UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
QUARTERLY REPORT
PURSUANT TO SECTION 13 OR 15(d) OF
THE SECURITIES EXCHANGE ACT OF 1934
FOR THE QUARTERLY PERIOD ENDED MARCH 31, 2006
0-49731
(Commission File No.)
SEVERN BANCORP, INC.
(Exact Name of registrant as Specified in Its Charter)
Maryland 52-1726127
(State of incorporation) (IRS employer identification number)
1919 A West Street, Annapolis, Maryland 21401
(Address of principal executive offices) (Zip Code)
410-268-4554
(Registrant’s telephone number)
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes [X] No [ ]
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer. See definition of “accelerated filer and large accelerated filer” in Rule 12-b-2 of the Exchange Act. (Check One): Large accelerated filer: Accelerated filer: Non-accelerated filer: X
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2). Yes [ ] No [ X]
APPLICABLE ONLY TO ISSUERS INVOLVED IN BANKRUPTCY
PROCEEDINGS DURING THE PRECEDING FIVE YEARS:
Indicate by check mark whether the registrant has filed all documents and reports required to be filed by Section 12, 13 or 15(d) of the Securities Exchange Act of 1934 subsequent to the distribution of securities under a plan confirmed by a court. Yes [ ] No [ ]
APPLICABLE ONLY TO CORPORATE ISSUERS:
The registrant has 9,149,950 shares of Common Stock, par value $0.01 per share, outstanding at May 10, 2006
SEVERN BANCORP, INC. AND SUBSIDIARIES
Table of Contents
PART I - FINANCIAL INFORMATION | |
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Item 1. | Financial Statements | |
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| Consolidated Statements of Financial Condition as of March 31, 2006 (Unaudited) and December 31, 2005 | 1 |
| Consolidated Statements of Income (Unaudited) for the Three Months Ended March 31, 2006 and 2005 | 2 |
| Consolidated Statements of Cash Flows (Unaudited) for the Three Months Ended March 31, 2006 and 2005 | 3 |
| Notes to Consolidated Financial Statements (Unaudited) | 5 |
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Item 2. | Management’s Discussion and Analysis of Financial Condition and Results of Operations | 10 |
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Item 3. | Quantitative and Qualitative Disclosures About Market Risk | 18 |
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Item 4. | Controls and Procedures | 18 |
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PART II - OTHER INFORMATION | |
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Item 1. | Legal Proceedings | 19 |
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Item 1A. | Risk Factors | 19 |
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Item 2. | Unregistered Sales of Equity Securities and Use of Proceeds | 19 |
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Item 3. | Defaults Upon Senior Securities | 19 |
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Item 4. | Submission of Matters to a Vote of Security Holders | 19 |
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Item 5. | Other Information | 19 |
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Item 6. | Exhibits | 19 |
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SIGNATURES | 20 |
PART I- FINANCIAL INFORMATION
Item 1. Financial Statements
SEVERN BANCORP, INC. AND SUBSIDIARIES
Annapolis, Maryland
CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION
(dollars in thousands, except per share amounts)
| | | March 31, | | | December 31, | |
| | | 2006 | | | 2005 | |
| | | (Unaudited | ) | | | |
ASSETS | | |
Cash and due from banks | | $ | 6,923 | | $ | 4,692 | |
Interest bearing deposits in other banks | | | 592 | | | 301 | |
Federal funds sold | | | 19,111 | | | 15,923 | |
Cash and cash equivalents | | | 26,626 | | | 20,916 | |
Investment securities held to maturity | | | 8,197 | | | 8,290 | |
Loans held for sale | | | 1,754 | | | 3,216 | |
Loans receivable, net of allowance for loan losses of | | | | | | | |
$7,887 and $7,505, respectively | | | 794,400 | | | 776,117 | |
Premises and equipment, net | | | 22,296 | | | 19,963 | |
Federal Home Loan Bank of Atlanta stock at cost | | | 8,298 | | | 8,513 | |
Accrued interest receivable and other assets | | | 8,137 | | | 8,680 | |
| | | | | | | |
Total assets | | $ | 869,708 | | $ | 845,695 | |
| | | | | | | |
LIABILITIES AND STOCKHOLDERS' EQUITY | | | | | | | |
Liabilities | | | | | | | |
Deposits | | $ | 619,397 | | $ | 590,814 | |
Short-term borrowings | | | - | | | 26,000 | |
Long-term borrowings | | | 147,000 | | | 132,000 | |
Subordinated debentures | | | 20,619 | | | 20,619 | |
Accrued interest payable and other liabilities | | | 6,548 | | | 3,550 | |
| | | | | | | |
Total liabilities | | | 793,564 | | | 772,983 | |
| | | | | | | |
| | | | | | | |
Stockholders’ Equity | | | | | | | |
Common stock, $0.01 par value, 20,000,000 shares authorized; | | | | | | | |
9,149,950 and 8,318,184 issued and outstanding, respectively | | | 91 | | | 83 | |
Additional paid-in capital | | | 28,094 | | | 11,516 | |
Retained earnings | | | 47,959 | | | 61,113 | |
| | | | | | | |
Total stockholders' equity | | | 76,144 | | | 72,712 | |
| | | | | | | |
Total liabilities and stockholders' equity | | $ | 869,708 | | $ | 845,695 | |
The accompanying notes to consolidated financial statements are an integral part of these statements.
SEVERN BANCORP, INC. AND SUBSIDIARIES
Annapolis, Maryland
CONSOLIDATED STATEMENTS OF INCOME (UNAUDITED)
(dollars in thousands, except per share data)
| | For Three Months Ended March 31, |
| | | 2006 | | | 2005 | |
| | | | | | | |
Interest Income | | | | | | | |
Loans | | $ | 15,857 | | $ | 12,295 | |
Securities, taxable | | | 71 | | | 85 | |
Other | | | 327 | | | 133 | |
Total interest income | | | 16,255 | | | 12,513 | |
| | | | | | | |
Interest Expense | | | | | | | |
Deposits | | | 4,826 | | | 3,389 | |
Short-term borrowings | | | 86 | | | 112 | |
Long-term borrowings | | | 1,932 | | | 1,002 | |
Total interest expense | | | 6,844 | | | 4,503 | |
| | | | | | | |
Net interest income | | | 9,411 | | | 8,010 | |
Provision for loan losses | | | 382 | | | 242 | |
Net interest income after provision for loan losses | | | 9,029 | | | 7,768 | |
| | | | | | | |
Other Income | | | | | | | |
Real estate commissions | | | 66 | | | 148 | |
Real estate management fees | | | 109 | | | 100 | |
Mortgage banking activities | | | 199 | | | 319 | |
Other | | | 226 | | | 139 | |
Total other income | | | 600 | | | 706 | |
| | | | | | | |
Non-Interest Expenses | | | | | | | |
Compensation and related expenses | | | 2,267 | | | 2,253 | |
Occupancy | | | 189 | | | 178 | |
Other | | | 583 | | | 849 | |
Total non-interest expenses | | | 3,039 | | | 3,280 | |
| | | | | | | |
Income before income tax provision | | | 6,590 | | | 5,194 | |
Income tax provision | | | 2,608 | | | 2,044 | |
| | | | | | | |
Net income | | $ | 3,982 | | $ | 3,150 | |
| | | | | | | |
Basic earnings per share | | $ | .44 | | $ | .34 | |
| | | | | | | |
Diluted earnings per share | | $ | .44 | | $ | .34 | |
| | | | | | | |
Common stock dividends declared per share | | $ | .06 | | $ | .06 | |
The accompanying notes to consolidated financial statements are an integral part of these statements.
SEVERN BANCORP, INC. AND SUBSIDIARIES
Annapolis, Maryland
CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)
(dollars in thousands)
| | For The Three Months Ended March 31, |
| | | 2006 | | | 2005 | |
| | | | | | | |
Cash Flows from Operating Activities | | | | | | | |
| | | | | | | |
Net income | | $ | 3,982 | | $ | 3,150 | |
Adjustments to reconcile net income to net cash provided by operating activities: | | | | | | | |
Amortization of deferred loan fees | | | (1,063 | ) | | (821 | ) |
Net amortization of premiums and discounts | | | 8 | | | 8 | |
Provision for loan losses | | | 382 | | | 242 | |
Provision for depreciation | | | 99 | | | 94 | |
Gain on sale of loans | | | (100 | ) | | (168 | ) |
Proceeds from loans sold to others | | | 8,935 | | | 16,615 | |
Loans originated for sale | | | (7,373 | ) | | (12,894 | ) |
(Increase) decrease in accrued interest receivable and other assets | | | 543 | | | (235 | ) |
Increase in accrued interest payable and other liabilities | | | 2,998 | | | 3,314 | |
| | | | | | | |
Net cash provided by operating activities | | | 8,411 | | | 9,305 | |
| | | | | | | |
Cash Flows from Investing Activities | | | | | | | |
| | | | | | | |
Principal collected on mortgage backed securities | | | 85 | | | 367 | |
Net increase in loans | | | (17,602 | ) | | (42,984 | ) |
Investment in premises and equipment | | | (2,432 | ) | | (2,816 | ) |
Redemption (purchase) of Federal Home Loan Bank of Atlanta stock | | | 215 | | | (1,630 | ) |
Net cash used in investing activities | | | (19,734 | ) | | (47,063 | ) |
SEVERN BANCORP, INC. AND SUBSIDIARIES
Annapolis, Maryland
CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED) (CONTINUED)
(dollars in thousands)
| | For The Three Months Ended March 31, |
| | | 2006 | | | 2005 | |
| | | | | | | |
Cash Flows from Financing Activities | | | | | | | |
| | | | | | | |
Net increase in deposits | | | 28,583 | | | 9,146 | |
Net increase (decrease) in short-term borrowings | | | (26,000 | ) | | 31,000 | |
Additional borrowed funds, long-term | | | 15,000 | | | - | |
Repayment of borrowed funds, long term | | | - | | | (2,000 | ) |
Redemption of preferred securities of subsidiary | | | - | | | (4,000 | ) |
Cash dividends paid | | | (550 | ) | | (499 | ) |
| | | | | | | |
Net cash provided by financing activities | | | 17,033 | | | 33,647 | |
Increase (decrease) in cash and cash equivalents | | | 5,710 | | | (4,111 | ) |
Cash and cash equivalents at beginning of year | | | 20,916 | | | 18,038 | |
| | | | | | | |
Cash and cash equivalents at end of period | | $ | 26,626 | | $ | 13,927 | |
| | | | | | | |
Supplemental disclosure of cash flows information: | | | | | | | |
Cash paid during period for: | | | | | | | |
| | | | | | | |
Interest paid | | $ | 6,787 | | $ | 4,296 | |
| | | | | | | |
Income taxes paid | | $ | 1,195 | | $ | 61 | |
The accompanying notes to consolidated financial statements are an integral part of these statements.
SEVERN BANCORP, INC. AND SUBSIDIARIES
Annapolis, Maryland
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
Note 1 - Principles of Consolidation
The unaudited consolidated financial statements include the accounts of Severn Bancorp, Inc. (the “Company”), and its wholly owned subsidiaries, Louis Hyatt, Inc., SBI Mortgage Company and SBI Mortgage Company’s subsidiary, Crownsville Development Corporation, and its subsidiary, Crownsville Holdings I, LLC, and Severn Savings Bank, FSB (the “Bank”), and the Bank’s subsidiaries, Homeowners Title and Escrow Corporation, Severn Financial Services Corporation, SSB Realty Holdings, LLC, SSB Realty Holdings II, LLC, HS West, LLC (“HS West”) and Severn Preferred Capital Corporation. All intercompany accounts and transactions have been eliminated in the accompanying financial statements.
Severn Preferred Capital Corporation, which qualified as a real estate investment trust (“REIT) under the Internal Revenue Code of 1986, as amended, liquidated effective January 31, 2005.
Note 2 - Basis of Presentation
The accompanying unaudited consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America for interim financial information and in accordance with the instructions to Form 10-Q. Accordingly, they do not include all of the disclosures required by accounting principles generally accepted in the United States of America for complete financial statements. In the opinion of management, all adjustments necessary for a fair presentation of the results of operations for the interim periods presented have been made. Such adjustments were of a normal recurring nature. The results of operations for the three months ended March 31, 2006 are not necessarily indicative of the results that may be expected for the fiscal year ending December 31, 2006 or any other interim period. The unaudited consolidated financial statements for the three months ended March 31, 2006 should be read in conjunction with the audited consolidated financial statements and related notes, which are incorporated by reference in the Company’s Annual Report on Form 10-K for the fiscal year, ended December 31, 2005.
Note 3 - Cash Flow Presentation
In the statements of cash flows, cash and cash equivalents include cash on hand, amounts due from banks, Federal Home Loan Bank of Atlanta (“FHLB Atlanta”) overnight deposits, and federal funds sold. Generally, federal funds are sold for one-day periods.
SEVERN BANCORP, INC. AND SUBSIDIARIES
Annapolis, Maryland
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) Continued
Note 4 - Earnings Per Share and Stock Dividend
Basic earnings per share of common stock for the three months ended March 31, 2006 and March 31, 2005 is computed by dividing net income by 9,149,950, the weighted average number of shares of common stock outstanding for each period. Diluted earnings per share of common stock for the three months ended March 31, 2006 and March 31, 2005 is computed by dividing net income by 9,150,323 and 9,149,950, respectively, to reflect additional common shares that would have been outstanding if dilutive potential common shares had been issued. Potential common shares that were issued by the Company relate solely to outstanding stock options, of which there were 113,300 and 0 outstanding as of March 31, 2006 and 2005, respectively. The above amounts have been retroactively adjusted to give effect to a 10% stock dividend declared on February 21, 2006, effective for shares outstanding on March 28, 2006. The accompanying Statement of Financial Condition for March 31, 2006 reflects the issuance of 831,766 shares of common stock and the $16,585,000 transfer from retained earnings to common stock and additional paid-in capital related to this 10% stock dividend.
Note 5 - Guarantees
The Company does not issue any guarantees that would require liability recognition or disclosure, other than its standby letters of credit. Standby letters of credit written are conditional commitments issued by the Company to guarantee the performance of a customer to a third party. Generally, all letters of credit, when issued have expiration dates within one year. The credit risks involved in issuing letters of credit are essentially the same as those that are involved in extending loan facilities to customers. The Company generally holds collateral supporting these commitments. The Company had $6,253,000 of standby letters of credit outstanding as of March 31, 2006. Management believes that the proceeds obtained through a liquidation of collateral would be sufficient to cover the potential amount of future payments required under the corresponding guarantees. The amount of the liability as of March 31, 2006 and December 31, 2005 for guarantees under standby letters of credit issued is not material.
Note 6 - Regulatory Matters
The Bank is subject to various regulatory capital requirements administered by the federal banking agencies. Failure to meet minimum capital requirements can initiate certain mandatory, and possible additional discretionary actions by the regulators that, if undertaken, could have a direct material effect on the Company’s financial statements. Under capital adequacy guidelines and the regulatory framework for prompt corrective action, the Bank must meet specific capital guidelines that involve quantitative measures of the Bank’s assets, liabilities, and certain off-balance sheet items as calculated under regulatory accounting practices. The Bank’s capital amounts and classifications are also subject to qualitative judgments by the regulators about components, risk weightings, and other factors.
SEVERN BANCORP, INC. AND SUBSIDIARIES
Annapolis, Maryland
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) Continued
The following table presents the Bank’s capital position:
| | | Actual | | | Actual | | | To Be Well Capitalized Under | |
| | | at March 31, 2006 | | | at December 31, 2005 | | | Prompt Corrective Provisions | |
Tangible (1) | | | 10.4 | % | | 10.3 | % | | N/A | |
Tier I Capital (2) | | | 12.4 | % | | 12.2 | % | | 6.0 | % |
Core (1) | | | 10.4 | % | | 10.3 | % | | 5.0 | % |
Total Capital (2) | | | 13.5 | % | | 13.3 | % | | 10.0 | % |
(1) To adjusted total assets
(2) To risk-weighted assets.
Note 7 - Stock-Based Compensation
The Company currently has a stock-based compensation plan in place for directors, officers, and other key employees of the Company. Under the terms of the plan, the Company grants stock options for the purchase of the Company’s common stock. The stock-based compensation is granted under terms and conditions determined by the Stock Option Committee of the Board of Directors. Stock options generally have a term of five years with a maximum term of ten years, and are granted with an exercise price at least equal to the fair market value of the common stock on the date the options are granted. Generally, options granted to directors of the Company vest immediately, and options granted to officers and employees vest over a five-year period, although the Stock Option Committee has the authority to provide for different vesting schedules.
Effective January 1, 2006, the Company adopted SFAS 123R using the modified-prospective transition method. SFAS 123R requires all share-based payments to employees, including grants of employee stock options, be recognized as compensation expense in the statement of income at fair value. Under the modified-prospective transition method, the Company would recognize an expense over the remaining required service period for any stock options granted prior to January 1, 2006 for the portion of those grants for which the requisite service has not yet been rendered of which there were none. Accordingly, no adjustment was made to prior period amounts nor was any expense recorded for options granted prior to January 1, 2006 for which their requisite service period had been rendered by that date. Stock-based compensation expense for the first quarter of 2006 and 2005 totaled $8,000 and $0, respectively
The grant-date fair value of options granted in February 2006, adjusted for stock dividends, was $6.57. The fair value of the options awarded under the option plan is estimated on the date of grant using the Black-Scholes valuation model, which is dependent upon certain assumptions as presented below
| | | 2006 | |
Expected life (in years) | | | 4.56 | |
Risk-free interest rate | | | 4.59 | % |
Expected volatility | | | 53.66 | % |
Expected dividend yield | | | 4.50 | % |
SEVERN BANCORP, INC. AND SUBSIDIARIES
Annapolis, Maryland
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) Continued
The expected life of the options was estimated using the average vesting period of the options granted and represents the period of time that options granted are expected to be outstanding. The risk-free interest rate is the U.S. Treasury rate commensurate with the expected life of the options on the grant date. Volatility of the Company’s stock price was based on historical volatility. Dividend yield was based on historical dividends divided by the average market price for that period.
Information regarding the Company’s stock option plan as of March 31, 2006 is as follows:
| | | | | | | | | Weighted | | |
| | | | | | Weighted | | | Average | | Aggregate |
| | | | | | Average | | | Remaining | | Intrinsic |
| | | Shares | | | Price | | | Life | | Value |
Options outstanding, beginning of year | | | - | | $ | - | | | | |
Options granted | | | 113,300 | | | 17.43 | | | | |
Options outstanding, end of quarter | | | 113,300 | | $ | 17.43 | | 4.92 | $ | 677,000 |
Options exercisable, end of quarter | | | 9,900 | | $ | 17.18 | | 4.92 | $ | 59,000 |
Option price range at end of quarter | | $17.18 to $18.90 | | | | |
There were no stock options exercised during the first quarter of 2006 or 2005.
Note 8 - Commitments
HS West is constructing a building in Annapolis, Maryland to serve as the Company’s and the Bank’s administrative headquarters. A branch office of the Bank will be included. As of March 31, 2006, HS West has incurred approximately $18.5 million of costs. The total cost is expected to be approximately $25.2 million after interior fit-out, with completion anticipated in the fall of 2006.
Note 9 - Recent Accounting Pronouncements
In February 2006, the FASB issued SFAS No. 155, “Accounting for Certain Hybrid Financial Instruments”. SFAS No. 155 amends FASB Statement No. 133 and FASB Statement No. 140, and improves the financial reporting of certain hybrid financial instruments by requiring more consistent accounting that eliminates exemptions and provides a means to simplify the accounting for these instruments. Specifically, SFAS No.155 allows financial instruments that have embedded derivatives to be accounted for as a whole (eliminating the need to bifurcate the derivative from its host) if the holder elects to account for the whole instrument on a fair value basis. SFAS No. 155 is effective for all financial instruments acquired or issued after the beginning of an entity’s first fiscal year that begins after September 15, 2006. The Company is required to adopt the provisions of SFAS No. 155, as applicable, beginning in fiscal year 2007. Management does not believe the adoption of SFAS No. 155 will have a material impact on the Company’s financial statements.
SEVERN BANCORP, INC. AND SUBSIDIARIES
Annapolis, Maryland
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) Continued
In March 2006, the FASB issued SFAS No. 156, “Accounting for Servicing of Financial Assets - An Amendment of FASB Statement No. 140” (“SFAS 156”). SFAS 156 requires that all separately recognized servicing assets and servicing liabilities be initially measured at fair value, if practicable. The statement permits, but does not require, the subsequent measurement of servicing assets and servicing liabilities at fair value. SFAS 156 is effective as of the beginning of an entity’s first fiscal year that begins after September 15, 2006, which for the Company will be as of the beginning of fiscal 2007. Management does not believe the adoption of SFAS 156 will have a material effect on the Company’s financial statements.
In February 2006, the FASB issued FASB Staff Position No. FAS 123(R)-4, “Classification of Options and Similar Instruments Issued as Employee Compensation That Allow for Cash Settlement upon the Occurrence of a Contingent Event.” This position amends SFAS 123R to incorporate that a cash settlement feature that can be exercised only upon the occurrence of a contingent event that is outside the employee’s control does not meet certain conditions in SFAS 123R until it becomes probable that the event will occur. The guidance in this FASB Staff Position shall be applied upon initial adoption of Statement 123R. Management has implemented FAS123R in the first quarter of 2006. Such implementation will not have a material effect on the Company’s financial statements.
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations.
The Company
The Company is a savings and loan holding company chartered in the state of Maryland in 1990. It conducts business through three subsidiaries: the Bank, which is the Company’s principal subsidiary; Louis Hyatt, Inc., t/a Hyatt Commercial, a commercial real estate brokerage and property management company; and SBI Mortgage Company, which holds mortgages that do not meet the underwriting criteria of the Bank, and is the parent company of Crownsville Development Corporation, t/a Annapolis Equity Group, which acquires real estate for syndication and investment purposes. The Bank has three branches in Anne Arundel County, Maryland, which offer a full range of deposit products. The Bank originates mortgages in its primary market of Anne Arundel County, Maryland and, to a lesser extent, in other parts of Maryland, Delaware and Northern Virginia. The Bank, through its subsidiary HS West, is currently constructing a building in Annapolis, Maryland to serve as the Company’s and the Bank’s administrative headquarters. A branch of the Bank will be included. As of March 31, 2006, HS West has incurred approximately $18.5 million of costs. The total cost is expected to be approximately $25.2 million after interior fit-out, with completion expected in the fall of 2006. The Company’s common stock trades under the symbol “SVBI” on the Nasdaq Capital Market.
Forward Looking Statements
In addition to the historical information contained herein, the discussion in this report contains forward-looking statements that involve risks and uncertainties and may be affected by various factors that may cause actual results to differ materially from those in the forward-looking statements. The forward-looking statements contained herein include, but are not limited to, those with respect to management’s determination of the amount of loan loss allowance; the effect of changes in interest rates; and changes in deposit insurance premiums. The words “anticipate,” “believe,” “estimate,” “expect,” “intend,” “may,” “plan,” “will,” “would,” “should,” “guidance,” “potential,” “continue,” “project,” “forecast,” “confident,” and similar expressions are typically used to identify forward-looking statements. The Company’s operations and actual results could differ significantly from those discussed in the forward-looking statements. Some of the factors that could cause or contribute to such differences include, but are not limited to, changes in the economy and interest rates in the nation and Company’s general market area, federal and state regulation, competition and other factors detailed from time to time in the Company’s filings with the Securities and Exchange Commission (the “SEC”), including “Item 1A. Risk Factors” contained in the Company’s Annual Report on Form 10-K for the fiscal year ended December 31, 2005.
Critical Accounting Policies
The Company’s significant accounting policies are set forth in note 1 of the audited consolidated financial statements as of December 31, 2005 which were filed on Form 10-K. Of these significant accounting policies, the Company considers its policy regarding the allowance for loan losses to be its most critical accounting policy, because it requires management’s most subjective and complex judgments. In addition, changes in economic conditions can have a significant impact on the allowance for loan losses and therefore the provision for loan losses and results of operations. The Company has developed appropriate policies and procedures for assessing the adequacy of the allowance for loan losses, recognizing that this process requires a number of assumptions and estimates with respect to its loan portfolio. The Company’s assessments may be impacted in future periods by changes in economic conditions, the impact of regulatory examinations, and the discovery of information with respect to borrowers that is not known to management at the time of the issuance of the consolidated financial statements.
The Company adopted Statement of Financial Accounting Standards No. 123R, “Share-Based Payments” (Statement 123R) in the first quarter of 2006, using the “modified prospective method”. Prior to the implementation of FAS 123R, stock options issued under shareholder approved employee and director stock option plans were accounted for under Accounting Principles Board Opinion No. 25, “Accounting for Stock Issued to Employees” (APB 25). Under APB 25, no compensation expense was recognized related to these plans. Stock options are granted at exercise prices not less than the fair value of the common stock on the date of grant. See Note 7 - Stock-Based Compensation.
Overview
The primary business of the Company is mortgage lending. The demand for construction lending and purchase money mortgage lending continues to remain high, even as interest rates increase from their historical low levels. The Company’s loan growth in its portfolio has been strong (loan receivables, net of the allowance for loan losses, outstanding as of March 31, 2006 were $794,400,000 compared to $776,117,000, as of December 31, 2005, a 2.4% increase) and it continues to earn what management believes is a good “spread” between the Company’s cost of funds and what it earns on loans.
It is generally anticipated that interest rates will continue to increase. The Company expects to be challenged as it seeks to grow assets in the form of mortgage loans in an environment where its cost of borrowing and interest rates on deposits are likely to increase. As interest rates increase, there may be less demand for mortgage loan refinancing. The Company will continue to balance its pricing and duration of its loan portfolio against the risks of rising costs of its deposits and borrowings.
The continued success and attraction of the markets in which the Company operates will also be important to the Company’s ability to originate and grow its mortgage loans, as will the Company’s continuing ability to maintain low overhead.
Results of Operations
Net income increased by $832,000, or 26.4%, to $3,982,000 for the first quarter of 2006, compared to $3,150,000 for the first quarter of 2005. Basic and diluted earnings per share increased by $.10, or 29.4%, to $.44 for the first quarter of 2006, compared to $.34 for the first quarter of 2005. The increase in net income and basic and diluted earnings per share over last year is a result of continued growth in the Company’s mortgage portfolio coupled with the Company’s continued ability to maintain low operating expenses. The Company’s interest rate spread decreased by .01%, to 4.30% for the three months ended March 31, 2006, compared to 4.31% for the same period in 2005. However, its mortgage portfolio balance increased over that same period of time.
Net interest income, which is interest earned net of interest charges, increased by $1,401,000, or 17.5%, to $9,411,000 for the first quarter of 2006, compared to $8,010,000 for the first quarter of 2005. The primary reason for the increase in net interest income was the Company’s growth in interest earning assets. This increase was a result of the continued loan demand and growth of the Company’s mortgage portfolio. Net yield on interest earning assets for the three months ended March 31, 2006 was 4.59% compared to 4.55% for the same period in 2005, a rise of .04%. The growth in net yield was primarily a result of a larger increase in interest earning assets compared to interest-bearing liabilities.
The provision for loan losses increased by $140,000, or 57.9%, to $382,000 for the first quarter of 2006, compared to $242,000 for the first quarter of 2005. The provision for loan losses and allowance for loan losses are based on management’s judgment and evaluation of the loan portfolio. Management assesses the adequacy of the allowance for loan losses and the need for any addition thereto, by considering the nature and size of the loan portfolio, overall portfolio quality, review of specific problem loans, economic conditions that may affect the borrowers’ ability to pay or the value of property securing loans, and other relevant factors. While management believes the current allowance is adequate, changing economic and other conditions may require future adjustments to the allowance for loan losses.
Other income decreased by $106,000, or 15.0%, to $600,000 for the first quarter of 2006, compared to $706,000 for the first quarter of 2005. The primary reason for the decrease in other income was a decrease in real estate commissions and mortgage banking activities. Real estate commissions decreased $82,000, or 55.4%, to $66,000 for the first quarter of 2006 compared to $148,000 for the first quarter of 2005. This decrease was a result of a temporary decrease in sales and leasing activity at Hyatt Commercial. In addition, mortgage-banking activities decreased by $120,000, or 37.6%, to $199,000 for the first quarter of 2006, compared to $319,000 for the same period in 2005. This decrease was primarily a result of a $68,000 decrease in gain on sale of loans, and a $52,000 decrease in mortgage processing and servicing fees. These decreases were a result of a decrease in loans sold on the secondary market, and in residential loans being refinanced during the first quarter of 2006 compared to the first quarter of 2005. Other increased by $87,000, or 62.6%, to $226,000 for the first quarter of 2006, compared to $139,000 for the first quarter of 2005. This increase was primarily a result of an increase in late fees collected in 2006.
Total non-interest expenses decreased by $241,000, or 7.3%, to $3,039,000 for the first quarter of 2006, compared to $3,280,000 for the first quarter of 2005. Compensation and related expenses increased by $14,000, or 0.6%, to $2,267,000 for the first quarter of 2006, compared to $2,253,000 for the same period in 2005. This increase was primarily because of salary increases effective January 1, 2006, partially offset by a decrease in commissions paid to mortgage loan officers due to a decreased amount of loan originations in 2006. Other non-interest expenses decreased by $266,000, or 31.3%, to $583,000 for the first quarter of 2006, compared to $849,000 for the first quarter of 2005. The decrease in 2006 was primarily due to one-time write-offs of $214,000 taken in the first quarter of 2005.
Income Taxes
The income tax provision increased by $564,000, or 27.6%, to $2,608,000 for the first quarter of 2006, compared to $2,044,000 for the first quarter of 2005. The effective tax rate for the three months ended March 31, 2006 was 39.6% compared to 39.4% for the same period in 2005.
Analysis of Financial Condition
Total assets increased by $24,013,000, or 2.8%, to $869,708,000 at March 31, 2006, compared to $845,695,000 at December 31, 2005. Cash and cash equivalents increased by $5,710,000, or 27.3%, to $26,626,000 at March 31, 2006, compared to $20,916,000 at December 31, 2005. This increase was primarily due to increased federal funds sold from deposit growth in excess of loan growth. Loan demand continued to grow during the first quarter of 2006, as net loans receivable increased $18,283,000, or 2.4%, to $794,400,000 at March 31, 2006, compared to $776,117,000 at December 31, 2005. Loans held for sale decreased $1,462,000, or 45.5%, to $1,754,000 at March 31, 2006, compared to $3,216,000 at December 31, 2005. Total deposits increased $28,583,000, or 4.8%, to $619,397,000 at March 31, 2006 compared to $590,814,000 at December 31, 2005. This increase is primarily attributable to an ongoing campaign by the Company to attract money market deposit accounts and promotions to obtain shorter-term certificates of deposit. FHLB Atlanta advances decreased $11,000,000, or 7.0%, to $147,000,000 at March 31, 2006, compared to $158,000,000 as of December 31, 2005. This is a result of paying off short term FHLB Atlanta advances with additional deposits, awaiting the Company’s need to fund loans.
Stockholders’ Equity
Total stockholders’ equity increased $3,432,000, or 4.7%, to $76,144,000 at March 31, 2006 compared to $72,712,000 as of December 31, 2005. This increase is a result of net earnings, offset by dividends declared.
Asset Quality
Non-accrual loans (those loans 90 or more days in arrears) decreased $642,000, or 37.9%, to $1,051,000 as of March 31, 2006, compared to $1,693,000 as of December 31, 2005. This decrease is a result of a decrease in the number and size of loans that were 90 or more days in arrears at March 31, 2006. There were no charge offs in the three months ended March 31, 2006. At March 31, 2006, the total allowance for loan losses was $7,887,000, which was .99% of total net loans, compared with $7,505,000, which was .96% of total net loans as of December 31, 2005. The allowance for loan losses is based on management’s judgment and evaluation of the loan portfolio. Management assesses the adequacy of the allowance for loan losses and the need for any addition thereto, by considering the nature and size of the loan portfolio, overall portfolio quality, review of specific problem loans, economic conditions that may affect the borrowers’ ability to pay or the value of property securing loans, and other relevant factors. While management believes the current allowance is adequate, changing economic and other conditions may require future adjustments to the allowance for loan losses.
Liquidity
The Company’s liquidity is determined by its ability to raise funds through loan payments, maturing investments, deposits, borrowed funds, capital, and the sale of loans. Based on the internal and external sources available, the Company’s liquidity position exceeded anticipated short-term and long-term needs at March 31, 2006. Additionally, loan payments, maturities, deposit growth and earnings contribute a flow of funds available to meet liquidity requirements.
In assessing its liquidity, the management of the Company considers operating requirements, anticipated deposit flows, expected funding of loans, deposit maturities and borrowing availability, so that sufficient funds may be available on short notice to meet obligations as they arise so that the Company may take advantage of business opportunities.
Management believes it has sufficient cash flow and liquidity to meet its current commitments. Certificates of deposit, which are scheduled to mature in less than one year, totaled $297,259,000 at March 31, 2006. Based on past experience, management believes that a significant portion of such deposits will remain with the Company. At March 31, 2006, the Company had commitments to originate loans of $41,044,000, unused lines of credit of $31,711,000, and commitments under standby letters of credit of $6,253,000. In addition, the Company expects to incur an additional $4,118,000, before interior fit-out, for construction costs associated with its new headquarters. The Company has the ability to reduce its commitments for new loan originations, adjust other cash outflows, and borrow from FHLB Atlanta should the need arise. As of March 31, 2006, outstanding FHLB Atlanta borrowings totaled $147,000,000, and the Company had available to it up to an additional $112,356,000 in borrowing availability from FHLB Atlanta.
Net cash provided by operating activities decreased $1,814,000 to $7,491,000 for the three months ended March 31, 2006 compared to $9,305,000 for the same period in 2005. This decrease is primarily the result of a decrease in mortgage banking activities and lower accrued interest payable and other liabilities, partially offset by higher net income in 2006 and a decrease in accrued interest receivable and other assets. Net cash used in investing activities decreased $27,329,000 to $19,734,000 for the three months ended March 31, 2006, compared to $47,063,000 for the same period in 2005. This decrease is primarily due to a decrease in loan originations. Net cash provided by financing activities decreased by $15,694,000 to $17,953,000 for the three months ended March 31, 2006, compared to $33,647,000 for the same period in 2005. This decrease is primarily due to a decrease in cash advances from FHLB Atlanta partially offset by an increase in cash from deposits. As a result, cash and cash equivalents increased $12,699,000 to $26,626,000 at March 31, 2006, compared to $13,927,000 at March 31, 2005.
Effects of Inflation
The consolidated financial statements and related consolidated financial data presented herein have been prepared in accordance with accounting principles generally accepted in the United States of America and practices within the banking industry which require the measurement of financial condition and operating results in terms of historical dollars, without considering the changes in the relative purchasing power of money over time due to inflation. Unlike most industrial companies, virtually all of the assets and liabilities of a financial institution are monetary in nature. As a result, interest rates have a more significant impact on a financial institution’s performance than the effects of general levels of inflation.
Average Balance Sheet
The following table presents the Company’s distribution of the average consolidated balance sheets as of March 31, 2006 and March 31, 2005, and net interest analysis for the three months ended March 31, 2006 and March 31, 2005.
| | Three Months Ended March 31, 2006 | | Three Months Ended March 31, 2005 |
| | Average Balance | | Interest | | Rate Annualized | | Average Balance | | Interest | | Rate Annualized |
| | (dollars in thousands) |
ASSETS | | | | | | | | | | | | |
Loans (1) | | $784,256 | | $15,857 | | 8.09% | | $681,606 | | $12,295 | | 7.22% |
Investments (2) | | 5,000 | | 38 | | 3.04% | | 5,000 | | 35 | | 2.80% |
Mortgage-backed securities | | 3,226 | | 33 | | 4.09% | | 4,656 | | 50 | | 4.30% |
Other interest-earning assets (3) | | 27,629 | | 327 | | 4.73% | | 12,158 | | 133 | | 4.38% |
| | | | | | | | | | | | |
Total interest-earning assets | | 820,111 | | 16,255 | | 7.93% | | 703,420 | | 12,513 | | 7.12% |
| | | | | | | | | | | | |
Non-interest earning assets | | 36,393 | | | | | | 24,864 | | | | |
| | | | | | | | | | | | |
Total assets | | $856,504 | | | | | | $728,284 | | | | |
| | | | | | | | | | | | |
LIABILITIES AND STOCKHOLDERS' EQUITY | | | | | | | | | | | | |
Savings and checking deposits | | $140,571 | | 438 | | 1.25% | | $162,371 | | 520 | | 1.28% |
Certificates of deposit | | 463,489 | | 4,388 | | 3.79% | | 369,376 | | 2,869 | | 3.11% |
Short-term borrowings | | 8,667 | | 86 | | 3.97% | | 20,333 | | 112 | | 2.20% |
Long-term borrowings | | 142,000 | | 1,932 | | 5.44% | | 88,334 | | 1,002 | | 4.53% |
| | | | | | | | | | | | |
Total interest-bearing liabilities | | 754,727 | | 6,844 | | 3.63% | | 640,414 | | 4,503 | | 2.81% |
| | | | | | | | | | | | |
Non-interest bearing liabilities | | 26,562 | | | | | | 25,972 | | | | |
| | | | | | | | | | | | |
Stockholders' equity | | 75,215 | | | | | | 61,898 | | | | |
| | | | | | | | | | | | |
Total liabilities and stockholders’ equity | | $856,504 | | | | | | $728,284 | | | | |
| | | | | | | | | | | | |
Net interest income and interest rate spread | | | | $9,411 | | 4.30% | | | | $8,010 | | 4.31% |
| | | | | | | | | | | | |
Net interest margin | | | | | | 4.59% | | | | | | 4.55% |
| | | | | | | | | | |
Average interest-earning assets to average interest-bearing liabilities | | | | 108.66% | | | | | | 109.84% |
(1) | Non-accrual loans are included in the average balances and in the computation of yields. |
(2) | The Company does not have any tax-exempt securities. |
(3) | Other interest-earning assets includes interest-bearing deposits in other banks, federal funds and FHLB stock investments. |
Off-Balance Sheet Arrangements
The Company is a party to financial instruments with off-balance-sheet risk in the normal course of business to meet the financial needs of its customers. These financial instruments include commitments to extend credit and standby letters of credit, which involve, to varying degrees, elements of credit risk in excess of the amount recognized in the statement of financial position. The contract amounts of these instruments express the extent of involvement the Company has in each class of financial instruments.
The Company’s exposure to credit loss from non-performance by the other party to the above mentioned financial instruments is represented by the contractual amount of those instruments. The Company uses the same credit policies in making commitments and conditional obligations as it does for on-balance-sheet instruments.
The credit risk involved in these financial instruments is essentially the same as that involved in extending loan facilities to customers. No amount has been recognized in the statement of financial condition at March 31, 2006, as a liability for credit loss.
Off-balance sheet financial instruments whose contract amounts represent credit and interest rate risk are summarized as follows:
Financial Instruments Whose Contract | | | Contract Amount At | |
Amounts Represent Credit Risk | | | March 31, 2006 | |
| | | (dollars in thousands) | |
Standby letters of credit | | $ | 6,253 | |
Home equity lines of credit | | $ | 21,014 | |
Unadvanced construction commitments | | $ | 123,999 | |
Loan commitments | | $ | 20,056 | |
Lines of credit | | $ | 31,711 | |
Loans sold with limited repurchase provisions | | $ | 9,369 | |
Legal Proceedings
There are various claims pending involving the Company, arising in the normal course of business. Management believes, based upon consultation with legal counsel, that liabilities arising from these proceedings, if any, will not be material to the Company’s financial condition.
Item 3. Quantitative and Qualitative Disclosures About Market Risk
There has been no material change in market risk since December 31, 2005, as reported in Company’s Form 10-K filed with the SEC on or about March 21, 2006.
Item 4. Controls and Procedures
Under the supervision and with the participation of the Company’s management, including its Chief Executive Officer and Chief Financial Officer, the Company has evaluated the effectiveness of its disclosure controls and procedures (as defined in Securities Exchange Act Rule 13a-15(e)) as of March 31, 2006. Based on this evaluation, the Chief Executive Officer and Chief Financial Officer have concluded that, as of March 31, 2006, the Company’s disclosure controls and procedures were effective in reaching a reasonable level of assurance that (i) information required to be disclosed by the Company in the reports that it files or submits under the Securities Exchange Act of 1934 is recorded, processed, summarized and reported within the time periods specified in the Securities and Exchange Commission’s rules and forms and (ii) information required to be disclosed by the Company in its reports that it files or submits under the Securities Exchange Act of 1934 is accumulated and communicated to its management, including its principal executive and principal financial officers, or persons performing similar functions, as appropriate to allow timely decisions regarding required disclosure.
There have not been any changes in the Company's internal control over financial reporting (as such term is defined in Rules 13a-15(f) and 15d-15(f) under the Exchange Act) during the quarter ended March 31, 2006 that have materially affected, or are reasonably likely to materially affect, the Company's internal control over financial reporting.
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. Because of the inherent limitations in all control systems, no evaluation of controls can provide absolute assurance that all control issues and instances of fraud, if any, within the Company have been detected. Because of the inherent limitations in a cost-effective control system, misstatements due to error or fraud may occur and not be detected.
PART II - OTHER INFORMATION
Item 1. Legal Proceedings.
None other than ordinary routine litigation incidental to the Company’s business.
Item 1A. Risk Factors
In addition to the other information set forth in this report, you should carefully consider the factors discussed in Part I, “Item 1A. Risk Factors” in our Annual Report on Form 10-K for the year ended December 31, 2005, which could materially affect our business, financial condition or future results. The risk factors in our Annual Report on Form 10-K have not materially changed. The risks described in our Annual Report on Form 10-K are not the only risks facing our Company. Additional risks and uncertainties not currently known to us or that we currently deem to be immaterial also may materially adversely affect our business, financial condition and/or operating results.
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds.
None.
Item 3. Defaults Upon Senior Securities.
None.
Item 4. Submission of Matters to a Vote of Security Holders.
None.
Item 5. Other Information.
None.
Item 6. Exhibits.
Exhibit No. Description
10.1 Form of Stock Option Award (incorporated by reference to Exhibit 99.1 in the Company’s Current Report on Form 8-K filed with the Securities and Exchange Commission
on March 20, 2006.
31.1 Certification of Chief Executive Officer pursuant to Section 302 of Sarbanes-Oxley Act of 2002
31.2 Certification of Chief Financial Officer pursuant to Section 302 of Sarbanes-Oxley Act of 2002
32 Certification of Chief Executive Officer and Chief Financial Officer pursuant to 18 U.S.C.
Section 1350 as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
SIGNATURES
Under 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.
| | SEVERN BANCORP, INC. |
| | |
| | |
May 12, 2006 | | ____Alan J. Hyatt_________________________________________ |
| | Alan J. Hyatt, Chairman of the Board, President and Chief Executive Officer |
| | (Principal Executive Officer) |
| | |
| | |
May 12, 2006 | | _____Thomas G. Bevivino___________________________________ |
| | Thomas G. Bevivino, Chief Financial Officer |
| | (Principal Financial and Accounting Officer) |
Exhibit Index
Exhibit No. Description
31.1 Certification of Chief Executive Officer pursuant to Section 302 of Sarbanes-Oxley Act of 2002
31.2 Certification of Chief Financial Officer pursuant to Section 302 of Sarbanes-Oxley Act of 2002
32 Certification of Chief Executive Officer and Chief Financial Officer pursuant to 18 U.S.C.
Section 1350 as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
21