The information is based on the Schedule 13G/A filed with the SEC on February 13, 2018 by Context BH Capital Management, LP. The Fund’s address is 401 City Avenue, Suite 800, Bala Cynwyd, Pennsylvania 19004. |
| (10) | | The information is based on the Schedule 13G filed with the SEC on February 13, 2018 by RMB Capital Management, LLC. The Fund’s address is 115 S. LaSalle Street, 34th Floor, Chicago, IL 60603. |
| (11) | | The information is based on the Form 4 filed by Eric D. Hovde on January 3, 2018. Eric D. Hovde is Chairman of the Board of Directors of Bay Bancorp, Inc. Eric D. Hovde is Chairman and CEO of H Bancorp and, in such capacity, has shared investment and voting discretion with respect to the securities owned by H Bancorp LLC. H Bancorp LLC’s address is 2050 Main Street, 3rd Floor, Irvine, CA 92614. The reported shares are also included in the amount shown for Mr. Hovde. |
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS, AND DIRECTOR INDEPENDENCE
CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
The discussion that follows provides information about related party transactions that occurred during 2017 and 2016 and related party transactions that are contemplated for 2018 (other than compensation paid or awarded to the Company’s directors, director nominees executive officers that is required to be discussed in Item 11 of Part II of this annual report, or is exempt from such discussion. For this purpose, the term “related party transaction” is generally defined as any transaction (or series of related transactions) in which (i) the Company or any of its subsidiaries is a participant, (ii) the amount involved exceeds the lesser of (a) $120,000 or (b) 1.0% of the Company’s average total assets at year-end for the last two completed fiscal years, and (iii) any director, director nominee or executive officer of the Company or any person who beneficially owns more than 5% of the outstanding shares of Common Stock (and the immediate family members and affiliates of the foregoing) has a direct or indirect interest. The term includes most financial transactions and arrangements, such as loans, guarantees and sales of property, and remuneration for services rendered (as an employee, consultant or otherwise) to the Company and its subsidiaries.
During 2017 and 2016, the Company, through the Bank, had banking transactions in the ordinary course of its business with the Company’s directors, director nominees, executive officers, 5% or greater stockholders and immediate family members and affiliates of the foregoing. All of these transactions were substantially the same terms, including interest rates, collateral, and repayment terms on loans, as those prevailing at the same time for comparable transactions with persons not related to the Company and its subsidiaries. The extensions of credit to these persons by the Bank have not had and do not currently involve more than the normal risk of collectability or present other unfavorable features.
In addition to the foregoing, related party transactions in 2017 and 2016 included (i) payments of $130,260 in 2016 by the Company and the Bank for appraisal, construction, brokerage and property management services to Mackenzie Commercial Real Estate Services, LLC (“MCRES”), a brokerage and real estate development firm, (ii) payments by the Bank to Joppa Green II Limited Partnership, LLP (“Joppa Green”) for the lease of the Bank’s Lutherville, Maryland location totaling $113,965 in 2017 and $120,107 in 2016, (iii) payments to H Bancorp LLC for services rendered to the Company and the Bank totaling $68,750 in 2017 and $111,250 in 2016, and (iv) payments to Hovde Group totaling $112,904 for investment banking services (discussed below). Mr. Aumiller is a member of MCRES, and he owns a 3.50% limited partnership interest in Joppa Green and also serves as an officer of Joppa Green’s ultimate parent company, Mackenzie Ventures. LLC. Eric D. Hovde owns a 61.70% interest in H Bancorp. Steven D. Hovde is the Chairman and Chief Executive Officer of Hovde Group.
In 2017, the Company’s board of directors engaged Hovde Group to provide investment banking services in connection with the proposed Merger. Steven D. Hovde, who serves on the boards of directors of the Company and the Bank, is the Chairman and Chief Executive Officer of Hovde Group. Pursuant to the engagement letter, Hovde Group received a $100,000 fairness opinion fee and $13,965 in related expenses in 2017 and will receive a completion fee equal to 1.0% of the transaction value, subject to the consummation of the Merger. For this purpose, the transaction value will include the aggregate Merger consideration plus the aggregate amount of cash paid in exchange for any Company stock option that remains unexercised as of the effective time of the Merger. The opinion fee will be credited in full toward the portion of the completion fee that will become payable to Hovde Group upon the consummation of the Merger. The Agreement and Plan of Merger, dated as of September 27, 2017, between the Company and Old Line Bancshares (the “Merger Agreement”) requires Old Line Bancshares to pay the Company a termination fee of $5,076,000 if the Merger Agreement is terminated under certain circumstances. In that event, Hovde Group will be entitled to $761,400, or 15% of that termination fee.
The Company uses the following guidelines to determine the impact of a credit relationship on a director’s independence. We consider extensions of credit which comply with Regulation O, promulgated by the Board of Governors of the Federal Reserve System, to be consistent with director independence. In other words, the Company does not consider normal, arm’s-length credit relationships entered into in the ordinary course of business to negate a director’s independence.
Regulation O requires that loans to directors and executive officers be made on substantially the same terms, including interest rates and collateral, and following credit-underwriting procedures that are no less stringent than those prevailing at the time for comparable transactions by the Company with persons who are not related to the Company or the Bank. Such loans also may not involve more than the normal risk of repayment or present other unfavorable features. Additionally, no event of default may have occurred (that is, such loans are not disclosed as non-accrual, past due, restructured, or potential problems). The Audit Committee must review and approve any credit to a director or his or her related interests and submit such transaction to the full Board of Directors for approval.
In addition, the Company does not consider as independent, for the purpose of voting on any such loans, any director who is also an executive officer of a company to which the Bank has extended credit unless such credit meets the substantive requirements of Regulation O. Similarly, the Company does not consider independent any director who is an executive officer of a company that makes payments to, or receives payments from, the Company for property or services in an amount which, in any fiscal year, is greater than 2% of such company’s consolidated gross revenues.
DIRECTOR INDEPENDENCE
The Company’s Board of Directors has determined that each of Pierre A. Abushacra, Robert J. Aumiller, Steven K. Breeden, Mark M. Caplan, Harold I. Hackerman and Charles L. Maskell, Jr. is an “independent director” as defined in Nasdaq Rule 5605(a)(2), and these independent directors constitute a majority of the Company’s Board of Directors.
In addition to an Audit Committee, the Board has appointed from its members a Nominating Committee and a Compensation Committee. The members of the Nominating Committee include Pierre A. Abushacra, Robert J. Aumiller, Harold I. Hackerman and Steven D. Hovde and the members of the Compensation Committee include Steven K. Breeden, Mark M. Caplan, Robert J. Aumiller and Steven D. Hovde. Each member of the Nominating Committee is an “independent director”, and each member of the Compensation Committee is an “independent director”. Each member of the Audit Committee satisfies the audit committee independence requirements of Nasdaq Rule 5605(c)(2)(A).
ITEM 14. PRINCIPAL ACCOUNTANT FEES AND SERVICE
The following table presents fees billed to the Company by its independent registered public accounting firm, Dixon Hughes Goodman, LLP, during the years ended December 31, 2017 and 2016:
| | | | | | |
| | December 31, 2017 | | December 31, 2016 |
Audit Fees | | $ | 157,329 | | $ | 117,776 |
Tax Fees | | | 16,832 | | | 7,750 |
All Other Fees | | | 139,741 | | | 57,423 |
Total | | $ | 313,902 | | $ | 182,949 |
Audit Fees billed in 2017 and 2016 consisted of professional services rendered for the audit of the Company’s annual consolidated financial statements included in the Company’s Annual Reports on Form 10-K and the review of the interim consolidated financial statements included in the Company’s Quarterly Reports on Form 10-Q.
Tax Fees billed in 2017 and 2016 represent fees for Hopkins Federal Savings Bank final tax returns. All Other Fees in 2017 and 2016 relate to Hopkins Federal Savings Bank merger related support.
It is the Audit Committee’s policy to pre-approve all audit services and permitted non-audit services (including the fees and terms thereof) to be performed for the Company by its independent registered public accounting firm, subject to the de minimis exceptions for non-audit services described in Section 10A(i)(l)(B) of the Exchange Act, which, when needed, are approved by the Audit Committee prior to the completion of the independent registered public accounting firm’s audit. All of the 2017 and 2016 services described above were pre-approved by the Audit Committee.
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.
The exhibits that are filed or furnished with this annual report are listed in the following exhibit index
| | | |
Exhibit No. | | Description | |
| | | |
2.1 | | Purchase and Assumption Agreement, All Deposits, dated May 30, 2015, by and between Bay Bank, FSB 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 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 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) | |
| | | |
2.4 | | Agreement and Plan of Merger, dated September 27, 2017, by and between Old Line Bancshares, Inc. and Bay Bancorp, Inc., (incorporated by reference to Exhibit 2.1 to the Registrant’s Current Report on Form 8-K filed on September 27, 2017, as amended by Amendment No. 1 on Form 8-K/A filed on September 28, 2017) | |
| | | |
3.1 | | Articles of Amendment and Restatement filed with the State Department of Assessments and Taxation of Maryland (“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, 2015 (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) | |
| | | |
3.7 | | Certificate of Correction filed with SDAT on March 23, 2018 (filed herewith) | |
| | | |
10.1 | | 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) | |
| | | |
10.2 | | 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) | |
| | | |
10.3 | | Employment Agreement, dated January 2, 2015, by and between Bay Bank, FSB 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) | |
| | | |
10.4 | | Employment Agreement, dated April 14, 2017, by and among Joseph J. Thomas, Bay Bank, FSB, and Bay Bancorp, Inc. (incorporated by reference to Exhibit 10.1 to the Registrant’s Current Report on Form 8-K filed on April 14, 2017) | |
| | | |
10.5 | | 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) | |
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10.6 | | 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) | |
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10.7 | | 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) | |
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10.8 | | 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) | |
| | | |
10.9 | | 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) | |
| | | |
10.10 | | 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 | | Subsidiaries (filed herewith) | |
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23.1 | | Consent of Dixon Hughes Goodman LLP (filed herewith) | |
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31.1 | | Rule 13a-14(a) Certification by the Principal Executive Officer (filed herewith) | |
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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) | |
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 28, 2018 | | 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 28, 2018 |
Joseph J. Thomas | | (Principal Executive Officer) | | |
| | | | |
/s/ Larry D. Pickett | | Executive Vice President - Chief Financial Officer | | March 28, 2018 |
Larry D. Pickett | | (Principal Accounting Officer) | | |
| | | | |
/s/ Robert J. Aumiller | | Director | | March 28, 2018 |
Robert J. Aumiller | | | | |
| | | | |
/s/ Steven K. Breeden | | Director | | March 28, 2018 |
Steven K. Breeden | | | | |
| | | | |
/s/ Pierre Abushacra | | Director | | March 28, 2018 |
Pierre Abushacra | | | | |
| | | | |
/s/ Mark M. Caplan | | Director | | March 28, 2018 |
Mark M. Caplan | | | | |
| | | | |
/s/ Howard I. Hackerman | | Director | | March 28, 2018 |
Howard I. Hackerman | | | | |
| | | | |
/s/ Eric D. Hovde | | Director | | March 28, 2018 |
Eric D. Hovde | | | | |
| | | | |
/s/ Steven D. Hovde | | Director | | March 28, 2018 |
Steven D. Hovde | | | | |
| | | | |
/s/ Charles L. Maskell | | Director | | March 28, 2018 |
Charles L. Maskell | | | | |
