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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-K
FOR ANNUAL AND TRANSITION REPORTS
PURSUANT TO SECTIONS 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
(MARK ONE)
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
For the fiscal year ended December 31, 2000
OR
[X] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the transition period from to
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Commission File No. 0-18279
TRI-COUNTY FINANCIAL CORPORATION
--------------------------------
(Exact name of registrant as specified in its charter)
MARYLAND 52-1652138
- ------------------------------------- ------------------
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
3035 LEONARDTOWN ROAD, WALDORF, MARYLAND 20601
- ---------------------------------------- ----------
(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code: (301) 645-5601
Securities registered pursuant to Section 12(b) of the Act: NONE
Securities registered pursuant to Section 12(g) of the Act:
COMMON STOCK, PAR VALUE $.01 PER SHARE
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(Title of Class)
Indicate by check mark whether the registrant (1) has filed all reports required
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 X No
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Indicate by check mark if disclosure of delinquent filers pursuant to Item 405
of Regulation S-K is not contained herein, and will not be contained, to the
best of 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. [ ]
The registrant's voting stock is not regularly and actively traded in any
established market and there are no regularly quoted bid and asked prices for
the registrant's common stock. As of March 26, 2001, the registrant believes the
approximate trading price for the stock to be $26.25 per share for an
approximate aggregate market value of voting stock held by non-affiliates of the
registrant of $16.7 million. For purposes of this calculation only, the shares
held by directors and executive officers of the registrant and by any
stockholder beneficially owning more than 5% of the registrant's outstanding
common stock are deemed to be shares held by affiliates.
Number of shares of Common Stock outstanding as of March 26, 2001: 773,053
DOCUMENTS INCORPORATED BY REFERENCE
1. Portions of Proxy Statement for 2001 Annual Meeting of Stockholders. (Part
III)
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PART I
ITEM 1. BUSINESS
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Tri-County Financial Corporation (the "Company") is a bank holding company
organized in 1989 under the laws of the State of Maryland. It presently owns all
the outstanding shares of capital stock of the Community Bank of Tri-County (the
"Bank"), a Maryland-chartered commercial bank. The Bank was originally organized
in 1951 as Tri-County Federal Savings and Loan Association of Waldorf, a federal
mutual savings and loan association, and in 1986 converted to a federal stock
savings bank and adopted the name Tri-County Federal Savings Bank. The Bank
converted to a Maryland-chartered commercial bank and adopted its current
corporate title in 1997. The Company engages in no significant activity other
than holding the stock of the Bank and operating the business of the Bank.
Accordingly, the information set forth in this report, including financial
statements and related data, relates primarily to the Bank and its subsidiaries.
The Bank serves the southern Maryland area through its main office and eight
branches located in Waldorf, Bryans Road, Dunkirk, Leonardtown, La Plata, and
California, Maryland. The Bank is engaged in the commercial and retail banking
business as authorized by the banking statutes of the State of Maryland and
applicable Federal regulations, including the acceptance of demand and time
deposits, and the origination of loans to individuals, associations,
partnerships and corporations. The Bank's real estate financing consists of
residential first and second mortgage loans, home equity lines of credit and
commercial mortgage loans. Commercial lending consists of both secured and
unsecured loans. The Bank is a member of the Federal Reserve and Federal Home
Loan Bank ("FHLB") Systems and its deposits are insured up to applicable limits
by Savings Association Insurance Fund ("SAIF") of the Federal Deposit Insurance
Corporation ("FDIC").
The Company's executive offices are located at 3035 Leonardtown Road, Waldorf,
Maryland. Its telephone number is (301) 645-5601. The Bank also maintains a
website at www.communitybktricounty.com.
----------------------------
MARKET AREA
The Bank considers its principal lending and deposit market area to consist of
the Southern Maryland counties of Charles, Calvert and St. Mary's. These
counties have experienced significant population growth during the past decade
due to their proximity to the rapidly growing Washington, D.C. and Baltimore
metropolitan areas. Southern Maryland is generally considered to have more
affordable housing than many other Washington and Baltimore area suburbs. In
addition, the area has experienced rapid growth in businesses and federal
facilities located in the area. Major federal facilities include the Patuxent
Naval Air Station in St. Mary's county. The Patuxent Naval Air Station has
undergone significant expansion in the last several years and is projected to
continue to expand for several more years.
LENDING ACTIVITIES
GENERAL. The Bank offers a wide variety of consumer and commercial loans. The
Bank's lending activities include residential and commercial real estate loans,
construction loans, land acquisition and development loans, equipment financing,
and commercial and consumer demand and installment loans. Most of the Bank's
customers are residents of, or businesses located in the southern Maryland area.
The Bank's primary market for commercial loans consists of small and medium
sized businesses located in southern Maryland. The Bank believes that this
market is responsive to the Bank's ability to provide personal service and
flexibility. The Bank attracts customers for its consumer lending products based
upon its ability to offer service, flexibility, and competitive pricing, as well
as by leveraging other banking relationships such as soliciting deposit
customers for loans.
The Bank's previous savings and loan charter restricted its ability to hold
certain loan types in its portfolio. As a result, prior to its conversion to a
state chartered commercial bank, the Bank's loan portfolio was primarily made up
of residential mortgage loans. Since conversion, the Bank has moved to diversify
its lending by adding a larger portion of commercial real estate, commercial,
and consumer loans to its portfolio. Management believes that this
2
diversification of the loan portfolio will increase the Bank's overall long-term
financial performance. Management recognizes that these new loan types may
increase the Bank's risk of losses due to loan default.
RESIDENTIAL FIRST MORTGAGE LOANS. Prior to its conversion to a commercial bank
on March 29, 1997, residential first mortgages made up the majority of the
Bank's loan portfolio. Since that date, residential first mortgage loans have
represented a progressively smaller portion of the Bank's loan portfolio. Since
December 31, 1996, residential first mortgage loans have increased in dollar
amount to $68.0 million from $63.7 million, while falling as a percentage of the
loan portfolio to 38.9% from 56.3%.
Residential first mortgage loans made by the Bank are generally long-term loans,
amortized on a monthly basis, with principal and interest due each month. The
initial contractual loan payment period for residential loans typically ranges
from 10 to 30 years. The Bank's experience indicates that real estate loans
remain outstanding for significantly shorter periods than their contractual
terms. Borrowers may refinance or prepay loans at their option, without penalty.
The Bank originates both fixed- and adjustable-rate residential first mortgages.
The Bank emphasizes the origination of adjustable-rate mortgages for its
portfolio. The Bank offers mortgages which are adjustable on a one-, three- and
five-year basis generally with limitations on upward adjustments of two
percentage points per year and six percentage points over the life of the loan.
The Bank markets adjustable-rate loans with rate adjustments based upon a United
States Treasury bill index. As of December 31, 2000, the Bank had $34.9 million
in loans using a U.S. Treasury bill index. In the past, the Bank also offered
adjustable-rate mortgage loans based upon other indices including various cost
of funds indices. These adjustable rate loans totaled $175 thousand as of
December 31, 2000. The Bank also offers long-term, fixed-rate loans. Fixed-rate
loans may be packaged and sold in the secondary market, primarily to the Federal
Home Loan Mortgage Corporation ("FHLMC"), private mortgage correspondents, the
Federal National Mortgage Association ("FNMA") and the Mortgage Partnership
Finance program of the FHLB of Atlanta, or are exchanged for FHLMC participation
certificates or FNMA mortgage-backed securities. Depending on market conditions
the Bank may elect to retain the right to service the loans sold for a payment
based upon a percentage, (generally 0.25% of the outstanding loan balance).
These servicing rights may be sold to other qualified servicers. As of December
31, 2000, the Bank serviced $64.8 million in residential mortgage loans for
various organizations.
The retention of adjustable-rate mortgage loans in the Bank's loan portfolio
helps reduce the negative effects of increases in interest rates on the Bank's
net interest income. Under certain conditions, however, the annual and lifetime
limitations on interest rate adjustments may limit the increases in interest
rates on these loans. There are also unquantifiable credit risks resulting from
potential increased costs to the borrower as a result of repricing of
adjustable-rate mortgage loans. It is probable that during periods of rising
interest rates, the risk of default on adjustable-rate mortgage loans will
increase due to the upward adjustment of interest cost to the borrower. In
addition, depending on market conditions, the initial interest rate on
adjustable-rate loans is generally lower than that on a fixed-rate loan of
similar credit quality and size.
The Bank makes loans up to 95% of appraised value or sales price of the
property, whichever is less, to qualified owner-occupants upon the security of
single-family homes. Non-owner occupied one- to four-family loans and loans
secured by other than residential real estate are generally permitted to a
maximum 70% loan-to-value of the appraised value depending on the overall
strength of the application. The Bank currently requires that substantially all
residential loans with loan-to-value ratios in excess of 80% carry private
mortgage insurance to lower the Bank's exposure to approximately 80% of the
value of the property.
All improved real estate which serves as security for a loan made by the Bank
must be insured, in the amount and by such companies as may be approved by the
Bank, against fire, vandalism, malicious mischief and other hazards. Such
insurance must be maintained through the entire term of the loan and in an
amount not less than that amount necessary to pay the Bank's indebtedness in
full.
COMMERCIAL REAL ESTATE AND OTHER NON-RESIDENTIAL REAL ESTATE LOANS. The Bank has
increased its emphasis on loans for the permanent financing of commercial and
other improved real estate projects, including, to a limited extent, office
buildings, as well as churches and other special purpose projects. As a result,
commercial real estate
3
loans increased $12.3 million or 41.0% during 2000. The primary security on a
commercial real estate loan is the real property and the leases which produce
income for the real property. Commercial real estate loans amounted to
approximately $42.2 million or 24.1% of the Bank's loan portfolio at December
31, 2000. The Bank generally limits its exposure to a single borrower to 15% of
the Bank's capital and frequently participates with other lenders on larger
projects. Loans secured by commercial real estate are generally limited to 80%
of appraised value and have an initial contractual loan payment period ranging
from three to 20 years. Virtually all of the Bank's commercial real estate
loans, as well as its construction loans discussed below, are secured by real
estate located in the Bank's primary market area.
Loans secured by commercial real estate are larger and involve greater risks
than one- to four-family residential mortgage loans. Because payments on loans
secured by such properties are often dependent on the successful operation or
management of the properties, repayment of such loans may be subject to a
greater extent to adverse conditions in the real estate market or the economy.
The Bank restricts its commercial real estate lending primarily to
owner-occupied buildings which will, to some extent, be occupied by the borrower
as opposed to speculative rental projects. As a result of the greater emphasis
that the Bank places on commercial real estate loans under its business plan as
a commercial bank, the Bank is increasingly exposed to the risks posed by this
type of lending.
CONSTRUCTION AND LAND DEVELOPMENT LOANS. The Bank offers construction loans to
individuals and building contractors primarily for the construction of one- to
four-family dwellings. Loans to individuals primarily consist
construction/permanent loans which have fixed rates, payable monthly for the
construction period and are followed by a 30-year, fixed- or adjustable-rate
permanent loan. The construction/permanent loans provide for disbursement of
loan funds based on draw requests submitted by the builder during construction
and site inspections by independent inspectors. The Bank will also make a
construction loan if the borrower has a commitment from another lender for a
permanent loan at the completion of the construction. These loans typically have
terms of six months. The application process includes the same items which are
required for other mortgage loans and also requires the borrower to submit to
the Bank accurate plans, specifications, and costs of the property to be
constructed. These items are used as a basis to determine the appraised value of
the subject property.
The Bank also provides construction and land development loans to home building
and real estate development companies. Generally, these loans are secured by the
real estate under construction as well as by guarantees of the principals
involved. Draws are made upon satisfactory completion of pre-defined stages of
construction or development. The Bank will lend up to 80% of the appraised
value.
The Bank also offers builders lines of credit, which are revolving notes
generally secured by real property. Outstanding builders lines of credit
amounted to approximately $5.6 million at December 31, 2000. The Bank offers a
builder's master note program in which the builder receives a revolving line of
credit at a market rate and the Bank obtains security in the form of a first
lien on home sites under construction.
In addition, the Bank offers loans for the purpose of acquisition and
development of land, as well as loans on undeveloped, subdivided lots for home
building by individuals. Land acquisition and development loans, included in
construction loans discussed above, totaled $5.8 million at December 31, 2000.
Bank policy provides that zoning and permits must be in place prior to making
development loans.
The Bank's ability to originate all types of construction and development loans
is heavily dependent on the continued demand for single family housing
construction in the Bank's market areas. In the event the demand for new houses
in the Bank's market areas were to decline, the Bank may be forced to shift a
portion of its lending emphasis. There can be no assurance of the Bank's ability
to continue growth and profitability in its construction lending activities in
the event of such a decline.
Construction and land development loans are inherently riskier than providing
financing on owner occupied real estate. The Bank's risk of loss is dependent on
the accuracy of the initial estimate of the market value of the completed
project as well as the accuracy of the cost estimates made to complete the
project. As these projects may take an extended period of time to complete,
market, economic, and regulatory conditions may change during the construction
or development period.
4
HOME EQUITY AND SECOND MORTGAGE LOANS. The Bank has maintained a growing level
of home equity and second mortgage loans in recent years. Home equity loans,
which totaled $12.9 million at December 31, 2000, are generally made in the form
of lines of credit with minimum amounts of $5,000, have terms of up to 20 years,
variable rates priced at prime or some margin above prime and require an 80% or
90% loan-to-value ratio (including any prior liens), depending on the specific
loan program. Second mortgage loans which totaled $5.8 million at December 31,
2000 are fixed-rate loans which have original terms between 5 and 15 years.
Loan-to-value ratios of up to 80% or 90% are allowed depending on the specific
loan program.
These products represent a higher risk of default than residential first
mortgages as in the event of foreclosure, the first mortgage would need to be
paid off prior to collection of the second. The Bank believes that its policies
and procedures are sufficient to mitigate the additional risk.
CONSUMER AND COMMERCIAL LOANS. The Bank has developed a number of programs to
serve the needs of its customers with primary emphasis upon loans secured by
automobiles, boats, recreational vehicles and trucks and heavy equipment. The
Bank also makes home improvement loans and offers both secured and unsecured
lines of credit.
The Bank also offers a variety of commercial loan services including term loans,
lines of credit and equipment financing. The Bank's commercial loans are
primarily underwritten on the basis of the borrower's ability to service the
debt from income. Such loans are generally made for terms of five years or less
at interest rates which adjust periodically.
The higher interest and shorter loan terms available on commercial and consumer
lending make these products attractive to the Bank. In particular, the consumer
and commercial loan portfolio will increase its yield as interest rates
increase. Consumer and commercial business loans, however, entail greater risk
than residential mortgage loans, particularly in the case of consumer loans
which are unsecured or secured by rapidly depreciable assets such as
automobiles. In such cases, any repossessed collateral may not provide an
adequate source of repayment of the outstanding loan balance as a result of the
greater likelihood of damage, loss or depreciation. The remaining deficiency
often does not warrant further substantial collection efforts against the
borrower. In addition, consumer loan collections are dependent on the borrower's
continuing financial stability, and thus are more likely to be adversely
affected by job loss, divorce, illness or personal bankruptcy. Furthermore, the
application of various Federal and state laws including Federal and state
bankruptcy and insolvency laws, may limit the amount which can be recovered on
such loans. Such loans may also give rise to claims and defenses by a consumer
loan borrower against an assignee such as the Bank, and a borrower may be able
to assert against such assignee claims and defenses which it has against the
seller of the underlying collateral.
5
LOAN PORTFOLIO ANALYSIS. Set forth below is selected data relating to the
composition of the Bank's loan portfolio by type of loan on the dates indicated.
AT DECEMBER 31,
----------------------------------------------------------------
2000 1999 1998
------------------- ------------------- ------------------
AMOUNT % AMOUNT % AMOUNT %
--------- ------ --------- ------ --------- -----
(DOLLARS IN THOUSANDS)
Real Estate Loans --
Residential first mortgage ............. $ 67,975 38.89% $ 66,263 44.42% $ 64,243 47.55%
Commercial ............................. 42,226 24.16 29,947 20.08 19,733 14.60
Construction and land development /1/... 17,301 9.90 17,142 11.49 20,776 15.38
Home equity and second mortgage ........ 18,637 10.66 16,691 11.19 16,314 12.07
Commercial loans.......................... 15,047 8.61 10,025 6.72 6,161 4.56
Consumer loans............................ 13,610 7.79 9,102 6.10 7,889 5.84
--------- ------ --------- ------ --------- ------
Total loans...................... 174,796 100.00% 149,171 100.00% 135,117 100.00%
====== ====== ======
Less: Deferred loan fees.............. 776 808 930
Loan loss reserve............ 1,930 1,653 1,540
--------- --------- ---------
Loans receivable, net............. $ 172,090 $ 146,710 $ 132,646
========= ========= =========
AT DECEMBER 31,
-----------------------------------------
1997 1996
------------------- -------------------
AMOUNT % AMOUNT %
--------- ------ --------- ------
(DOLLARS IN THOUSANDS)
Real Estate Loans --
Residential first mortgage ............. $ 61,630 49.61% $ 63,674 56.32%
Commercial ............................. 19,201 15.46 14,172 12.54
Construction and land development /1/... 14,707 11.84 11,756 10.40
Home equity and second mortgage ........ 17,428 14.03 14,147 12.51
Commercial loans.......................... 4,852 3.91 3,887 3.44
Consumer loans............................ 6,420 5.17 5,422 4.80
-------- ------ -------- ------
Total loans...................... 124,238 100.00% 113,058 100.00%
====== ======
Less: Deferred loan fees.............. 1,060 1,086
Loan loss reserve............ 1,310 1,120
-------- --------
Loans receivable, net............. $121,867 $110,851
======== ========
<FN>
- ----------
1 Presented net of loans in process.
</FN>
6
LOAN ORIGINATIONS, PURCHASES AND SALES. The Bank solicits loan applications
through its branch network, direct solicitation of customers, referrals from
customers, and marketing by commercial and residential mortgage loan officers.
Loans are processed and approved according to guidelines deemed appropriate for
each product type. Loan requirements such as income verification, collateral
appraisal, credit reports, etc. vary by loan type. Loan processing functions are
generally centralized except for small consumer loans. Loan approval authority
is established by Board policy and delegated as deemed necessary and
appropriate. Loan approval authorities vary by individual with the President
having approval authority up to $750,000, Senior Vice Presidents up to $400,000,
and Business Development officers up to $150,000. Authorities may be combined up
to $1,000,000. For residential mortgage loans, the residential loan underwriter
may approve loans up to the conforming loan limit of $255,000. Selected branch
personnel may approve secured loans up to $75,000, and unsecured loans up to
$50,000. A loan committee consisting of the President and two members of the
Board, ratify all real estate mortgages and approve all loans in excess of
$1,000,000. Depending on the loan and collateral type, conditions for protecting
the Bank's collateral are specified in the loan documents. Typically these
conditions might include requirements to maintain hazard and title insurance,
pay property taxes, and other conditions.
Depending on market conditions, mortgage loans may be originated primarily with
the intent to sell to third parties such as FNMA or FHLMC. During the year 2000,
the Bank sold $2.5 million of mortgage loans which were originated during the
year generating $85 thousand in gains. In order to comply with internal and
regulatory limits on loans to one borrower, the Bank routinely sells portions of
commercial and commercial real estate loans to other lenders. The Bank also
routinely buys portions of loans, whole loans, or participation certificates
from other lenders. The Bank only purchases loans or portions of loans after
reviewing loan documents, underwriting support, and other procedures as
necessary. Purchased loans are subject to the same regulatory and internal
policy requirements as other loans in the Bank's portfolio.
LOANS TO ONE BORROWER. Under Maryland law, the maximum amount which the Bank is
permitted to lend to any one borrower and their related interests may generally
not exceed 10% of the Bank's unimpaired capital and surplus which is defined to
include the Bank's capital, surplus, retained earnings and 50% of its reserve
for possible loan losses. Under this authority, the Bank would have been
permitted to lend up to $2.4 million to any one borrower at December 31, 2000.
By interpretive ruling of the Commissioner of Financial Regulation, Maryland
banks have the option of lending up to the amount that would be permissible for
a national bank which is generally 15% of unimpaired capital and surplus
(defined to include a bank's total capital for regulatory capital purposes plus
any loan loss allowances not included in regulatory capital). Under this
formula, the Bank would have been permitted to lend up to $3.7 million to any
one borrower at December 31, 2000. At December 31, 2000, the largest amount
outstanding to any one borrower and their related interests was $2.4 million.
LOAN COMMITMENTS. The Bank does not normally negotiate standby commitments for
the construction and purchase of real estate. Conventional loan commitments are
granted for a one-month period. The total amount of the Bank's outstanding
commitments to originate loans at December 31, 2000, was approximately $995
thousand, excluding undisbursed portions of loans in process. It has been the
Bank's experience that few commitments expire unfunded.
7
MATURITY OF LOAN PORTFOLIO. The following table sets forth certain information
at December 31, 2000 regarding the dollar amount of loans maturing in the Bank's
portfolio based on their contractual terms to maturity. Demand loans, loans
having no stated schedule of repayments and no stated maturity, and overdrafts
are reported as due in one year or less.
DUE AFTER 1 DUE MORE
DUE WITHIN THROUGH 5 THAN 5
1 YEAR AFTER YEARS FROM YEARS FROM
DECEMBER DECEMBER DECEMBER
31, 2000 31, 2000 31, 2000 TOTAL
---------- ---------- ---------- -----
(IN THOUSANDS)
Real estate loans --
Residential first mortgages...... $ 3,232 $ 13,940 $ 50,803 $ 67,975
Commercial ...................... 2,621 10,508 29,097 42,226
Construction..................... 12,552 1,410 3,339 17,301
Home equity and second
mortgage....................... 13,891 2,527 2,219 18,637
Commercial loans.................... 15,047 -- -- 15,047
Consumer loans...................... 3,760 9,850 -- 13,610
---------- ---------- ---------- ----------
$ 51,103 $ 38,235 $ 85,458 $ 174,796
========== ========== ========== ==========
The next table sets forth the dollar amount of all loans due after one year from
December 31, 2000 which have predetermined interest rates and have floating or
adjustable interest rates.
FLOATING OR
FIXED RATES ADJUSTABLE RATES TOTAL
----------- ---------------- -----
(IN THOUSANDS)
Real estate loans --
Residential first mortgage... $ 31,198 $ 33,545 $ 64,743
Commercial................... 2,910 36,695 39,605
Construction................. 4,749 -- 4,749
Home equity and second
mortgage................... 4,746 -- 4,746
Consumer........................ 9,850 -- 9,850
----------- ----------- ----------
$ 53,453 $ 70,240 $ 123,693
=========== =========== ==========
DELINQUENCIES. The Bank's collection procedures provide that when a loan is 15
days delinquent, the borrower is contacted by mail and payment is requested. If
the delinquency continues, subsequent efforts will be made to contact the
delinquent borrower and obtain payment. If these efforts prove unsuccessful, the
Bank will pursue appropriate legal action including repossession of the
collateral and other actions as deemed necessary. In certain instances, the Bank
will attempt to modify the loan or grant a limited moratorium on loan payments
to enable the borrower to reorganize his financial affairs.
NON-PERFORMING ASSETS AND ASSET CLASSIFICATION. Loans are reviewed on a regular
basis and are placed on a non-accrual status when, in the opinion of management,
the collection of additional interest is doubtful. Residential mortgage loans
are placed on non-accrual status when either principal or interest is 90 days or
more past due unless they are adequately secured and there is reasonable
assurance of full collection of principal and interest. Consumer loans generally
are charged off when the loan becomes over 120 days delinquent. Commercial
business and real estate loans are placed on non-accrual status when the loan is
90 days or more past due or when the loan's condition puts the timely repayment
of principal and interest in doubt. Interest accrued and unpaid at the time a
loan is placed
8
on non-accrual status is charged against interest income. Subsequent payments
are either applied to the outstanding principal balance or recorded as interest
income, depending on the assessment of the ultimate collectibility of the loan.
Real estate acquired by the Bank as a result of foreclosure or by deed in lieu
of foreclosure is classified as foreclosed real estate until such time as it is
sold. When such property is acquired, it is recorded at its fair market value.
Subsequent to foreclosure, the property is carried at the lower of cost or fair
value less selling costs. Additional write-downs as well as carrying expenses of
the foreclosed properties are charged to expenses in the current period. The
Bank had foreclosed real estate with a fair market value of approximately $176
thousand at December 31, 2000.
The following table sets forth information with respect to the Bank's
non-performing loans for the periods indicated. During the periods shown, the
Bank had no impaired loans within the meaning of Statement of Financial
Accounting Standards No. 114 and 118
AT DECEMBER 31,
-----------------------------------------------------------------
2000 1999 1998 1997 1996
---- ---- ---- ---- ----
(DOLLARS IN THOUSANDS)
Restructured loans.................... $ -- $ -- $ -- $ -- $ --
---------- ---------- ---------- --------- -----------
Accruing loans which are contractually
past due 90 days or more:
Real estate:
Residential first mortgage........ $ -- $ -- $ -- $ -- $ --
Commercial........................ -- -- -- -- --
Construction and land
development..................... -- -- -- -- --
Home equity and second
mortgage........................ 102 171 196 165 262
Commercial ......................... -- -- -- -- --
Consumer............................ -- -- -- -- 79
---------- ---------- ---------- --------- -----------
Total............................. 102 171 196 165 341
---------- ---------- ---------- --------- -----------
Loans accounted for on a nonaccrual
basis:
Real estate:
Residential first mortgage........ $ $ 20 $ 126 $ 34 $ 358
Commercial........................ -- -- -- -- --
Construction and land
development..................... -- -- -- -- --
Home equity and second
mortgage........................ -- -- -- -- --
Commercial ......................... -- -- 85 30 --
Consumer............................ 7 198 58 95 --
---------- ---------- ---------- --------- -----------
Total............................. 7 218 269 159 358
---------- ---------- ---------- --------- -----------
Total non-performing loans............ $ 109 $ 389 $ 465 $ 324 $ 699
========== ========== ========== ========= ===========
Non-performing loans to total
loans............................. 0.06% 0.26% 0.34% 0.26% 0.62%
========== ========== ========== ========= ===========
Allowance for loan losses
to non-performing loans........... 1,770.55% 424.94% 331.18% 404.32% 160.23%
========== =========== ========== ========= ===========
9
During the year ended December 31, 2000, gross interest income of $1 thousand
would have been recorded on loans accounted for on a non-accrual basis if the
loans had been current throughout the period. During the year 2000, the Company
recognized no interest on these loans.
At December 31, 2000, there were no loans outstanding not reflected in the above
table as to which known information about possible credit problems of borrowers
caused management to have serious doubts as to the ability of such borrowers to
comply with present loan repayment terms.
The following table sets forth an analysis of activity in the Bank's allowance
for possible loan losses for the periods indicated.
YEAR ENDED DECEMBER 31,
-----------------------------------------------------------------
2000 1999 1998 1997 1996
---- ---- ---- ---- ----
(DOLLARS IN THOUSANDS)
Balance at Beginning of Period........ $ 1,653 $ 1,540 $ 1,310 $ 1,120 $ 734
---------- ---------- ---------- --------- -----------
Charge-Offs:
Real estate:
Residential first mortgages........ 56 -- -- 11 17
Commercial .......................... 33 102 -- 21 --
Consumer............................. 6 32 10 18 5
---------- ---------- ---------- --------- -----------
Total Charge-Offs..................... 95 134 10 50 22
---------- ---------- ---------- --------- -----------
Recoveries:
Real estate:
Residential first mortgages........ -- -- -- -- --
Commercial........................... -- -- -- -- --
Consumer............................. 12 7 -- -- --
---------- ---------- ---------- --------- -----------
Total Recoveries...................... 12 7 -- -- --
---------- ---------- ---------- --------- -----------
Net Charge-Offs....................... 83 127 10 50 --
Provision for Possible Loan Losses.... 360 240 240 240 408
---------- ---------- ---------- --------- -----------
Balance at End of Period.............. $ 1,930 $ 1,653 $ 1,540 $ 1,310 $ 1,120
========== ========== ========== ========= ===========
Ratio of Net Charge-Offs to Average
Loans Outstanding During
the Period.......................... 0.05 % 0.09% 0.01% 0.04% 0.02%
=========== ========== ========== ========= ==========
10
The following table allocates the allowance for loan losses by loan category at
the dates indicated. The allocation of the allowance to each category is not
necessarily indicative of future losses and does not restrict the use of the
allowance to absorb losses in any category.
AT DECEMBER 31,
----------------------------------------------------------------------------
2000 1999 1998
------------------------- ----------------------- ------------------------
PERCENT OF PERCENT OF PERCENT OF
LOANS IN EACH LOANS IN EACH LOANS IN EACH
CATEGORY TO CATEGORY TO CATEGORY TO
AMOUNT TOTAL LOANS AMOUNT TOTAL LOANS AMOUNT TOTAL LOANS
--------- ------------- --------- ------------- -------- -------------
(DOLLARS IN THOUSANDS)
Real estate:
Residential first mortgage............. $ 192 38.9% $ 632 44.4% $ 652 47.6%
Commercial............................. 645 24.1 399 20.1 281 14.6
Construction and land development...... 285 9.9 164 11.5 211 15.4
Home equity and second mortgage........ 394 10.7 159 11.2 166 12.1
Commercial................................ 138 8.6 178 6.7 117 4.5
Consumer.................................. 276 7.8 121 6.1 113 5.8
--------- ----- --------- ----- --------- -----
Total allowance for loan losses... $ 1,930 100.0% $ 1,653 100.0% $ 1,540 100.0%
========= ===== ========= ===== ========= =====
AT DECEMBER 31,
---------------------------------------------------
1997 1996
------------------------- -----------------------
PERCENT OF PERCENT OF
LOANS IN EACH LOANS IN EACH
CATEGORY TO CATEGORY TO
AMOUNT TOTAL LOANS AMOUNT TOTAL LOANS
--------- ------------- --------- -------------
(DOLLARS IN THOUSANDS)
Real estate:
Residential first mortgage............. $ 579 49.6% $ 559 56.3%
Commercial............................. 255 15.5 240 12.6
Construction and land development...... 138 11.8 103 10.4
Home equity and second mortgage........ 164 14.0 124 12.5
Commercial................................ 87 3.9 41 3.4
Consumer.................................. 87 5.2 53 4.8
--------- ----- --------- -----
Total allowance for loan losses... $ 1,310 100.0% $ 1,120 100.0%
========= ===== ========= =====
The Bank closely monitors the loan payment activity of all its loans. A loan
loss provision is provided by a monthly accrual. The Bank periodically reviews
the adequacy of the allowance for loan losses based on an analysis of the loan
portfolio, the Bank's historical loss experience, economic conditions in the
Bank's market area, and a review of selected individual loans. Loan losses are
charged off against the allowance when the uncollectibility is confirmed.
Subsequent recoveries, if any, are credited to the allowance. The Bank believes
it has established its existing allowance for loan losses in accordance with
generally accepted accounting principles and is in compliance with appropriate
regulatory guidelines. However, the establishment of the level of the allowance
for loan losses is highly subjective and dependent on incomplete information as
to the ultimate disposition of loans. Accordingly, there can be no assurance
that actual losses may vary from the amounts estimated or that the Bank's
regulators will not request the Bank to significantly increase its allowance for
loan losses, thereby negatively affecting the Bank's financial condition and
earnings.
11
INVESTMENT ACTIVITIES
The Bank maintains a portfolio of investment securities to provide liquidity as
well as a source of earnings. The Bank's investment securities portfolio
consists primarily of mortgage-backed and other securities issued by U.S.
Government-sponsored enterprises ("GSEs") including FHLMC, FNMA, SLMA and the
FHLB System. The Bank also has smaller holdings of privately issued
mortgage-backed securities, U.S. Treasury obligations, and other equity and debt
securities. As a member of the Federal Reserve and FHLB Systems, the Bank is
also required to invest in the stock of the Federal Reserve Bank of Richmond and
FHLB of Atlanta, respectively.
The following table sets forth the carrying value of the Company's investment
securities portfolio and FHLB of Atlanta and Federal Reserve Bank stock at the
dates indicated. At December 31, 2000, their market value was $61.6 million.
AT DECEMBER 31,
--------------------------------------------------
2000 1999 1998
---- ----- ------
(IN THOUSANDS)
Asset-backed securities:
FHLMC and FNMA.................................... $ 30,577 $ 29,501 $ 32,270
Other............................................. 16,855 17,964 13,694
--------- --------- ---------
Total asset-backed securities.................. 47,432 47,465 45,964
FHLMC, FNMA, SLMA and FHLB notes..................... 7,912 7,619 9,045
FHLMC and FNMA stock................................. 764 751 1,221
Money market funds................................... 753 820 293
Treasury bills....................................... 200 198 196
Other investments.................................... 1,514 1,749 1,397
--------- --------- ---------
Total investment securities.................... 58,575 58,602 58,116
FHLB and Federal Reserve Bank stock......... 3,036 2,288 2,005
--------- --------- ---------
Total investment securities and FHLB and
Federal Reserve Bank stock................... $ 61,611 $ 60,890 $ 60,121
========= ========= =========
The maturities and weighted average yields for investment securities available
for sale and held to maturity at December 31, 2000 are shown below.
AFTER ONE AFTER FIVE
ONE YEAR OR LESS THROUGH FIVE YEARS THROUGH TEN YEARS AFTER TEN YEARS
-------------------- -------------------- ----------------- -------------------
CARRYING AVERAGE CARRYING AVERAGE CARRYING AVERAGE CARRYING AVERAGE
VALUE YIELD VALUE YIELD VALUE YIELD VALUE YIELD
-------- ------- -------- ------- -------- ------- -------- -------
(DOLLARS IN THOUSANDS)
Investment securities available
for sale:
Corporate equity securities... $ 764 3.93% $ -- -- % $ -- -- % $ -- -- %
Asset-backed securities....... -- -- -- -- 6,258 6.55% 41,174 7.12%
Money market funds............ 753 6.36% -- -- -- -- -- --
Obligations of U.S. government
sponsored enterprises
(GSEs)...................... -- -- 912 7.02% 7,000 6.65% -- --
-------- --------- --------- -------
Total investment securities
available for sale....... $ 1,517 5.20% $ 912 7.02% $ 13,258 6.60% $41,174 7.12%
======== ==== ========= ==== ========= ==== ======= ====
Investment securities held-to-
maturity:
Treasury bills............. $ -- -- $ 200 4.69% $ -- -- $ -- --
Other investments.......... 1,514 7.23% -- -- -- -- -- --
-------- --------- --------- -------
Total investment securities
held-to-maturity......... $ 1,514 7.23% $ 200 4.69% $ -- -- % $ -- -- %
======== ==== ========= ==== ========= ==== ======= ====
12
The Bank's investment policy provides that securities that will be held for
indefinite periods of time, including securities that will be used as part of
the Bank's asset/liability management strategy and that may be sold in response
to changes in interest rates, prepayments and similar factors, are classified as
available for sale and accounted for at the fair value. Management's intent is
to hold securities reported at amortized cost to maturity.
Certain of the Company's securities are issued by private issuers (defined as an
issuer which is not a government or a government sponsored entity). Although the
Company generally limits its exposure to private issuers to total investments
from any one issuer to less than 10% of equity, in certain cases the Company has
made higher investments. These investments are classified as available for sale,
and carrying value therefore equals market value. Details of such investments at
December 31, 2000 follow:
FAIR
ISSUER MOODY'S RATING MARKET VALUE
- ------ -------------- ------------
(IN THOUSANDS)
Countrywide Home Loans, Inc............... AAA $ 3,875
GE Capital Mortgage Services.............. AAA 5,733
IMPAC..................................... AAA 2,065
-----------
$ 11,673
===========
For further information regarding the Company's investment securities, see Note
2 of Notes to Consolidated Financial Statements.
DEPOSITS AND OTHER SOURCES OF FUNDS
GENERAL. The funds needed by the Bank to make loans are primarily generated by
deposit accounts solicited from the communities surrounding its main office and
seven branches in the southern Maryland area. Consolidated total deposits were
$167,805,999 as of December 31, 2000. The Bank uses borrowings from the FHLB of
Atlanta and other sources to supplement funding from deposits.
DEPOSITS. The Bank's deposit products include regular savings accounts
(statements), money market deposit accounts, demand deposit accounts, interest
bearing demand deposit accounts, IRA and SEP accounts, Christmas club accounts
and certificates of deposit. Variations in service charges, terms and interest
rates are used to target specific markets. Ancillary products and services for
deposit customers include safe deposit boxes, money orders and travelers checks,
night depositories, automated clearinghouse transactions, wire transfers, ATMs,
and telephone banking. The Bank is a member of several ATM networks. The Bank
has occasionally used deposit brokers to obtain funds. At year end, no brokered
deposits were held.
The following table sets forth for the periods indicated the average balances
outstanding and average interest rates for each major category of deposits.
FOR THE YEAR ENDED DECEMBER 31,
-------------------------------------------------------------------------
2000 1999 1998
-------------------- --------------------- -------------------
AVERAGE AVERAGE AVERAGE AVERAGE AVERAGE AVERAGE
BALANCE RATE BALANCE RATE BALANCE RATE
------- ------- ------- ------- ------- -------
(DOLLARS IN THOUSANDS)
Savings.......................... $ 20,051 2.37% $ 23,774 2.32% $ 26,253 2.76%
Interest-bearing demand and money
market accounts............... 59,720 3.58 46,663 2.82 31,602 2.51
Certificates of deposit.......... 69,592 5.32 75,093 4.87 80,078 5.22
------------ ----------- ------------
Total interest-bearing
deposits................... 149,363 4.23 145,530 3.80 137,933 4.13
Non-interest-bearing demand
deposits...................... 10,691 9,169 7,819
------------ ----------- ------------
Total average deposits...... $ 160,324 3.94 $ 154,699 3.57 $ 145,752 3.91
============ =========== ============
13
The following table indicates the amount of the Bank's certificates of deposit
and other time deposits of more than $100,000 by time remaining until maturity
as of December 31, 2000.
CERTIFICATES
MATURITY PERIOD OF DEPOSIT
--------------- ------------
(IN THOUSANDS)
Three months or less........................... $ 2,566
Three through six months....................... 3,836
Six through twelve months...................... 5,904
Over twelve months............................. 2,551
----------
Total................................... $ 14,857
==========
BORROWINGS. Deposits are the primary source of funds for the Bank's lending and
investment activities and for its general business purposes. The Bank uses
advances from the FHLB of Atlanta to supplement its supply of lendable funds and
to meet deposit withdrawal requirements. Advances from the FHLB are secured by
the Bank's stock in the FHLB, a portion of the Bank's residential mortgage loans
and its eligible investments. Generally the Bank's ability to borrow from the
FHLB of Atlanta is limited by its available collateral and also by an overall
limitation of 35% of assets. Other short-term debt consists of notes payable to
the U.S. Treasury on Treasury, Tax and Loan accounts. Long-term borrowings
consist of adjustable-rate advances with rates based upon LIBOR, fixed-rate
advances, and convertible advances. Information about borrowings for the years
indicated (which consisted almost entirely of FHLB advances) is as follows:
AT OR FOR THE
YEAR ENDED DECEMBER 31,
------------------------------------------
2000 1999 1998
---------- ---------- ---------
(DOLLARS IN THOUSANDS)
Long-term amounts outstanding at end of period............... $ 41,400 $ 31,400 $ 16,496
Weighted average rate on outstanding long-term............... 5.91% 5.54% 5.66%
Short-term borrowings outstanding at end of period........... $ 13,551 $ 13,398 $ 16,937
Weighted average rate on outstanding short-term.............. 6.35% 5.55% 5.76%
Maximum outstanding short-term debt at any month end......... $ 35,100 $ 16,500 $ 22,500
Average outstanding short-term debt ......................... $ 25,810 $ 9,129 $ 15,208
Approximate weighted average rate paid on short-term debt.... 6.62% 5.39% 5.45%
<FN>
__________
(1) Based on month-end balances.
</FN>
For more information regarding the Bank's borrowings, see Note 7 of Notes to
Consolidated Financial Statements.
SUBSIDIARY ACTIVITIES
Under the Maryland Financial Institutions Code, commercial banks may invest in
service corporations and in other subsidiaries that offer the public a
financial, fiduciary or insurance service. In 1985, the Bank formed Tri-County
Federal Finance One as a finance subsidiary for the purpose of issuing a $6.5
million collateralized mortgage obligation. In June 1999, the obligation was
satisfied, allowing the return of the participation certificates serving as
collateral to the Bank and closing the subsidiary. In April 1997, the Bank
formed a wholly owned subsidiary, Community Mortgage Corporation of Tri-County,
to offer mortgage banking and brokerage services to the public. To date, this
corporation has been inactive. In August 1999, the Bank formed a wholly owned
subsidiary, Tri-County Investment Corporation to hold and manage a portion of
the Bank's investment portfolio in the State of Delaware.
COMPETITION
The Bank faces strong competition in the attraction of deposits and in the
origination of loans. Its most direct competition for deposits and loans comes
from other banks, savings and loan associations, and federal and state
14
credit unions located in its primary market area. There are currently 15
FDIC-insured depository institutions operating in the Tri-County area including
subsidiaries of several regional and super-regional bank holding companies.
According to statistics compiled by the FDIC, the Bank was ranked sixth in
deposit market share in the Tri-County area as of June 30, 2000, the latest date
for which such data is available. The Bank faces additional significant
competition for investors' funds from mutual funds, brokerage firms, and other
financial institutions.
The Bank competes for loans by providing competitive rates, flexibility of
terms, and service. It competes for deposits by offering depositors a wide
variety of account types, convenient office locations, and competitive rates.
Other services offered include tax-deferred retirement programs, brokerage
services, safe deposit boxes, and miscellaneous services. The Bank has used
direct mail, billboard and newspaper advertising to increase its market share of
deposits, loans and other services in its market area. It provides ongoing
training for its staff in an attempt to ensure high quality service.
SUPERVISION AND REGULATION
REGULATION OF THE BANK
GENERAL. The Bank is a Maryland commercial bank and its deposit accounts are
insured by the SAIF. The Bank is a member of the Federal Reserve and FHLB
Systems. The Bank is subject to supervision, examination and regulation by
Commissioner of Financial Regulation of the State of Maryland (the
"Commissioner") and the Board of Governors of the Federal Reserve System (the
"FRB") and to Maryland and federal statutory and regulatory provisions governing
such matters as capital standards, mergers and establishment of branch offices.
The Bank is required to file reports with the Commissioner and the FRB
concerning its activities and financial condition and will be required to obtain
regulatory approvals prior to entering into certain transactions, including
mergers with, or acquisitions of, other depository institutions.
As an institution with federally insured deposits, the Bank is subject to
various regulations promulgated by the FRB, including Regulation B (Equal Credit
Opportunity), Regulation D (Reserve Requirements), Regulation E (Electronic Fund
Transfers), Regulation Z (Truth in Lending), Regulation CC (Availability of
Funds and Collection of Checks) and Regulation DD (Truth in Savings).
The system of regulation and supervision applicable to the Bank establishes a
comprehensive framework for the operations of the Bank and is intended primarily
for the protection of the FDIC and the depositors of the Bank. Changes in the
regulatory framework could have a material effect on the Bank and its respective
operations that in turn, could have a material effect on the Company.
FINANCIAL MODERNIZATION LEGISLATION. On November 12, 1999, President Clinton
signed legislation which could have a far-reaching impact on the financial
services industry. The Gramm-Leach-Bliley ("G-L-B") Act authorizes affiliations
between banking, securities and insurance firms and authorizes bank holding
companies and national banks to engage in a variety of new financial activities.
Under the G-L-B Act any bank holding company whose depository institution
subsidiaries have satisfactory Community Reinvestment Act ("CRA") records may
elect to become a financial holding company if it certifies to the FRB that all
of its depository institution subsidiaries are well-capitalized and
well-managed. Financial holding companies may engage in any activity that the
FRB, after consultation with the Secretary of the Treasury, determines to be
financial in nature or incidental to a financial activity. Financial holding
companies may also engage in activities that are complementary to financial
activities and do not pose a substantial risk to the safety and soundness of
their depository institution subsidiaries or the financial system generally. The
G-L-B Act specifies that activities that are financial in nature include lending
and investing activities, insurance and annuity underwriting and brokerage,
financial, investment and economic advice, selling interests in pooled
investment vehicles, securities underwriting, engaging in activities currently
permitted to bank holding companies (including activities in which bank holding
companies may currently engage outside the United States) and merchant banking
through a securities or insurance underwriting affiliate. The FRB, in
consultation with the Department of Treasury, may approve additional financial
activities.
15
The G-L-B Act permits well capitalized and well managed national banks with
satisfactory CRA records to invest in financial subsidiaries that engage in
activities that are financial in nature (or incidental thereto) on an agency
basis. National banks that are among the 50 largest insured banks and have at
least one issue of investment grade debt outstanding may invest in financial
subsidiaries that engage in activities as principal other than insurance
underwriting real estate development or merchant banking. All national banks are
given the authority to underwrite municipal revenue bonds. The aggregate total
consolidated assets of a national bank's financial subsidiaries may not exceed
the lesser of 45% of the bank's total consolidated assets or $50 billion. A
national bank would be required to deduct its investments in financial
subsidiaries from its regulatory capital. National banks must also adopt
procedures for protecting the bank against risks associated with the financial
subsidiary and to preserve the separate corporate identity of the financial
subsidiary. Financial subsidiaries of state and national banks (which include
any subsidiary engaged in an activity not permitted to a national bank directly)
would be treated as affiliates for purposes of the limitations on aggregate
transactions with affiliates in Sections 23A and 23B of the Federal Reserve Act
and for purposes of the antitying restrictions of the Bank Holding Company Act.
State-chartered banks would be prohibited from investing in financial
subsidiaries unless they would be well capitalized after deducting the amount of
their investment from capital and observe the other safeguards applicable to
national banks.
The G-L-B Act imposes functional regulation on bank securities and insurance
activities. Banks will only be exempt from regulation by the Securities and
Exchange Commission ("SEC") as securities brokers if they limit their activities
to those described in the G-L-B Act. Banks that advise mutual funds will be
subject to the same SEC regulation as other investment advisors. Bank common
trust funds will be regulated as mutual funds if they are advertised or offered
for sale to the general public. National banks and their subsidiaries will be
prohibited from underwriting 'insurance products other than those which they
were lawfully underwriting as of January 1, 1999 and are prohibited from
under-writing title insurance or tax-free annuities. National banks may only
sell title insurance in states in which state-chartered banks are authorized to
sell title insurance. The G-L-B Act directs the federal banking agencies to
promulgate regulations governing sales practices in connection with permissible
bank sales of insurance.
The G-L-B Act imposes new requirements on financial institutions with respect to
customer privacy. The G-L-B Act generally prohibits disclosure of customer
information to non-affiliated third parties unless the customer has been given
the opportunity to object and has not objected to such disclosure. Financial
institutions are further required to disclose their privacy policies to
customers annually. Financial institutions, however, will be required to comply,
with state law if it is more protective of customer privacy than the G-L-B Act.
The G-L-B Act directs the federal banking agencies, the National Credit Union
Administration, the Secretary of the Treasury, the SEC and the Federal Trade
Commission, after consultation with the National Association of Insurance
Commissioners, to promulgate implementing regulations within six months of
enactment. The privacy provisions will become effective in July 2001.
The G-L-B Act contains significant revisions to the FHLB System. The G-L-B Act
imposes new capital requirements on the FHLBs and authorizes them to issue two
classes of stock with differing dividend rates and redemption requirements. The
G-L-B Act deletes the current requirement that the FHLBs annually contribute
$300 million to pay interest on certain government obligations in favor of a 20%
of net earnings formula. The G-L-B Act expands the permissible uses of FHLB
advances by community financial institutions (under $500 million in assets) to
include funding loans to small businesses, small farms and small
agri-businesses.
The G-L-B Act contains a variety of other provisions including a prohibition
against ATM surcharges unless the customer has first been provided notice of the
imposition and amount of the fee. The G-L-B Act reduces the frequency of CRA
examinations for smaller institutions and imposes certain reporting requirements
on depository, institutions that make payments to non-governmental entities in
connection with the CRA.
CAPITAL ADEQUACY. The FRB has established guidelines with respect to the
maintenance of appropriate levels of capital by bank holding companies and state
member banks, respectively. The regulations impose two sets of capital adequacy
requirements: minimum leverage rules, which require bank holding companies and
member banks to maintain a specified minimum ratio of capital to total assets,
and risk-based capital rules, which require the maintenance of specified minimum
ratios of capital to "risk-weighted" assets.
16
The regulations of the FRB require bank holding companies and state member
banks, respectively, to maintain a minimum leverage ratio of "Tier 1 capital"
(as defined in the risk-based capital guidelines discussed in the following
paragraphs) to total assets of 3.0%. Although setting a minimum 3.0% leverage
ratio, the capital regulations state that only the strongest bank holding
companies and banks, with composite examination ratings of 1 under the rating
system used by the federal bank regulators, would be permitted to operate at or
near such minimum level of capital. All other bank holding companies and banks
are expected to maintain a leverage ratio of at least 1% to 2% above the minimum
ratio, depending on the assessment of an individual organization's capital
adequacy by its primary regulator. Any bank or bank holding company experiencing
or anticipating significant growth would be expected to maintain capital well
above the minimum levels. In addition, the FRB has indicated that whenever
appropriate, and in particular when a bank holding company is undertaking
expansion, seeking to engage in new activities or otherwise facing unusual or
abnormal risks, it will consider, on a case-by-case basis, the level of an
organization's ratio of tangible Tier 1 capital (after deducting all
intangibles) to total assets in making an overall assessment of capital.
The risk-based capital rules of the FRB require bank holding companies and state
member banks, respectively, to maintain minimum regulatory capital levels based
upon a weighting of their assets and off-balance sheet obligations according to
risk. Risk-based capital is composed of two elements: Tier 1 capital and Tier 2
capital. Tier 1 capital consists primarily of common stockholders' equity,
certain perpetual preferred stock (which must be noncumulative in the case of
banks), and minority interests in the equity accounts of consolidated
subsidiaries; less all intangible assets, except for certain purchased mortgage
servicing rights and credit card relationships. Tier 2 capital elements include,
subject to certain limitations, the allowance for losses on loans and leases;
perpetual preferred stock that does not qualify as Tier 1 capital and long-term
preferred stock with an original maturity of at least 20 years from issuance;
hybrid capital instruments, including perpetual debt and mandatory convertible
securities; and subordinated debt and intermediate-term preferred stock.
The risk-based capital regulations assign balance sheet assets and credit
equivalent amounts of off-balance sheet obligations to one of four broad risk
categories based principally on the degree of credit risk associated with the
obligor. The assets and off-balance sheet items in the four risk categories are
weighted at 0%, 20%, 50% and 100%. These computations result in the total
risk-weighted assets. The risk-based capital regulations require all banks and
bank holding companies to maintain a minimum ratio of total capital (Tier 1
capital plus Tier 2 capital) to total risk-weighted assets of 8%, with at least
4% as Tier 1 capital. For the purpose of calculating these ratios: (i) Tier 2
capital is limited to no more than 100% of Tier 1 capital; and (ii) the
aggregate amount of certain types of Tier 2 capital is limited. In addition, the
risk-based capital regulations limit the allowance for loan losses includable as
capital to 1.25% of total risk-weighted assets.
FRB regulations and guidelines additionally specify that state member banks with
significant exposure to declines in the economic value of their capital due to
changes in interest rates may be required to maintain higher risk-based capital
ratios. The federal banking agencies, including the FRB, have proposed a system
for measuring and assessing the exposure of a bank's net economic value to
changes in interest rates. The federal banking agencies, including the FRB, have
stated their intention to propose a rule establishing an explicit capital charge
for interest rate risk based upon the level of a bank's measured interest rate
risk exposure after more experience has been gained with the proposed
measurement process. FRB regulations do not specifically take into account
interest rate risk in measuring the capital adequacy of bank holding companies.
The FRB has issued regulations which classify state member banks by capital
levels and which authorize the FRB to take various prompt corrective actions to
resolve the problems of any bank that fails to satisfy the capital standards.
Under such regulations, a well-capitalized bank is one that is not subject to
any regulatory order or directive to meet any specific capital level and that
has or exceeds the following capital levels: a total risk-based capital ratio of
10%, a Tier 1 risk-based capital ratio of 6%, and a leverage ratio of 5%. An
adequately capitalized bank is one that does not qualify as well-capitalized but
meets or exceeds the following capital requirements: a total risk-based capital
ratio of 8%, a Tier 1 risk-based capital ratio of 4%, and a leverage ratio of
either (i) 4% or (ii) 3% if the bank has the highest composite examination
rating. A bank not meeting these criteria is treated as undercapitalized,
significantly undercapitalized, or critically undercapitalized depending on the
extent to which the bank's capital levels are below these standards. A state
member bank that falls within any of the three undercapitalized categories
established by
17
the prompt corrective action regulation will be subject to severe regulatory
sanctions. As of December 31, 2000, the Bank was well capitalized as defined by
the FRB's regulations.
BRANCHING. Maryland law provides that, with the approval of the Commissioner,
Maryland banks may establish branches within the State of Maryland without
geographic restriction and may establish branches in other states by any means
permitted by the laws of such state or by federal law. The Riegle-Neal Act
authorizes the FRB to approve interstate branching de novo by state banks, only
in states which specifically allow for such branching. The Riegle-Neal Act also
required the appropriate federal banking agencies to prescribe regulations which
prohibit any out-of-state bank from using the interstate branching authority
primarily for the purpose of deposit production. These regulations include
guidelines to ensure that interstate branches operated by an out-of-state bank
in a host state are reasonably helping to meet the credit needs of the
communities which they serve.
DIVIDEND LIMITATIONS. Pursuant to the Maryland Financial Institutions Code,
Maryland banks may only pay dividends from undivided profits or, with the prior
approval of the Commissioner, their surplus in excess of 100% of required
capital stock. The Maryland Financial Institutions Code further restricts the
payment of dividends by prohibiting a Maryland bank from declaring a dividend on
its shares of common stock until its surplus fund equals the amount of required
capital stock or, if the surplus fund does not equal the amount of capital
stock, in an amount in excess of 90% of net earnings.
Without the approval of the FRB, a state member bank may not declare or pay a
dividend if the total of all dividends declared during the year exceeds its net
income during the current calendar year and retained net income for the prior
two years. The Bank is further prohibited from making a capital distribution if
it would not be adequately capitalized thereafter. In addition, the Bank may not
make a capital distribution that would reduce its net worth below the amount
required to maintain the liquidation account established for the benefit of its
depositors at the time of its conversion to stock form.
DEPOSIT INSURANCE. The Bank is required to pay semi-annual assessments based on
a percentage of its insured deposits to the FDIC for insurance of its deposits
by the Savings Association Insurance Fund ("SAIF"). Under the Federal Deposit
Insurance Act, the FDIC is required to set semi-annual assessments for
SAIF-insured institutions to maintain the designated reserve ratio of the SAIF
at 1.25% of estimated insured deposits or at a higher percentage of estimated
insured deposits that the FDIC determines to be justified for that year by
circumstances raising a significant risk of substantial future losses to the
SAIF.
Under the risk-based deposit insurance assessment system adopted by the FDIC,
the assessment rate for an insured depository institution depends on the
assessment risk classification assigned to the institution by the FDIC, which is
determined by the institution's capital level and supervisory evaluations. Based
on the data reported to regulators for the date closest to the last day of the
fourth month preceding the semi-annual assessment period, institutions are
assigned to one of three capital groups -- "well capitalized, adequately
capitalized or undercapitalized." Within each capital group, institutions are
assigned to one of three subgroups on the basis of supervisory evaluations by
the institution's primary supervisory authority and such other information as
the FDIC determines to be relevant to the institution's financial condition and
the risk posed to the deposit insurance fund. Under the current assessment
schedule, well-capitalized banks with the best supervisory ratings are not
required to pay any premium for deposit insurance. All SAIF-insured banks,
however, are required to pay assessments to the FDIC to help fund interest
payments on certain bonds issued by the Financing Corporation, an agency
established by the federal government to finance takeovers of insolvent thrifts.
TRANSACTIONS WITH AFFILIATES. A state member bank or its subsidiaries may not
engage in "covered transactions" with any one affiliate in an amount greater
than 10% of such bank's capital stock and surplus, and for all such transactions
with all affiliates a state non-member bank is limited to an amount equal to 20%
of capital stock and surplus. All such transactions must also be on terms
substantially the same, or at least as favorable, to the bank or subsidiary as
those provided to a non-affiliate. The term "covered transaction" includes the
making of loans, purchase of assets, issuance of a guarantee and similar other
types of transactions. An affiliate of a state non-member bank is any company or
entity which controls or is under common control with the state non-member bank
and, for purposes of the aggregate limit on transactions with affiliates, any
subsidiary that would be deemed a
18
financial subsidiary of a national bank. In a holding company context, the
parent holding company of a state non-member bank (such as the Company) and any
companies which are controlled by such parent holding company are affiliates of
the state non-member bank. The BHCA further prohibits a depository institution
from extending credit to or offering any other services, 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 certain of
its affiliates or not obtain services of a competitor of the institution,
subject to certain limited exceptions.
LOANS TO DIRECTORS, EXECUTIVE OFFICERS AND PRINCIPAL STOCKHOLDERS. Loans to
directors, executive officers and principal stockholders of a state non-member
bank must be made on substantially the same terms as those prevailing for
comparable transactions with persons who are not executive officers, directors,
principal stockholders or employees of the Bank unless the loan is made pursuant
to a compensation or benefit plan that is widely available to employees and does
not favor insiders. Loans to any executive officer, director and principal
stockholder together with all other outstanding loans to such person and
affiliated interests generally may not exceed 15% of the bank's unimpaired
capital and surplus and all loans to such persons may not exceed the
institution's unimpaired capital and unimpaired surplus. Loans to directors,
executive officers and principal stockholders, and their respective affiliates,
in excess of the greater of $25,000 or 5% of capital and surplus (up to
$500,000) must be approved in advance by a majority of the board of directors of
the bank with any "interested" director not participating in the voting. State
member banks are prohibited from paying the overdrafts of any of their executive
officers or directors. In addition, loans to executive officers may not be made
on terms more favorable than those afforded other borrowers and are restricted
as to type, amount and terms of credit.
REGULATION OF THE COMPANY
GENERAL. The Company, as the sole shareholder of the Bank, is a bank holding
company and registered as such with the FRB. Bank holding companies are subject
to comprehensive regulation by the FRB under the Bank Holding Company Act of
1956, as amended (the "BHCA"), and the regulations of the FRB. As a bank holding
company, the Company is required to file with the FRB annual reports and such
additional information as the FRB may require, and is subject to regular
examinations by the FRB. The FRB also has extensive enforcement authority over
bank holding companies, including, among other things, the ability to assess
civil money penalties, to issue cease and desist or removal orders and to
require that a holding company divest subsidiaries (including its bank
subsidiaries). In general, enforcement actions may be initiated for violations
of law and regulations and unsafe or unsound practices.
Under the BHCA, a bank holding company must obtain FRB approval before: (i)
acquiring, directly or indirectly, ownership or control of any voting shares of
another bank or bank holding company if, after such acquisition, it would own or
control more than 5% of such shares (unless it already owns or controls the
majority of such shares); (ii) acquiring all or substantially all of the assets
of another bank or bank holding company; or (iii) merging or consolidating with
another bank holding company.
Effective September 29, 1995, the Riegle-Neal Interstate Banking and Branching
Efficiency of 1994 (the "Riegle-Neal Act") authorized the FRB to approve an
application of an adequately capitalized and adequately managed bank holding
company to acquire control of, or acquire all or substantially all of the assets
of, a bank located in a state other than such holding company's home state,
without regard to whether the transaction is prohibited by the laws of any
state. The FRB may not approve the acquisition of a bank that has not been in
existence for the minimum time period (not exceeding five years) specified by
the statutory law of the host state. The Riegle-Neal Act also prohibits the FRB
from approving such an application if the applicant (and its depository
institution affiliates) controls or would control more than 10% of the insured
deposits in the United States or 30% or more of the deposits in the target
bank's home state or in any state in which the target bank maintains a branch.
The Riegle-Neal Act does not affect the authority of states to limit the
percentage of total insured deposits in the state which may be held or
controlled by a bank or bank holding company to the extent such limitation does
not discriminate against out-of-state banks or bank holding companies.
Individual states may also waive the 30% state-wide concentration limit
contained in the Riegle-Neal Act. Under Maryland law, a bank holding company is
prohibited from acquiring control of any bank if the bank holding company would
control more than 30% of the total deposits of all depository institutions in
the State of Maryland unless waived by the Commissioner of Financial Regulation.
19
Additionally, the federal banking agencies are authorized to approve interstate
merger transactions without regard to whether such transaction is prohibited by
the law of any state, unless the home state of one of the banks opted out of the
Riegle-Neal Act by adopting a law after the date of enactment of the Riegle-Neal
Act and prior to June 1, 1997 which applies equally to all out-of-state banks
and expressly prohibits merger transactions involving out-of-state banks. The
State of Maryland did not pass such a law during this period. Interstate
acquisitions of branches will be permitted only if the law of the state in which
the branch is located permits such acquisitions. Interstate mergers and branch
acquisitions will also be subject to the nationwide and statewide insured
deposit concentration amounts described above.
The BHCA also prohibits a bank holding company, with certain exceptions, from
acquiring direct or indirect ownership or control of more than 5% of the voting
shares of any company which is not a bank or bank holding company, or from
engaging directly or indirectly in activities other than those of banking,
managing or controlling banks, or providing services for its subsidiaries. The
principal exceptions to these prohibitions involve certain non-bank activities
which, by statute or by FRB regulation or order, have been identified as
activities closely related to the business of banking or managing or controlling
banks. The list of activities permitted by the FRB includes, among other things,
operating a savings institution, mortgage company, finance company, credit card
company or factoring company; performing certain data processing operations;
providing certain investment and financial advice; underwriting and acting as an
insurance agent for certain types of credit-related insurance; leasing property
on a full-payout, non-operating basis; selling money orders, travelers' checks
and United States Savings Bonds; real estate and personal property appraising;
providing tax planning and preparation services; and, subject to certain
limitations, providing securities brokerage services for customers.
Effective with the enactment of the G-L-B Act on November 12, 1999, bank holding
companies whose financial institution subsidiaries are well capitalized and well
managed and have satisfactory Community Reinvestment Act records can elect to
become "financial holding companies" which will be permitted to engage in a
broader range of financial activities than are currently permitted to bank
holding companies. Financial holding companies are authorized to engage in,
directly or indirectly, financial activities. A financial activity is an
activity that is: (i) financial in nature; (ii) incidental to an activity that
is financial in nature; or (iii) complementary to a financial activity and that
does not pose a safety and soundness risk. The G-L-B Act includes a list of
activities that are deemed to be financial in nature. Other activities also may
be decided by the Federal Reserve Board to be financial in nature or incidental
thereto if they meet specified criteria. A financial holding company that
intends to engage in a new activity to acquire a company to engage in such an
activity is required to give prior notice to the FRB. If the activity is not
either specified in the G-L-B Act as being a financial activity or one that the
FRB has determined by rule or regulation to be financial in nature, the prior
approval of the FRB is required.
The Maryland Financial Institutions Code prohibits a bank holding company from
acquiring more than 5% of any class of voting stock of a bank or bank holding
company without the approval of the Commissioner of Financial Regulation except
as otherwise expressly permitted by federal law or in certain other limited
situations. The Maryland Financial Institutions Code additionally prohibits any
person from acquiring voting stock in a bank or bank holding company without 60
days' prior notice to the Commissioner if such acquisition will give the person
control of 25% or more of the voting stock of the bank or bank holding company
or will affect the power to direct or to cause the direction of the policy or
management of the bank or bank holding company. Any doubt whether the stock
acquisition will affect the power to direct or cause the direction of policy or
management shall be resolved in favor of reporting to the Commissioner. The
Commissioner may deny approval of the acquisition if the Commissioner determines
it to be anti-competitive or to threaten the safety or soundness of a banking
institution. Voting stock acquired in violation of this statute may not be voted
for five years.
DIVIDENDS. The FRB has issued a policy statement on the payment of cash
dividends by bank holding companies, which expresses the FRB's view that a bank
holding company should pay cash dividends only to the extent that the company's
net income for the past year is sufficient to cover both the cash dividends and
a rate of earning retention that is consistent with the company's capital needs,
asset quality and overall financial condition. The FRB also indicated that it
would be inappropriate for a company experiencing serious financial problems to
borrow funds to pay dividends. Furthermore, under the prompt corrective action
regulations adopted by the FRB pursuant to
20
FDICIA, the FRB may prohibit a bank holding company from paying any dividends if
the holding company's bank subsidiary is classified as "undercapitalized".
Bank holding companies are required to give the FRB prior written notice of any
purchase or redemption of its outstanding equity securities if the gross
consideration for the purchase or redemption, when combined with the net
consideration paid for all such purchases or redemptions during the preceding 12
months, is equal to 10% or more of the their consolidated retained earnings. The
FRB may disapprove such a purchase or redemption if it determines that the
proposal would constitute an unsafe or unsound practice or would violate any
law, regulation, FRB order, or any condition imposed by, or written agreement
with, the FRB.
CAPITAL REQUIREMENTS. The FRB has established capital requirements, similar to
the capital requirements for state member banks described above, for bank
holding companies with consolidated assets of $150 million or more. As of
December 31, 2000, the Company's levels of consolidated regulatory capital
exceeded the FRB's minimum requirements.
PERSONNEL
As of December 31, 2000, the Bank had 82 full-time employees and seven part-time
employees. The employees are not represented by a collective bargaining
agreement. The Bank believes its employee relations are good.
ITEM 2. PROPERTIES
- -------------------
The following table sets forth the location of the Bank's offices, as well as
certain additional information relating to these offices as of December 31,
2000.
YEAR
FACILITY LEASED APPROXIMATE
OFFICE COMMENCED OR SQUARE
LOCATION OPERATION OWNED FOOTAGE
- -------- --------- ------ -----------
MAIN OFFICE
3035 Leonardtown Road 1974 Owned 16,500
Waldorf, Maryland
BRANCH OFFICES
502 Great Mills Road (1) 1974 Owned 1,000
Lexington Park, Maryland
Rt. 235 and Maple Road (1) 1992 Owned 2,500
Lexington Park, Maryland
Route 5 and Lawrence Avenue 1961 Owned 2,500
Leonardtown, Maryland
Potomac Square (2) 1990 Leased 24,200
729 North 301 Highway
La Plata, Maryland
10321 Southern Md. Blvd. 1991 Leased 1,400
Dunkirk, Maryland
8010 Matthews Road 1996 Owned 2,500
Bryans Road, Maryland
20 St. Patrick's Drive (3) 1998 Leased (Land) 2,840
Waldorf, Maryland Owned (Building)
21
YEAR
FACILITY LEASED APPROXIMATE
OFFICE COMMENCED OR SQUARE
LOCATION OPERATION OWNED FOOTAGE
- -------- --------- ------ -----------
Charles County Community College 1997 Leased 126
8730 Mitchell Road
La Plata, Maryland
10195 Berry Road 1999 Leased 600
Waldorf, Maryland
<FN>
__________
(1) The Bank purchased land early in 1992, and built a new Lexington Park
branch office which opened in August 1992. The Bank is currently
leasing out the former office space and is actively seeking to sell the
site.
(2) Includes land purchased in February 1993 as potential branch location.
(3) The Bank purchased the location in 1998. The building is owned by the
Bank with the land on a lease basis.
</FN>
ITEM 3. LEGAL PROCEEDINGS
- --------------------------
Neither the Company, the Bank, nor any subsidiary is engaged in any legal
proceedings of a material nature at the present time. From time to time the Bank
is a party to legal proceedings in the ordinary course of business.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
- ------------------------------------------------------------
No matters were submitted to a vote of security holders during the fourth
quarter of the fiscal year ended December 31, 2000.
PART II
ITEM 5. MARKET FOR THE REGISTRANT'S COMMON STOCK AND RELATED SECURITY HOLDER
MATTERS
- --------------------------------------------------------------------------------
Although the Company's stock is not traded or listed on a public exchange, stock
does change hands over the course of the year. The Company attempts to keep a
record of persons who have expressed an interest in buying or selling the Common
Stock and will make this information available to persons seeking to sell or buy
shares, as the case may be. During 2000, a total of 22,349 shares traded, with a
high price of $31.00 and a low price of $25.00. The weighted average price was
$27.46. The number of stockholders at December 31, 2000 was 550 and the total
outstanding shares were 777,180. On January 31, 2001, the Board of Directors
declared a $0.40 per share cash dividend to be distributed on April 9, 2001 to
holders of record as of March 26, 2001. On February 3, 2000, the Board of
Directors declared a $.30 per share cash dividend which was distributed April
14, 2000 to holders of record as of March 14, 2000. On January 22, 1999, the
Board of Directors declared a $0.20 per share cash dividend, payable on April
17, 1999 to shareholders of record on March 17, 1999.
The Company's ability to pay dividends is governed by the policies and
regulations of the FRB which prohibit the payment of dividends under certain
circumstances involving the bank holding company's financial condition and
capital adequacy. The Company's ability to pay dividends is also dependent on
the receipt of dividends from the Bank.
Federal regulations impose certain limitations on the payment of dividends and
other capital distributions by the Bank. The Bank's ability to pay dividends is
governed by the Maryland Financial Institutions Code and the regulations of the
FRB. Under the Maryland Financial Institution Code, a Maryland bank (1) may only
pay dividends from undivided profits or, with prior regulatory approval, its
surplus in excess of 100% of required capital stock and (2) may not declare
dividends on its common stock until its surplus funds equals the amount of
required
22
capital stock or, if the surplus fund does not equal the amount of capital
stock, in an amount in excess of 90% of net earnings.
Without the approval of the FRB, a state member bank may not declare or pay a
dividend if the total of all dividends declared during the year exceeds its net
income during the current calendar year and retained net income for the prior
two years. The Bank is further prohibited from making a capital distribution if
it would not be adequately capitalized thereafter. In addition, the Bank may not
make a capital distribution that would reduce its net worth below the amount
required to maintain the liquidation account established for the benefit of its
depositors at the time of its conversion to stock form.
23
ITEM 6. SELECTED FINANCIAL DATA
- --------------------------------
The following table presents consolidated selected financial data for the
Company and its subsidiaries for each of the periods indicated. Dividends and
earnings per share have been adjusted to give retroactive effect to stock splits
and stock dividends accounted for as stock splits.
YEAR ENDED DECEMBER 31,
---------------------------------------------------------------
2000 1999 1998 1997 1996
-------- -------- -------- -------- --------
(DOLLARS IN THOUSANDS EXCEPT PER SHARE DATA)
OPERATIONS DATA:
Net Interest Income......................... $ 8,862 $ 8,412 $ 8,125 $ 7,616 $ 7,604
Provision for Loan Losses................... 360 240 240 240 408
Noninterest Income.......................... 1,373 1,271 1,421 931 798
Noninterest Expense......................... 6,332 6,726 5,467 4,877 5,350
Net Income.................................. 2,336 2,153 2,382 2,057 1,320
SHARE DATA:
Basic Net Income Per Common Share........... $ 2.98 $ 2.75 $ 3.00 $ 2.53 $ 1.65
Diluted Net Income Per Common Share......... 2.85 2.59 2.79 2.37 1.53
Cash Dividends Paid Per Common Share...... 0.30 0.20 0.125 0.10 0.10
Weighted Average Common
Shares Outstanding:
Basic............................... 784,605 782,950 793,458 811,694 799,804
Diluted............................. 821,139 832,283 853,145 867,503 862,026
FINANCIAL CONDITION DATA:
Total Assets................................ $ 248,339 $ 222,897 $ 206,863 $ 191,188 $ 178,146
Loans Receivable, Net....................... 172,090 146,710 132,646 121,867 110,851
Total Deposits.............................. 167,806 155,742 151,815 142,276 135,534
Long and Short Term Debt.................... 54,951 44,798 33,434 29,202 24,733
Total Stockholders' Equity.................. 23,430 21,115 20,975 19,086 17,077
PERFORMANCE RATIOS:
Return on Average Assets.................... 1.00% 1.00% 1.20% 1.13% 0.77%
Return on Average Equity.................... 10.65 10.23 11.87 11.53 7.94
Net Interest Margin......................... 3.98 4.11 4.21 4.21 4.32
Efficiency Ratio............................ 61.86 64.81 57.27 57.07 68.04
Dividend Payout Ratio....................... 10.13 7.29 4.10 3.62 5.35
CAPITAL RATIOS:
Average Equity to Average
Assets.................................... 9.37% 9.79% 10.10% 9.79% 9.70%
Leverage Ratio.............................. 9.61 9.86 10.28 9.68 9.88
Total Risk-Based Capital Ratio.............. 13.53 17.23 18.27 17.38 17.47
ASSET QUALITY RATIOS:
Allowance for Loan Losses to
Total Loans............................... 1.10% 1.11% 1.14% 1.05% 0.99%
Nonperforming Loans to Total Loans.......... 0.06 0.26 0.34 0.26 0.62
Allowance for Loan Losses to
Nonperforming Loans....................... 1770.55 424.94 331.18 404.32 160.23
Net Charge-offs to Average Loans............ 0.05 0.09 0.01 0.04 0.02
24
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
- --------------------------------------------------------------------------------
OVERVIEW
Since its conversion from a savings bank charter in 1997, the Bank has sought to
increase total assets as well as the percentage of assets represented by certain
targeted loan types. The Bank feels that its ability to offer fast, flexible and
local decision-making in the commercial, commercial real estate, and consumer
loan areas will continue to attract significant new loans and spur asset growth.
Since December 31, 1997, total loan assets have increased by $50 million or 41%,
with increases concentrated in commercial real estate, commercial, and consumer
lending. The Bank's local focus and targeted marketing is also directed towards
increasing its balances of consumer and business deposit accounts such as
interest-bearing and non-interest bearing checking accounts, money market
accounts, and other transaction-oriented accounts. The Bank believes that
increases in these account types will lessen the Bank's dependence on time
deposits such as certificates of deposit to fund loan growth.
For the year 2000, the Company earned $2.3 million, an increase of $183
thousand, or 8.5%, over 1999. Earnings were positively affected by the Bank's
continued success in building its loan portfolio while controlling its
non-performing loans. The Company has also continued to build its fee income
sources, primarily by increasing its transaction account fee volume from the
levels experienced in 1999 and 1998. The Company also benefited from a gain on
investment sales compared to the two prior years. These gains offset a continued
decline in loan sale and loan fee income which is a result of the continued
higher interest rate environment experienced in 2000 compared to the prior two
years. This higher rate environment has led to a decline in residential first
mortgage loan volume and the income associated with it.
FORWARD-LOOKING STATEMENTS
When used in this discussion and elsewhere in this Annual Report on Form 10-K,
the words or phrases "will likely result," "are expected to," "will continue,"
"is anticipated," "estimate," "project" or similar expressions are intended to
identify "forward-looking statements" within the meaning of the Private
Securities Litigation Reform Act of 1995. The Company cautions readers not to
place undue reliance on any such forward-looking statements, which speak only as
of the date made, and to advise readers that various factors, including regional
and national economic conditions, unfavorable judicial decisions, substantial
changes in levels of market interest rates, credit and other risks of lending
and investment activities and competitive and regulatory factors could affect
the Company's financial performance and could cause the Company's actual results
for future periods to differ materially from those anticipated or projected.
The Company does not undertake and specifically disclaims any obligation to
update any forward-looking statements to reflect occurrence of anticipated or
unanticipated events or circumstances after the date of such statements.
COMPARISON OF RESULTS OF OPERATIONS FOR THE YEARS ENDED DECEMBER 31, 2000, 1999
AND 1998
GENERAL. For the year ended December 31, 2000, the Company reported consolidated
net income of $2,336,196 ($2.98 basic and $2.85 diluted earnings per share)
compared to consolidated net income of $2,153,490 ($2.75 basic and $2.59 diluted
earnings per share) for the year ended December 31, 1999, and consolidated net
income of $2,381,847 ($3.00 basic and $2.79 diluted earnings per share) for the
year ended December 31, 1998. The increase in net income for 2000 compared to
1999 was attributable to continued improvement in net interest income. For the
year ended December 31, 2000, net interest income was $8,862,072 compared to
$8,412,151 for the year ended December 31, 1999, an increase of $449,921 or
5.4%. This increase was partially offset by an increase in the provision for
loan losses to $360,000 for the year ended December 31, 2000 compared to
$240,000 for 1999, an increase of $120,000 or 50%. The Company also increased
total non-interest income to $1,372,928 in 2000 from $1,271,464 in 1999, an
increase of $101,524 or 8.0%. Non-interest expenses increased to $6,331,864 for
the year ended December 31, 2000, compared to $6,276,125 an increase of $55,739
or 0.9%. Income before income taxes increased to $3,543,196 for the year ended
December 31, 2000, compared to $3,167,490 for the year ended December 31, 1999,
an increase of $375,706 or 11.9%.
25
For the year ended December 31, 1999, the Company earned $2,153,490 compared to
$2,381,847 for the prior year, a decrease of $228,357 or 9.6%. Net interest
income, however, increased to $8,412,151 for the year ended December 31, 1999
compared to $8,124,948 for the year ended December 31, 1998, an increase of
$287,203 or 3.5%. Non-interest income fell to $1,271,464 for 1999 compared to
$1,420,536 for 1998, a decrease of $149,072 or 10.5%. This decline is
attributable to the higher interest rate environment experienced in 1999
compared to 1998 which significantly reduced income related to residential first
mortgage originations and sales. Non-interest expenses totaled $6,276,125 for
1999, an increase of $809,488 or 14.8% over 1998.
NET INTEREST INCOME. The primary component of the Company's net income is its
net interest income which is the difference between income earned on assets and
interest paid on the deposits and borrowings used to fund them. Net interest
income is determined by the spread between the yields earned on the Company's
interest-earning assets and the rates paid on interest-bearing liabilities as
well as the relative amounts of such assets and liabilities. Net interest
income, divided by average interest-earning assets, represents the Company's net
interest margin.
Consolidated net interest income for the year ended December 31, 2000 was
$8,862,072 compared to $8,412,151 for the year ended December 31, 1999 and
$7,884,948 for the year ended December 31, 1998. The $449,121 increase in the
most recent year was due to an increase of $2,436,232 in interest income
partially offset by an increase of $1,986,311 in interest expense for the same
period. For the year ended December 31, 1999 compared to the prior year,
interest income increased by $131,655 while interest expense fell by $155,548.
Changes in the components of net interest income due to changes in average
balances of assets and liabilities compared to changes in net interest income
caused by changes in interest rates are presented in the rate volume analysis
below. During 2000, the Company's interest rate spread declined as the rates
paid on deposits and borrowings increased faster than the rates earned on assets
increased. This was caused by the relatively shorter period for deposits and
borrowings to reprice as rates increase compared to assets. In addition, in
2000, the Company increased its reliance on advances and other borrowings, which
have a higher interest rate cost compared to deposits.
The following table presents information on the average balances of the
Company's interest-earning assets and interest-bearing liabilities and interest
earned or paid thereon for the past three fiscal years. Average balances are
computed on the basis of month-end balances.
FOR THE YEAR ENDED DECEMBER 31,
----------------------------------------------------------------------------------------------
2000 1999 1998
----------------------------- ----------------------------- --------------------------
AVERAGE AVERAGE AVERAGE
AVERAGE YIELD/ AVERAGE YIELD/ AVERAGE YIELD/
BALANCE INTEREST COST BALANCE INTEREST COST BALANCE INTEREST COST
------- -------- ------- ------- -------- ------- ------- -------- ------
(DOLLARS IN THOUSANDS)
Interest-earning assets:
Loan portfolio (1)............. $159,989 $13,950 8.72 % $138,140 $11,563 8.37% $129,375 $11,638 9.00%
Cash and investment
securities................... 62,673 4,340 6.92 66,379 4,290 6.46 63,609 4,084 6.42
-------- ------- -------- ------- -------- -------
Total interest-earning
assets.................... 222,662 18,290 8.21 204,519 15,853 7.75 192,984 15,722 8.15
-------- ------- ------ -------- ------- ------ -------- ------- -----
Interest-bearing liabilities:
Savings deposits and escrow.... $160,324 $ 6,315 3.94% $154,699 $ 5,529 3.59% $145,752 $ 5,694 3.91%
FHLB advances and other
borrowings................... 49,664 3,113 6.26 35,859 1,912 5.33 33,294 1,903 5.72
-------- ------- -------- ------- -------- -------
Total interest-bearing
liabilities............... $209,988 9,428 4.49 $190,558 7,441 3.92 $179,046 7,597 4.24
======== ------- ------ ======== ------- ------ ======== ------- -----
Net interest income.............. $ 8,862 $ 8,412 $ 8,125
======= ======= =======
Interest rate spread............. 3.72% 3.83% 3.91%
====== ====== ======
Net yield on interest-earning
assets......................... 3.98% 4.11% 4.21%
====== ====== ======
Ratio of average interest-
earning assets to average
interest-bearing liabilities... 106.0% 105.1% 107.8%
===== ===== =====
<FN>
- ----------
(1) Average balance includes non-accrual loans.
</FN>
26
The table below sets forth certain information regarding changes in interest
income and interest expense of the Bank for the periods indicated. For each
category of interest-earning asset and interest-bearing liability, information
is provided on changes attributable to (1) changes in volume (changes in volume
multiplied by old rate); and (2) changes in rate (changes in rate multiplied by
old volume). Changes in rate-volume (changes in rate multiplied by the change in
volume) have been allocated to changes due to volume.
YEAR ENDED DECEMBER 31,
------------------------------------------------------------
1999 VS. 2000 1998 VS. 1999
------------------------- -------------------------
INCREASE (DECREASE) INCREASE (DECREASE)
DUE TO DUE TO
------------------------- -------------------------
VOLUME RATE TOTAL VOLUME RATE TOTAL
------ ----- ----- ------ ---- -----
(IN THOUSANDS)
Interest income:
Loan portfolio........................... $ 1,905 $ 482 $ 2,387 $ 734 $ (809) $ (75)
Interest-earning cash and
investment portfolio................... (257) 306 49 181 26 206
------- ------- ------- ------- ------- --------
Total interest-earning assets............... $ 1,648 $ 788 $ 2,436 $ 915 $ (783) $ 131
------- ------- ------- ------- ------- --------
Interest expense:
Savings deposits and escrow.............. $ 222 $ 564 $ 786 $ 321 $ (486) $ (165)
FHLB advances and other
borrowings............................. 864 336 1,200 137 (128) 9
------- ------- ------- ------- -------- --------
Total interest-bearing liabilities.......... $ 1,086 $ 896 $ 1,986 $ (614) $ (39) $ (156)
======= ======= ======= ======= ======= ========
PROVISION FOR LOAN LOSSES. Provision for loan losses for the year ended December
31, 2000 was $360,000 compared to $240,000 for each of the two preceding years.
The increase in provision for loan losses is reflective of the increases in the
size of the Bank's loan portfolio as well as increased emphasis on certain loan
types which have inherently higher credit risks than residential first mortgage
lending. At December 31, 2000 the allowance for loan loss equaled 1,771% of
non-accrual and past due loans compared to 425% and 331% at December 31, 1999
and 1998, respectively. During the year ended December 31, 2000, the Company
recorded net charge-offs of $83 thousand (0.05% of average loans) compared to
$127 thousand (0.09% of average loans) and $10 thousand (0.01% of average loans)
in net charge-offs during the years ended December 31, 1999 and 1998.
NON-INTEREST INCOME. Non-interest income increased to $1,372,988 for the year
ended December 31, 2000 compared to $1,271,464, for the prior year, an increase
of 8.0%. Non-interest income for the year ended December 31, 1999 represented a
decline of 10.5% from the December 31, 1998 total of $1,420,536. The overall
totals of non-interest income are indicative of two ongoing developments in the
Company's operations. The first is the continuing decline in the Company's
residential first mortgage origination and sale activity over the last three
years. In the year ended December 31, 1998, the Company recorded income on
originating and selling residential first mortgage loans of $416,838. For the
next two years, 1999 and 2000, this income declined to $238,215 and $85,716
respectively, declines of $178,6223 and $106,168. These declines were 42.9% and
64.0% from prior year levels in 1999 and 2000. The decline in residential first
mortgage originations and sales also affected loan appraisal, credit and
miscellaneous charges ("loan fees"). Loan fees declined from $223,326 for the
year ended December 31, 1998 to $182,494 and $76,326 for the years ended
December 31, 1999 and 2000 respectively. These declines totaled $40,832 or 18.3%
for 1999 compared to 1998 and $106,168 or 58.2% for 2000 compared to 1999. While
the Bank will continue to make residential mortgage loans, it believes that this
portion of its business will continue to decline in importance to its operations
and provide less income relative to its targeted loan areas of commercial real
estate, commercial loans, consumer, and second mortgage lending.
Declines in non-interest income related to the origination and sales of
residential first mortgage loans were partially offset by increases in service
charges and fees. Service charges and fees are primarily generated by the Bank's
ability to attract and retain transaction-based deposit accounts. Service
charges and fees increased to $996,884 for the year ended December 31, 2000 as
compared to $811,991 and $600,067 in the two prior years. The increase for
27
the year ended December 31, 2000 from the prior year was $184,893 or 22.8% while
the increase for the year ended December 31, 1999 from the prior year was
$211,924 or 35.3%. The Company hopes to increase its service charge and fee
revenues in the future by increasing the level of transaction-based accounts.
Other changes in non-interest income from the prior two years included a gain on
the sale of investments of $184,704 for the year ended December 31, 2000
compared to small losses in the prior two years. Finally, other non-interest
income declined slightly from 1999. For the year ended December 31, 2000, other
non-interest income was $29,358, a decline from the prior year total of $39,369.
Other non-interest income for the year ended December 31, 1998 primarily
consisted of gain on the sale of foreclosed property and a gain on the sale of
land due to a condemnation award from the State of Maryland in connection with a
road project.
NON-INTEREST EXPENSES. Non-interest expenses for the year ended December 31,
2000 totaled $6,331,864, an increase of $55,739 or 0.9% from the prior year.
Salary and employee benefits increased by 1.2% to $3,643,865 for the year ended
December 31, 2000 compared to $3,600,119 for the prior year. The small increase
reflects a stabilization in the size of the Company's workforce, an effort by
management to control certain discretionary employee costs such as the cost of
the Company's Employee Stock Ownership Plan ("ESOP") program and other measures.
Occupancy expense increased to $615,809 compared to $540,667 and $494,113 in the
two prior years. This increase was due to certain needed repairs and maintenance
at several of the Company's locations. ATM and deposit expenses increased to
$340,534 for the year 2000 from $287,178 and $255,645 for the prior two years.
Data processing expense also increased to $255,792 from the prior year total of
$215,227, an increase of 18.9%. The increase in ATM and deposit expenses and
data processing expense is reflective of the Company's additional transaction
based deposit accounts. Advertising decreased from 1999 levels to $246,619 for
the year ended December 31, 2000 compared to $280,044 and $162,133 in the two
prior years.
INCOME TAX EXPENSE. During the year ended December 31, 2000, the Company
recorded income tax expense of $1,207,000 compared to expenses of $1,014,000 and
$1,457,000 in the two prior years. The Company's effective tax rates for the
years ended December 31, 2000, 1999, and 1998 were 34.1%, 32.0%, and 37.9%,
respectively. As explained further in Note 8 to the Consolidated Financial
Statements, interest income earned by the Bank's subsidiary, Tri-County
Investment Corporation, is not subject to state income tax. Tri-County
Investment Corporation was established by the Bank in 1999 and has reduced the
effective tax rate for the years ended December 31, 2000 and 1999. The Company's
effective tax rate was further reduced in 1999 by the exercise of non-incentive
stock options by certain directors.
COMPARISON OF FINANCIAL CONDITION AT DECEMBER 31, 2000 AND 1999
The Company's total assets increased $25,442,176, or 11.4%, to $248,339,456 as
of December 31, 2000 from $222,897,280 at December 31, 1999. The increase in
assets was primarily due to an increase in the loan portfolio which grew to
$172,090,088 at December 31, 2000 from $146,710,367 at December 31, 1999. The
increase in the loan portfolio were concentrated in the loan types targeted by
management in its long-term business plan to increase the financial performance
of the Company. The Company experienced its greatest loan growth in the
commercial mortgage loan portfolio which grew $12,278,787 or 41.0% during 2000
to $42,226,137. Commercial mortgages constituted 24.2% of total loans at
December 31, 2000. The Company also registered strong growth in its commercial
and consumer loan portfolios which grew 50.1% and 49.5%, respectively. Although
residential first mortgage lending continues to be a major portion of the
Company's loan portfolio, it has declined as a percentage of the loan portfolio
from 44.4% at December 31, 1999 to 38.9% at December 31, 2000, while increasing
slightly in dollar terms for the same period to $67,975,177 from $66,263,457 at
December 31, 1999.
Investments and interest-bearing deposits totaled $67,586,227 at December 31,
2000 compared to $63,953,051 for December 31, 1999. The increase of $3,633,176
or 4.7% is the result of earnings on the portfolio combined with increases in
the portfolio's market value partially offset by principal paydowns. Management
expects that future growth in the investment portfolio will be limited as the
Company will use principal paydowns and calls to increase the size of its loan
portfolio.
28
Deposits increased to $167,805,999 at December 31, 2000 compared to $155,741,800
for the prior year. The total increase of 7.8% was concentrated in certain
transaction-based account types. Non-interest-bearing demand deposits increased
to $12,537,649 at December 31, 2000 from the prior year's total of $10,102,479,
an increase of $2,435,170 or 24.1%. Interest-bearing demand deposits increased
to $20,551,420 at year end compared with $19,041,881, an increase of $1,509,539
or 7.9%. Money market deposits increased to $44,965,316 at December 31, 2000
from $34,669,161 at December 31, 1999 for the prior year end, an increase of
$10,296,155 or 29.7%. Certificates of deposit balances increased to $71,199,037
at December 31, 2000 compared to $70,501,000 for the prior year, an increase of
$698,037 or 1.0%. These increases in deposit balances were offset by the
declines in savings deposits to $18,552,577 from $21,427,279 a decrease of
$2,874,702 or 13.4%.
In order to fund the loan portfolio increases noted above, the Company also
increased short- and long-term debt. Short-term debt increased slightly to
$13,550,903 at December 31, 2000 compared to $13,398,378 for the prior year, an
increase of $152,525 or 1.1%. Long-term debt increased to $41,400,000 at
December 31, 2000, an increase of $10,000,000, or 31.9%.
The Company experienced a $2,314,439, or 11.0%, increase in stockholders' equity
for the year ended December 31, 2000. The increase in stockholders' equity was
attributable to the retention of earnings from the period less cash dividends
combined with comprehensive income of $603,569, option exercises and smaller
amounts of ESOP activity. These increases in equity were partially offset by
repurchases of common stock totaling $479,217.
ASSET/LIABILITY MANAGEMENT
Net interest income, the primary component of the Company's net income, arises
from the difference between the yield on interest-earning assets and the cost of
interest-bearing liabilities and the relative amounts of such assets and
liabilities. The Company manages its assets and liabilities by coordinating the
levels of and gap between interest-rate sensitive assets and liabilities to
control changes in net interest income and in the economic value of its equity
despite changes in market interest rates.
Among other tools used to monitor interest rate risk is a "gap" report which
measures the dollar difference between the amount of interest-earning assets and
interest-bearing liabilities subject to repricing within a given time period.
Generally, during a period of rising interest rates, a negative gap position
would adversely affect net interest income, while a positive gap would result in
an increase in net interest income, while, conversely, during a period of
falling interest rates, a negative gap would result in an increase in net
interest income and a positive gap would adversely affect net interest income.
The following sets forth the Bank's interest rate sensitivity at December 31,
2000:
29
OVER 1
OVER 3 TO THROUGH 5 OVER 5
0-3 MONTHS 12 MONTHS YEARS YEARS
---------- --------- ----- -----
(AMOUNTS IN THOUSANDS)
Assets:
Cash and due from banks................... $ 646 $ -- $ -- $ --
Interest-bearing deposits................. 5,975 -- -- --
Securities................................ 21,100 6,809 22,163 8,503
Loans held for sale....................... -- -- -- --
Loans..................................... 53,060 27,919 76,632 14,479
Fixed assets.............................. -- -- -- 4,495
Other assets.............................. -- -- -- 6,558
----------- ----------- ---------- -----------
Total Assets.............................. $ 80,781 $ 34,728 $ 98,795 $ 34,035
=========== =========== ========== ===========
Liabilities:
Non-interest bearing deposits............. $ 12,538 $ -- $ -- $ --
Interest-bearing demand deposits.......... 20,551 -- -- --
Money Market Deposits..................... 44,965 -- -- --
Savings................................... 18,553 -- -- --
Certificates of Deposit................... 9,458 41,962 19,393 385
Short-term debt........................... 13,551 -- -- --
Long-term debt............................ -- -- 26,400 15,000
Other liabilities......................... -- -- -- 2,153
----------- ----------- ---------- -----------
Total Liabilities......................... $ 119,616 $ 41,962 $ 45,793 $ 17,538
=========== =========== ========== ===========
Gap....................................... $ (38,835) $ (7,234) $ 53,002 $ 16,497
Cumulative Gap............................ $ (38,835) $ (46,070) $ 6,932 $ 23,429
Cumulative Gap as % of total assets....... (15.64)% (18.55)% 2.79% 9.43%
The foregoing analysis assumes that the Bank's assets and liabilities move with
rates at their earliest repricing opportunities based on final maturity.
Mortgage-backed securities are assumed to mature during the period in which they
are estimated to prepay and it is assumed that loans and other securities are
not called prior to maturity. Certificates of deposit and IRA accounts are
presumed to reprice at maturity. NOW and savings accounts are assumed to reprice
within three months although it is the Company's experience that such accounts
may be less sensitive to changes in market rates.
LIQUIDITY AND CAPITAL RESOURCES
The Company currently has no business other than that of the Bank and does not
currently have any material funding commitments. The Company's principal sources
of liquidity are cash on hand and dividends received from the Bank. The Bank is
subject to various regulatory restrictions on the payment of dividends.
The Bank's principal sources of funds for investments and operations are net
income, deposits from its primary market area, principal and interest payments
on loans, interest received on investment securities and proceeds from maturing
investment securities. Its principal funding commitments are for the origination
or purchase of loans and the payment of maturing deposits. Deposits are
considered the primary source of funds supporting the Bank's lending and
investment activities. The Bank also uses borrowings from the FHLB of Atlanta to
supplement deposits. The amount of FHLB advances available to the Bank is
limited to the lower of 35% of Bank assets or the amount supportable by eligible
collateral including FHLB stock, current residential first mortgage loans, and
certain securities.
30
The Bank's most liquid assets are cash, cash equivalents, and interest-bearing
deposits which are comprised of cash on hand, amounts due from financial
institutions, and interest-bearing deposits. The levels of such assets are
dependent on the Bank's operating financing and investment activities at any
given time. The variations in levels of cash and cash equivalents are influenced
by deposit flows and anticipated future deposit flows.
Cash, cash equivalents, and interest-bearing deposits as of December 31, 2000,
totaled $6,621,131, an increase of $88,548 (1.2%) from the December 31, 1999
total of $6,532,583. This increase was in interest-bearing deposits at other
financial institutions which totaled $5,975,314 at December 31, 2000 compared to
$3,063,279 at the end of 1999. Cash on hand declined to $645,817 from $3,469,304
at December 31, 1999.
The Company's principal sources of cash flows are its financing activities
including deposits and borrowings and issuances of shares on the exercise of
stock options or allocations of shares to participant accounts in the ESOP.
During the year 2000, financing activities provided $21.6 million in cash
compared to $14.6 million during 1999 and $13.2 million during 1998. The
increase in cash flows from financing activities during the most recent period
was principally due to a net increase in deposits of $12.1 million. The Company
also receives cash from its operating activities which provided $4.1 million in
cash during 2000, compared to cash flows of $4.4 million and $1.3 million during
1999 and 1998, respectively. The decrease in operating cash flows during 2000
was primarily due to lower sales of loans originated for resale.
The Company's principal use of cash has been in investing activities including
its investments in loans for portfolio, investment securities and other assets.
During the year ended December 31, 2000, the Company used a total of $28.5
million in its investing activities compared to $16.5 million in 1999 and $14.3
million in 1998. The principal reason for the greater use of cash in investing
activities during 2000 was an increase in loans originated for portfolio and in
interest-bearing deposits at other banks which offset decreases in proceeds from
sales, redemptions or principal collections on available-for-sale securities and
principal collections on loans.
Federal banking regulations require the Company and the Bank to maintain
specified levels of capital. At December 31, 2000 the Company was in compliance
with these requirements with a leverage ratio of 9.4%, a Tier 1 risk-based
capital ratio of 12.5% and total risk-based capital ratio of 13.5%. At December
31, 2000, the Bank met the criteria for designation as a well-capitalized
depository institution under FRB regulations.
IMPACT OF INFLATION AND CHANGING PRICES
The consolidated financial statements and notes thereto presented herein have
been prepared in accordance with generally accepted accounting principles, which
require the measurement of financial position 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,
nearly all of the Company's assets and liabilities are monetary in mature. As a
result, interest rates have a greater impact on the Company's performance than
do the effects of general levels of inflation. Interest rates do not necessarily
move in the same direction or to the same extent as the prices of goods and
services.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
- -------------------------------------------------------------------
Not applicable since the registrant is a small business issuer.
31
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
- ----------------------------------------------------
The Company's financial statements and supplementary data appear in this Annual
Report beginning on the page immediately following Item 14 hereof.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
- --------------------------------------------------------------------------------
Not applicable.
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
- ------------------------------------------------------------
The information contained under the section captioned "Proposal I -- Election of
Directors" in the Company's definitive proxy statement for the Company's 2001
Annual Meeting of Stockholders (the "Proxy Statement") is incorporated herein by
reference.
The executive officers of the Company are as follows:
MICHAEL L. MIDDLETON (53 years old) is President and Chief Executive Officer of
the Company and the Bank. He joined the Bank in 1973 and served in various
management positions until 1979 when he became president of the Bank. Mr.
Middleton is a Certified Public Accountant and holds a Masters of Business
Administration. As President and Chief Executive Officer of the Bank, Mr.
Middleton is responsible for the overall operation of the Bank pursuant to the
policies and procedures established by the Board of Directors. Mr. Middleton is
a member of the Rotary Club of Waldorf and is a Paul Harris Fellow. Since
December 1995, Mr. Middleton has served on the Board of Directors of the Federal
Home Loan Bank of Atlanta and also serves as its Board Representative to the
Council of Federal Home Loan Banks. In January 2000, Mr. Middleton was appointed
to the National Association of Home Builders Mortgage Roundtable.
C. MARIE BROWN (58 years old) has been employed with the Bank for over 27 years
and has served as Chief Operating Officer since 1999. Prior to her appointment
as Chief Operating Officer, Ms. Brown served as Senior Vice President of the
Bank. She is a supporter of the Handicapped and Retarded Citizens of Charles
County, of Zonta and serves on various administrative committees of the
Hughesville Baptist Church and the board of the Charles County Chapter of the
American Red Cross.
H. BEAMAN SMITH (55 years old) was the Treasurer of the Company in 1998 and
became Secretary-Treasurer in January 1999 and has been the president of
Accoware, a computer software company, since 1989. Prior to that time, Mr. Smith
was a majority owner of the Smith's Family Honey Company in Bryans Road,
Maryland. Mr. Smith is a Vice President of Fry Plumbing Company of Washington,
D.C., a Trustee of the Ferguson Foundation, a member of the Bryans Road Sports
Council and the Treasurer of the Mayaone Association.
GREGORY C. COCKERHAM (46 years old) joined the Bank in November 1988 and has
served as Senior Vice President of Lending since 1996. Prior to his appointment
as Senior Vice President, Mr. Cockerham served as Vice President of the Bank.
Mr. Cockerham has been in banking for 22 years. He is a Paul Harris Fellow with
the Rotary Club of Charles County and serves on various civic boards in the
County.
WILLIAM J. PASENELLI (42 years old) joined the Bank as Chief Financial Officer
in April 2000. Prior to joining the Bank, Mr. Pasenelli had been Chief Financial
Officer of Acacia Federal Savings Bank, Annandale, Virginia, with which he had
been employed since 1987. Mr. Pasenelli is a member of the American Institute of
Certified Public Accountants, the DC Institute of Certified Public Accountants,
and other civic groups.
32
ITEM 11. EXECUTIVE COMPENSATION
- --------------------------------
The information contained under the section captioned "Proposal I -- Election of
Directors -- Executive Compensation" in the Proxy Statement is incorporated
herein by reference.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
- ------------------------------------------------------------------------
(A) SECURITY OWNERSHIP OF CERTAIN OWNERS
The information required by this item is incorporated herein by reference to the
sections captioned "Proposal I -- Election of Directors" and "Voting Securities
and Principal Holders Thereof" of the Proxy Statement.
(B) SECURITY OWNERSHIP OF MANAGEMENT
Information required by this item is incorporated herein by reference to the
section captioned "Proposal I -- Election of Directors" of the Proxy Statement.
(C) CHANGES IN CONTROL
Management of the Company knows of no arrangements, including any pledge by any
person of securities of the Company, the operation of which may at a subsequent
date result in a change in control of the registrant.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
- --------------------------------------------------------
The information required by this item is incorporated herein by reference to the
section captioned "Proposal I -- Election of Directors" and "Transactions with
the Company and the Bank" of the Proxy Statement.
PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K
- --------------------------------------------------------------------------
(A) LIST OF DOCUMENTS FILED AS PART OF THIS REPORT
----------------------------------------------
(1) Financial Statements. The following is a list of the consolidated
financial statements which are being filed as part of this Annual Report on Form
10-K.
Page
Independent Auditors' Report F-1
Consolidated Balance Sheets as of December 31, 2000 and 1999 F-2
Consolidated Statements of Income for the Years Ended December
31, 2000, 1999 and 1998 F-3
Consolidated Statements of Changes in Stockholders' Equity
for the Years Ended December 31, 2000, 1999 and 1998 F-4
Consolidated Statements of Cash Flows for the Years Ended
December 31, 2000, 1999 and 1998 F-5
Notes to Consolidated Financial Statements F-7
(2) Financial Statement Schedules. All schedules for which provision is
made in the applicable accounting regulations of the Securities and Exchange
Commission are omitted because of the absence of conditions under which they are
required or because the required information is included in the consolidated
financial statements and related notes thereto.
33
(3) Exhibits. The following is a list of exhibits filed as part of this
Annual Report on Form 10-K and is also the Exhibit Index.
3.1 Articles of Incorporation of Tri-County Financial
Corporation*
3.2 Bylaws of Tri-County Financial Corporation
10.1 + Tri-County Financial Corporation 1995 Stock Option and
Incentive Plan, as amended
10.2 + Tri-County Financial Corporation 1995 Stock Option
Plan for Non-Employee Directors, as amended
10.3 + Employment Agreements with Michael L. Middleton, as
amended, C. Marie Brown, as amended, and Gregory C.
Cockerham **
10.4 + Guaranty Agreements with Michael L. Middleton, C. Marie
Brown and Gregory C. Cockerham
10.5 + Executive Incentive Compensation Plan
10.6 + Employment Agreement with William J. Pasenelli
10.7 + Retirement Plan for Directors
10.8 + Split Dollar Agreements with Michael L. Middleton and
C. Marie Brown
21 Subsidiaries of the Registrant
23 Consent of Stegman & Company
____________
+ Management contract or compensatory plan required to be filed
as an exhibit pursuant to Item 14(c).
* Incorporated by reference to the registrant's Form S-4
Registration Statement No. 33-31287.
** Incorporated by reference to the registrant's Form 10-K for
the fiscal year ended December 31, 1998.
(b) REPORTS ON FORM 8-K. No reports on Form 8-K have been filed
--------------------
during the last quarter of the fiscal year covered by this
report.
(c) EXHIBITS. The exhibits required by Item 601 of Regulation S-K
--------
are either filed as part of this Annual Report on Form 10-K or
incorporated by reference herein.
(d) FINANCIAL STATEMENTS AND SCHEDULES EXCLUDED FROM ANNUAL
--------------------------------------------------------------
REPORT. There are no other financial statements and financial
------
statement schedules which were excluded from the Annual Report
pursuant to Rule 14a-3(b)(1) which are required to be included
herein.
34
[LETTERHEAD OF STEGMAN & COMPANY]
Stockholders and Board of Directors
Tri-County Financial Corporation
Waldorf, Maryland
We have audited the accompanying consolidated balance sheets of
Tri-County Financial Corporation as of December 31, 2000 and 1999, and the
related consolidated statements of income, changes in stockholders' equity and
cash flows for each of the three years in the period ended December 31, 2000.
These financial statements are the responsibility of the Company's management.
Our responsibility is to express an opinion on these financial statements based
on our audits.
We conducted our audits in accordance with auditing standards generally
accepted in the United States. Those standards require that we plan and perform
the audit to obtain reasonable assurance about whether the financial statements
are free of material misstatement. An audit includes examining, on a test basis,
evidence supporting the amounts and disclosures in the financial statements. An
audit also includes assessing the accounting principles used and significant
estimates made by management, as well as evaluating the overall financial
statement presentation. We believe that our audits provide a reasonable basis
for our opinion.
In our opinion, the consolidated financial statements referred to above
present fairly, in all material respects, the consolidated financial position of
Tri-County Financial Corporation as of December 31, 2000 and 1999, and the
results of its operations and cash flows for each of the three years in the
period ended December 31, 2000, in conformity with accounting principles
generally accepted in the United States.
/s/ Stegman & Company
Baltimore, Maryland
February 15, 2001
F-1
TRI-COUNTY FINANCIAL CORPORATION
CONSOLIDATED BALANCE SHEETS
DECEMBER 31, 2000 AND 1999
ASSETS
2000 1999
------------ ------------
Cash and due from banks $ 645,817 $ 3,469,304
Interest-bearing deposits with banks 5,975,314 3,063,279
Investment securities available-for-sale - at fair value 56,860,996 56,655,300
Investment securities held-to-maturity - at amortized cost 1,714,367 1,946,772
Stock in Federal Home Loan Bank and Federal Reserve Bank - at cost 3,035,550 2,287,700
Loans held for sale 355,000 773,099
Loans receivable - net of allowance for loan losses
of $1,929,531 and $1,653,290, respectively 172,090,088 146,710,367
Premises and equipment, net 4,495,431 4,516,386
Foreclosed real estate 176,626 176,626
Accrued interest receivable 1,353,658 1,146,520
Other assets 1,636,609 2,151,927
------------ ------------
TOTAL ASSETS $248,339,456 $222,897,280
============ ============
LIABILITIES AND STOCKHOLDERS' EQUITY
LIABILITIES:
Noninterest-bearing deposits $ 12,537,649 $ 10,102,479
Interest-bearing deposits 155,268,350 145,639,321
------------ ------------
Total deposits 167,805,999 155,741,800
Short-term borrowings 13,550,903 13,398,378
Long-term debt 41,400,000 31,400,000
Accrued expenses and other liabilities 2,152,732 1,241,719
------------ ------------
Total liabilities 224,909,634 201,781,897
------------ ------------
STOCKHOLDERS' EQUITY:
Common stock - par value $.01; authorized - 15,000,000 shares;
issued 777,680 and 788,173 shares, respectively 7,777 7,882
Surplus 7,500,865 7,447,240
Retained earnings 16,175,708 14,555,324
Accumulated other comprehensive (loss) income (114,929) (718,498)
Unearned ESOP shares (139,599) (176,565)
------------ ------------
Total stockholders' equity 23,429,822 21,115,383
------------ ------------
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $248,339,456 $222,897,280
============ ============
See notes to consolidated financial statements.
F-2
TRI-COUNTY FINANCIAL CORPORATION
CONSOLIDATED STATEMENTS OF INCOME
FOR THE YEARS ENDED DECEMBER 31, 2000, 1999 AND 1998
2000 1999 1998
-------------- --------------- ------------
INTEREST INCOME:
Interest and fees on loans $13,950,200 $11,562,846 $11,637,672
Taxable interest and dividends on investment securities 4,237,326 4,197,132 3,941,744
Interest on deposits with banks 102,036 93,352 142,259
----------- ----------- -----------
Total interest income 18,289,562 15,853,330 15,721,675
----------- ----------- -----------
INTEREST EXPENSE:
Interest on deposits 6,314,871 5,528,672 5,693,385
Interest on short-term borrowings 1,694,473 501,644 958,119
Interest on long-term debt 1,418,146 1,410,863 945,223
----------- ----------- -----------
Total interest expense 9,427,490 7,441,179 7,596,727
----------- ----------- -----------
NET INTEREST INCOME 8,862,072 8,412,151 8,124,948
PROVISION FOR LOAN LOSSES 360,000 240,000 240,000
----------- ----------- -----------
NET INTEREST INCOME AFTER PROVISION
FOR LOAN LOSSES 8,502,072 8,172,151 7,884,948
----------- ----------- -----------
NONINTEREST INCOME:
Loan appraisal, credit, and miscellaneous charges 76,326 182,494 223,326
Net gains on sale of loans 85,716 238,215 416,838
Net gain (loss) on sales of investment securities 184,704 (605) (391)
Service charges and fees 996,884 811,991 600,067
Other income 29,358 39,369 180,696
----------- ----------- -----------
Total noninterest income 1,372,988 1,271,464 1,420,536
----------- ----------- -----------
NONINTEREST EXPENSE:
Salaries and employee benefits 3,643,865 3,600,119 3,114,748
Occupancy expense 615,809 540,667 494,113
ATM and deposit expenses 340,532 287,178 255,645
Advertising 246,619 280,044 162,133
Data processing expense 255,792 215,227 259,025
Depreciation of furniture, fixtures, and equipment 241,714 231,240 204,230
Other expenses 987,533 1,121,650 976,743
----------- ----------- -----------
Total noninterest expense 6,331,864 6,276,125 5,466,637
----------- ----------- -----------
INCOME BEFORE INCOME TAXES 3,543,196 3,167,490 3,838,847
Income tax expense 1,207,000 1,014,000 1,457,000
----------- ----------- -----------
NET INCOME $ 2,336,196 $ 2,153,490 $ 2,381,847
=========== =========== ===========
INCOME PER COMMON SHARE:
Basic earnings per share $2.98 $2.75 $3.00
Diluted earnings per share 2.85 2.59 2.79
See notes to consolidated financial statements.
F-3
TRI-COUNTY FINANCIAL CORPORATION
CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY
FOR THE YEARS ENDED DECEMBER 31, 2000, 1999 AND 1998
Accumu-
lated
Other
Compre-
hensive Unearned
Common Paid-in Retained Income ESOP
Stock Capital Earnings (Loss) Shares Total
------ ---------- ----------- --------- --------- -----------
BALANCES, JANUARY 1, 1998 $7,827 $6,574,162 $12,104,129 $ 442,032 $(194,385) $18,933,765
Comprehensive income:
Net income - - 2,381,847 - - 2,381,847
Unrealized gains on investment
securities net of tax of $129,980 - - - 206,582 - 206,582
-----------
Total comprehensive income - - - - - 2,588,429
Cash dividend - $0.125 per share - - (97,627) - - (97,627)
5% stock dividend 310 693,962 (694,272) - - -
Cash paid in lieu of stock dividend
for fractional shares - - (4,871) - - (4,871)
Exercise of stock options 58 41,777 - - - 41,835
Repurchase of common stock (200) - (473,436) - - (473,636)
Net change in unearned ESOP shares (102) - - - (12,498) (12,600)
------ ---------- ----------- ---------- --------- -----------
BALANCES, DECEMBER 31, 1998 7,893 7,309,901 13,215,770 648,614 (206,883) 20,975,295
Comprehensive income:
Net income - - 2,153,490 - - 2,153,490
Unrealized loss on investment
securities net of tax of $770,187 - - - (1,367,112) - (1,367,112)
-----------
Total comprehensive income 786,378
Cash dividend - $0.20 per share - - (157,034) - - (157,034)
Excess of fair market value over cost
of leveraged ESOP shares released - 11,401 - - - 11,401
Exercise of stock options 222 125,938 - - - 126,160
Repurchase of common stock (248) - (656,902) - - (657,150)
Net change in unearned ESOP shares 15 - - - 30,318 30,333
------ ---------- ----------- ---------- --------- -----------
BALANCES, DECEMBER 31, 1999 7,882 7,447,240 14,555,324 (718,498) (176,565) 21,115,383
Comprehensive income:
Net income - - 2,336,196 - - 2,336,196
Unrealized gain on investment
securities net of tax of $310,083 - - - 603,569 - 603,569
------------
Total comprehensive income 2,939,765
Cash dividend - $0.30 per share - - (236,595) - - (236,595)
Excess of fair market value over cost
of leveraged ESOP shares released - 12,964 - - - 12,964
Exercise of stock options 50 40,661 - - - 40,711
Repurchase of common stock (173) - (479,217) - - (479,390)
Net change in unearned ESOP shares 18 - - - 36,966 36,984
------ ---------- ----------- --------- --------- -----------
BALANCES, DECEMBER 31, 2000 $7,777 $7,500,865 $16,175,708 $(114,929) $(139,599) $23,429,822
====== ========== =========== ========= ========= ===========
See notes to consolidated financial statements.
F-4
TRI-COUNTY FINANCIAL CORPORATION
CONSOLIDATED STATEMENTS OF CASH FLOWS
FOR THE YEARS ENDED DECEMBER 31, 2000, 1999 AND 1998
2000 1999 1998
------------- ------------- -------------
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income $ 2,336,196 $ 2,153,490 $ 2,381,847
Adjustments to reconcile net income to net cash
provided by operating activities:
Provision for loan losses 360,000 240,000 240,000
Depreciation and amortization 348,110 336,383 301,238
Amortization of premium/discount on mortgage-
backed securities and investments (86,909) (236,443) 33,346
Deferred income tax benefit (118,000) (68,000) (131,000)
(Increase) decrease in accrued interest receivable (207,138) 183,585 (206,043)
Decrease in deferred loan fees (31,732) (122,180) (130,320)
Increase in accrued expenses and other liabilities 911,013 690,273 14,765
Decrease (increase) in other assets 323,234 (276,747) (539,020)
Loss (gain) on disposal of premises and equipment - 3,256 (66,813)
(Gain) loss on sale of investment securities (184,704) 605 391
Origination of loans held for sale (1,966,774) (9,268,298) (23,740,825)
Proceeds from sale of loans held for sale 2,470,589 11,000,111 23,589,839
Gain on sales of loans (85,716) (238,215) (416,839)
Gain on sale of foreclosed real estate - - (61,654)
------------ ------------ ------------
Net cash provided by operating activities 4,068,169 4,397,820 1,268,912
------------ ------------ ------------
CASH FLOWS FROM INVESTING ACTIVITIES:
Net (increase) decrease in interest-bearing deposits with banks (2,912,035) 1,089,537 1,017,014
Purchase of investment securities available-for-sale (18,235,337) (74,254,708) (90,192,914)
Proceeds from sale, redemption or principal payments
of investment securities available-for-sale 19,212,629 71,673,801 87,391,528
Purchase of investment securities held-to-maturity (893,649) (1,697,520) (3,110,963)
Proceeds from maturities or principal payments
of investment securities held-to-maturity 1,128,333 1,890,569 2,127,218
Net purchase of FHLB stock and Federal Reserve Bank stock (747,850) (282,350) (281,350)
Loans originated or acquired (70,415,720) (62,475,059) (54,084,255)
Principal collected on loans 44,707,731 48,239,092 42,431,995
Purchase of premises and equipment (327,155) (551,968) (478,661)
Proceeds from sales of premises and equipment - 12,150 117,251
Proceeds from disposition of foreclosed real estate - - 825,060
Acquisition from foreclosed real estate - (122,910) -
------------ ------------ ------------
Net cash used in investing activities (28,483,053) (16,479,366) (14,238,077)
------------ ------------ ------------
F-5
TRI-COUNTY FINANCIAL CORPORATION
Consolidated Statements of Cash Flows (Continued)
For the Years Ended December 31, 2000, 1999 and 1998
2000 1999 1998
------------- ------------- -------------
CASH FLOWS FROM FINANCING ACTIVITIES:
Net increase in deposits $ 12,064,199 $ 3,926,436 $ 9,539,287
Net increase (decrease) in short-term borrowings 152,525 (3,539,504) 4,414,672
Dividends paid (236,595) (157,034) (102,498)
Exercise of stock options 40,711 126,160 41,835
Net change in unearned ESOP shares 49,948 41,734 (12,600)
Repurchase of common stock (479,391) (657,150) (473,636)
Proceeds from long-term debt 30,000,000 35,000,000 -
Payments of long-term debt (20,000,000) (20,096,450) (182,160)
------------ ------------ -----------
Net cash provided by financing activities 21,591,397 14,644,192 13,224,900
------------ ------------ -----------
(DECREASE) INCREASE IN CASH AND
CASH EQUIVALENTS (2,823,487) 2,562,646 255,735
CASH AND CASH EQUIVALENTS AT
BEGINNING OF YEAR 3,469,304 906,658 650,923
------------ ------------ -----------
CASH AND CASH EQUIVALENTS AT
END OF YEAR $ 645,817 $ 3,469,304 $ 906,658
============ ============ ===========
Supplementary cash flow information:
Cash paid during the year for:
Interest $ 8,737,746 $7,368,462 $ 7,942,034
Income taxes 925,000 1,288,882 1,502,868
Transfers from loans receivable to
foreclosed real estate - 53,716 763,406
See notes to consolidated financial statements.
F-6
TRI-COUNTY FINANCIAL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR THE YEARS ENDED DECEMBER 31, 2000, 1999 AND 1998
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Basis of Presentation and Consolidation
---------------------------------------
The consolidated financial statements include the accounts of
Tri-County Financial Corporation and its wholly owned subsidiary, Community Bank
of Tri-County (the "Bank") and the Bank's wholly owned subsidiaries, Tri-County
Investment Corporation and Tri-County Federal Finance One (collectively, the
"Company"). All significant intercompany balances and transactions between the
parent corporations and their subsidiaries have been eliminated in
consolidation. The accounting and reporting policies of the Company conform with
accounting principles generally accepted in the United States and to general
practices within the banking industry. Certain reclassifications have been made
to amounts previously reported to conform with classifications made in 2000.
Use of Estimates
----------------
In preparing consolidated financial statements in conformity
with accounting principles generally accepted in the United States, management
is required to make estimates and assumptions that affect the reported amounts
of assets and liabilities as of the date of the balance sheet and reported
amounts of revenues and expenses during the reporting period. Actual results
could differ from those estimates. Material estimates that are particularly
susceptible to significant change in the near term relate to the determination
of the allowance for loan losses, and the valuation of foreclosed real estate
and deferred tax assets.
Nature of Operations
--------------------
The Company, through its bank subsidiary, conducts full service
commercial banking operations throughout the Southern Maryland area. Its primary
financial deposit products are savings, transaction, and term certificate
accounts. Its primary lending products are mortgage loans on residential,
construction and commercial real estate and various types of consumer and
commercial lending.
Significant Group Concentrations of Credit
------------------------------------------
Most of the Company's activities take place in the Southern
Maryland area comprising St. Mary's, Charles, and Calvert counties. Note 2
discusses the types of securities the Company invests in. Note 3 discusses the
type of lending that the Company engages in. The Company does not have any
significant concentration to any one customer or industry.
F-7
Cash and Cash Equivalents
-------------------------
For purposes of the consolidated statements of cash flows, the
Company considers all highly liquid debt instruments with original maturities
when purchased of three months or less to be cash equivalents. These instruments
are presented as cash and due from banks.
Investment Securities
---------------------
Investment securities that are held principally for resale in
the near term are classified as trading assets and are recorded at fair value
with changes in fair value recorded in earnings. Debt securities that management
has the positive intent and ability to hold to maturity are classified as "held-
to-maturity" and recorded at amortized cost. Securities not classified as held
to maturity or trading, including equity securities with readily determinable
fair values are classified as "available-for-sale" and recorded at fair value,
with unrealized gains and losses excluded from earnings and reported net of
deferred taxes in other comprehensive income, a separate component of
stockholders' equity.
Purchase premiums and discounts are recognized in interest
income using the interest method over the terms of the securities. Declines in
the fair value of held-to-maturity and available-for-sale securities below their
cost that are deemed to be other than temporary are reflected in earnings as
realized losses. Gains and losses on the sales of securities are recorded on the
trade date and are determined using the specific identification method.
The Company invests in Federal Home Loan Bank and Federal
Reserve Bank stock which are considered restricted as to marketability.
Loans Held for Sale
-------------------
Loans originated and intended for sale in the secondary market
are carried at the lower of cost or estimated fair value, in the aggregate. Net
unrealized losses, if any, are recognized through a valuation allowance by
charges to income.
Loans Receivable
----------------
The Company grants mortgage, commercial, and consumer loans to
customers. A substantial portion of the loan portfolio is represented by loans
throughout Southern Maryland. The ability of the Company's debtors to honor
their contracts is dependent upon the real estate and general economic
conditions in this area.
Loans that management has the intent and ability to hold for
the foreseeable future or until maturity or payoff generally are reported at
their outstanding unpaid principal balances adjusted for charge-offs, the
allowance for loan losses, and any deferred fees or costs on originated loans.
Interest income is accrued on the unpaid principal balance. Loan origination
fees, net of certain direct origination costs, are deferred and recognized as an
adjustment of the related loan yield using the interest method.
F-8
The accrual of interest on mortgage and commercial loans is
discontinued at the time the loan is 90 days delinquent unless the credit is
well secured and in the process of collection. Personal loans are charged-off no
later than 120 days past due. In all cases, loans are placed on nonaccrual or
charged-off at an earlier date if collection of principal or interest is
considered doubtful.
All interest accrued but not collected from loans that are
placed on nonaccrual or charged-off is reversed against interest income. The
interest on these loans is accounted for on the cash-basis or cost-recovery
method, until qualifying for return to accrual. Loans are returned to accrual
status when all principal and interest amounts contractually due are brought
current and future payments are reasonably assured.
Allowance for Loan Losses
-------------------------
The allowance for loan losses is established as losses are
estimated to have occurred through a provision for loan losses charged to
earnings. Loan losses are charged against the allowance when management believes
that the uncollectibility of a loan balance is confirmed. Subsequent recoveries,
if any, are credited to the allowance.
The allowance for loan losses is evaluated on a regular basis
by management and is based upon management's periodic review of the
collectibility of the 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 for loan losses may consist of an allocated
component and an unallocated component. The components of allowance for loan
losses represent an estimation done pursuant to either SFAS No. 5 "Accounting
for Contingencies", or SFAS No. 114 "Accounting by Creditors for Impairment of a
Loan". The allocated component of the allowance for credit losses reflects
expected losses resulting from analysis developed through specific credit
allocations for individual loans and historical loss experience for each loan
category. The specific credit allocations are based on a regular analysis of all
loans over a fixed-dollar amount where the internal credit rating is at or below
a predetermined classification. The historical loan loss element is determined
statistically using a loss migration analysis that examines loss experience and
the related internal gradings of loans charged-off. The loss migration analysis
is performed quarterly and loss factors are updated regularly based on actual
experience. The allocated component of the allowance for credit losses also
includes management's determination of the amounts necessary for concentrations
and changes in portfolio mix and volume.
The unallocated portion, if any, of the allowance is determined
based on management's assessment of general economic conditions, as well as
specific economic factors in the individual markets in which the Company
operates. This determination inherently involves a higher risk of uncertainty
and considers current risk factors that may not have yet manifested themselves
in the Company's historical loss factors used to determine the allocated
component of the allowance and it recognizes knowledge of the portfolio may be
incomplete.
F-9
A loan is considered impaired when, based on current
information and events, it is probable that the Company will be unable to
collect the scheduled payments of principal or interest when due according to
the contractual terms of the loan agreement. 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 are
reviewed 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 reasons for the delay, the borrower's prior payment record, and the
amount of the shortfall in relation to the principal and interest owed.
Impairment is measured on a loan by loan basis for commercial and construction
loans by either the present value expected future cash flows discounted at the
loan's effective interest rate, the loan's obtainable market price, or the fair
value of the collateral if the loan is collateral dependent. Large groups of
smaller homogeneous loans are collectively evaluated for impairment.
Accordingly, the Company does not separately identify individual consumer and
residential loans for impairment disclosures.
Mortgage Servicing Assets
-------------------------
Mortgage servicing assets are recognized as separate assets
when rights are acquired through purchase or through sale of mortgages or
mortgage servicing rights. Capitalized servicing rights are reported in other
assets and are amortized into noninterest income in proportion to, and over the
period of, the estimated future net servicing income of the underlying financial
assets. Servicing assets are evaluated for impairment based upon the fair value
of the rights as compared to amortized cost. Impairment is determined by
stratifying rights by predominant characteristics, when available, such as
interest rates and terms. Fair value is determined using prices for similar
assets with similar characteristics, when available, or based upon discounted
cash flows using market based assumptions. Impairment is recognized through a
valuation allowance for an individual stratum, to the extent that fair value is
less than the capitalized amount for the stratum.
Premises and Equipment
----------------------
Land is carried at cost. Premises and equipment are carried at
cost, less accumulated depreciation computed by the straight-line method over
the estimated useful lives of the assets which are as follows:
Buildings and improvements 15 - 50 years
Furniture and equipment 5 - 15 years
Automobiles 5 years
Foreclosed Real Estate
----------------------
Assets acquired through, or in lieu of, loan foreclosure are
held for sale and are initially recorded at fair value at the date of
foreclosure, establishing a new cost basis. Subsequent to foreclosure,
valuations are periodically performed by management and the assets are carried
at the lower of carrying amount or fair value less cost to sell. Revenue and
expenses from operations and changes in the valuation allowance are included in
noninterest expense.
F-10
Income Taxes
------------
The Company files a consolidated federal income tax return with
its subsidiaries. Deferred tax assets and liabilities are determined using the
liability (or balance sheet) method. Under this method, the net deferred tax
asset or liability is determined based on the tax effects of the temporary
differences between the book and tax bases of the various balance sheet assets
and liabilities and gives current recognition to changes in tax rates and laws.
Earnings Per Share
------------------
Basic earnings per common share represents 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 potential dilutive common
shares had been issued, as well as any adjustment to income that would result
from the assumed issuance. Potential common shares that may be issued by the
Company relate solely to outstanding stock options, and are determined using the
treasury stock method.
Stock-Based Compensation
------------------------
Stock based compensation is recognized using the intrinsic
value method. For disclosure purposes, pro forma net income and earnings per
share effects are provided as if the fair value method had been applied.
New Accounting Standards
------------------------
Statement of Financial Accounting Standards No. 133 ("SFAS No.
133"), Accounting for Derivative Instruments and Hedging Activities, as amended
by SFAS No. 137, Accounting for Derivative Instruments and Hedging Activities -
Deferral of the Effective Date of FASB Statement No. 133, requires derivative
instruments be carried at fair value on the balance sheet. The statement
continues to allow derivative instruments to be used to hedge various risks and
sets forth specific criteria to be used to determine when hedge accounting can
be used. The statement also provides for offsetting changes in fair value or
cash flows of both the derivative and the hedged asset or liability to be
recognized in earnings in the same period; however, any changes in fair value or
cash flows that represent the ineffective portion of a hedge are required to be
recognized in earnings and cannot be deferred. For derivative instruments not
accounted for as hedges, changes in fair value are required to be recognized in
earnings.
The Company adopted the provisions of this statement, as
amended, for its quarterly and annual reporting beginning January 1, 2000, the
statement's effective date. The impact of adopting the provisions of this
statement had no effect on the Company's financial position, results of
operations and cash flows because the Company did not engage in any activities
covered by the relevant statements.
F-11
2. INVESTMENT SECURITIES
The amortized cost and estimated fair values of securities with
gross unrealized losses and gains are:
December 31, 2000
----------------------------------------------------------------------
Gross Gross Estimated
Amortized Unrealized Unrealized Fair
Cost Gains Losses Value
----------- ------------- ------------- --------------
Securities available-for-sale:
Mutual funds $ 753,116 $ - $ - $ 753,116
Government Sponsored
Enterprises (GSE's) 8,000,000 - 88,397 7,911,603
Asset-backed securities issued by:
GSE's 30,894,088 139,721 456,854 30,576,955
Other 16,890,571 32,527 68,100 16,854,997
----------- -------- -------- -----------
Total debt securities available-for-sale 56,537,775 172,247 613,350 56,096,672
Corporate equity securities 509,010 255,314 - 764,324
----------- -------- -------- -----------
Total securities available-for-sale $57,046,785 $427,561 $613,350 $56,860,996
=========== ======== ======== ===========
Securities held-to-maturity:
Obligations of U.S. government
agencies $ 200,000 $ - $ - $ 200,000
Other investments 1,514,367 - - 1,514,367
----------- -------- -------- -----------
Total securities held-to-maturity $ 1,714,367 $ - $ - $ 1,714,367
=========== ======== ======== ===========
December 31, 1999
----------------------------------------------------------------------
Gross Gross Estimated
Amortized Unrealized Unrealized Fair
Cost Gains Losses Value
----------- ------------- ------------- --------------
Securities available-for-sale:
Mutual funds $ 820,125 $ - $ - $ 820,125
Government Sponsored
Enterprises (GSE's) 8,000,000 - 381,073 7,618,927
Asset-backed securities issued by:
GSE's 30,126,266 102,799 727,988 29,501,077
Other 18,191,069 42,643 269,637 17,964,075
----------- -------- ---------- -----------
Total debt securities available-for-sale 57,137,460 145,442 1,378,698 55,904,204
Corporate equity securities 511,206 239,890 - 751,096
------------ -------- ---------- -----------
Total securities available-for-sale $57,648,666 $385,332 $1,378,698 $56,655,300
=========== ======== ========== ===========
F-12
December 31, 1999
----------------------------------------------------------------------
Gross Gross Estimated
Amortized Unrealized Unrealized Fair
Cost Gains Losses Value
----------- ------------- ------------- --------------
Securities held-to-maturity:
Obligations of U.S. government
securities $ 197,719 $ - $ - $ 197,719
Other investments 1,749,053 - - 1,749,053
---------- ---------- -------- ----------
Total securities held-to-maturity $1,946,772 $ - $ - $1,946,772
========== ========== ======== ==========
At December 31, 2000 and 1999, U.S. Government obligations with a
carrying value of $200,000 and $197,719, respectively, were pledged to secure
public unit deposits and for other purposes required or permitted by law. At
December 31, 2000 securities with a carrying value of $50,646,000 were pledged
as collateral for advances from the Federal Home Loan Bank of Atlanta.
The scheduled maturities of securities at December 31, 2000 are as
follows:
Available-for-Sale Held to Maturity
----------------------------- ---------------------------
Amortized Fair Amortized Fair
Cost Value Cost Value
------------- ----------- ------------- ----------
Within one year $ 753,116 $ 753,116 $ 970,716 $ 970,716
Over one year through five years 1,000,000 999,961 734,103 734,103
Over five years through ten years 7,000,000 6,911,642 9,548 9,548
----------- ----------- ---------- ----------
8,753,116 8,664,719 1,714,367 1,714,367
Mortgage-backed securities 47,784,659 47,431,953 - -
----------- ----------- ---------- ----------
$56,537,775 $56,096,672 $1,714,367 $1,714,367
=========== =========== ========== ==========
Proceeds from the sales of investment securities available-for-sale
during 2000, 1999, and 1998 were $186,900, $200,000, and $408,500, respectively.
Gross gains in the years ending December 31, 2000, 1999, and 1998 were $184,704,
$-0-, and $2,111. Gross losses for the years ending December 31, 2000, 1999, and
1998 were $-0-, $605, and $391, respectively.
Asset-backed securities are comprised of mortgage-backed securities
as well as mortgage derivative securities such as collateralized mortgage
obligations and real estate mortgage investment conduits. In certain cases, the
Bank will purchase securities of a single private issuer, defined as an issuer
which is not a government or government sponsored entity, in total amounts in
excess of 10% of stockholders' equity. The Bank only does so when satisfied that
such concentrations pose no threat to the Bank's safety or soundness. The
following summarizes securities positions and the quality of private issuers
where those positions were in excess of 10% of stockholders' equity as of
December 31, 2000 and 1999:
F-13
2000 1999
------------------------- ----------------------
Carrying Moody's Carrying Moody's
Value Rating Value Rating
------------ -------- --------- -------
Country Wide Home Loans $ 3,874,885 AAA $3,581,472 AAA
GE Capital Mortgage Services 5,733,391 AAA 3,800,897 AAA
IMPAC 2,064,577 AAA 2,286,222 AAA
----------- ----------
$11,672,853 $9,668,591
=========== ==========
3. LOANS RECEIVABLE
Loans receivable at December 31, 2000 and 1999 consist of the
following:
2000 1999
------------ ------------
Commercial real estate $ 42,226,137 $ 29,947,350
Residential real estate 67,975,177 66,263,457
Residential construction 17,301,263 17,142,072
Second mortgage loans 18,637,062 16,691,345
Lines of credit - commercial 15,046,074 10,024,782
Consumer loans 13,609,934 9,102,409
------------ ------------
174,795,647 149,171,415
------------ ------------
Less:
Deferred loan fees 776,028 807,758
Allowance for loan losses 1,929,531 1,653,290
------------ ------------
2,705,559 2,461,048
------------ ------------
Total $172,090,088 $146,710,367
============ ============
The following table sets forth the activity in the allowance
for loan losses:
2000 1999 1998
---------- ---------- -----------
Balance, January 1 $1,653,290 $1,540,551 $1,310,365
Add:
Provision charged to operations 360,000 240,000 240,000
Recoveries 12,034 6,790 275
Less:
Charge-offs 95,793 134,051 10,089
---------- ---------- ----------
Balance, December 31 $1,929,531 $1,653,290 $1,540,551
========== ========== ==========
No loans included within the scope of SFAS No. 114 were identified
as being impaired at December 31, 2000 or 1999 and for the years then ended.
F-14
Loans on which the recognition of interest has been discontinued,
which were not included within the scope of SFAS No. 114, amounted to
approximately $7,000, $218,000, and $269,000 at December 31, 2000, 1999, and
1998, respectively. If interest income had been recognized on nonaccrual loans
at their stated rates during 2000, 1999, and 1998, interest income would have
been increased by approximately $913, $27,000, and $21,000, respectively. No
income was recognized for these loans in 2000, 1999 and 1998.
Included in loans receivable at December 31, 2000 and 1999, is
$536,005 and $1,379,274 due from officers and directors of the Bank. Activity in
loans outstanding to officers and directors is summarized as follows:
2000 1999
---------- ----------
Balance, beginning of year $1,379,274 $1,347,263
Changes due to retirement or addition
of directors, net (916,170) -
New loans made during year 131,636 908,424
Repayments made during year (58,735) (876,413)
---------- ----------
Balance, end of year $ 536,005 $1,379,274
========== ==========
4. LOAN SERVICING
Loans serviced for others and not reflected in the balance sheets
are $64,754,825 and $62,016,171 at December 31, 2000 and 1999, respectively.
Servicing loans for others generally consists of collecting mortgage payments,
maintaining escrow accounts, disbursing payments to investors and foreclosure
processing. Loan servicing income is recorded on the accrual basis and includes
servicing fees from investors and certain charges collected from borrowers, such
as late payment fees. Mortgage servicing rights capitalized during 2000, 1999,
and 1998 totaled $45,365, $142,201, and $438,406, respectively.
Amortization of mortgage servicing rights totaled $144,000,
$103,097, and $61,577, respectively. Net servicing rights assets totaled
$486,956, $585,591, and $546,487 at December 31, 2000, 1999, and 1998,
respectively.
F-15
5. PREMISES AND EQUIPMENT
A summary of premises and equipment at December 31, 2000 and 1999 is
as follows:
2000 1999
---------- ----------
Land $1,533,412 $1,439,224
Building and improvements 3,011,967 2,964,425
Furniture and equipment 2,318,860 2,133,436
Automobiles 103,144 103,144
---------- ----------
Total cost 6,967,383 6,640,229
Less accumulated depreciation 2,471,952 2,123,843
---------- ----------
Premises and equipment, net $4,495,431 $4,516,386
========== ==========
Certain bank facilities are leased under various operating leases.
Rent expense was $168,921, $175,949, and $161,167 in 2000, 1999 and 1998,
respectively. Future minimum rental commitments under noncancellable leases are
as follows:
2001 $179,175
2002 134,188
2003 127,188
2004 127,188
2005 127,188
Thereafter 193,475
--------
Total $888,402
========
6. DEPOSITS
Deposits outstanding at December 31 consist of:
2000 1999
------------ ------------
Noninterest-bearing demand $ 12,537,649 $ 10,102,479
------------ ------------
Interest-bearing:
Demand 20,551,420 19,041,881
Money market deposits 44,965,316 34,669,161
Savings 18,552,577 21,427,279
Certificates of deposit 71,199,037 70,501,000
------------ ------------
Total interest-bearing 155,268,350 145,639,321
------------ ------------
Total deposits $167,805,999 $155,741,800
============ ============
The aggregate amount of time deposits in denominations of $100,000
or more at December 31, 2000 and 1999 were $14,857,000 and $13,734,000,
respectively.
F-16
At December 31, 2000, the scheduled maturities of time deposits are
as follows:
2001 $51,420,396
2002 11,031,813
2003 4,524,591
2004 2,154,620
2005 1,682,159
Thereafter 385,458
-----------
$71,199,037
===========
7. LONG-TERM DEBT AND OTHER BORROWINGS
The Bank's long-term debt consists of advances from the Federal Home
Loan Bank of Atlanta. These include fixed rate, adjustable rate, and convertible
advances. The Bank's fixed rate, non-convertible, long-term debt of $5,000,000
at December 31, 2000 matures in 2002. At December 31, 2000 and 1999, the
interest rates on fixed rate, non-convertible, long-term debt were 6.25% and
5.98%, respectively.
The Bank's fixed rate, convertible, long-term debt of $30,000,000 at
December 31, 2000 matures through 2010. This debt is callable by the issuer,
after an initial period ranging from three months to five years. These advances
become callable on dates ranging from 2001 to 2005. Depending on the specific
instrument, the instrument is callable either continuously after the initial
period (Bermuda option) or only at the date ending the initial period
(European). At December 31, 2000 and 1999 the interest rates on this debt ranged
from 4.67% to 6.25% and 4.92% and 5.13%, respectively. At December 31, 2000 and
1999 the weighted average interest rates on fixed rate, convertible, long-term
debt were 5.63% and 4.99%, respectively.
The Bank's adjustable rate, long-term debt at December 31, 2000
matures in 2002. This debt adjusts quarterly based upon a margin over the three
month London Interbank Offer Rate ("LIBOR"). Margins range from 29 to 31 basis
points. The debt has minimum interest rates ranging from 5.31% to 5.51%. The
debt has maximum rates ranging from 7.50% to 7.81%. At December 31, 2000 and
1999, the interest rates on adjustable rate, long-term debt ranged from 6.94% to
6.96% and 5.88% to 6.18%, respectively. At December 31, 2000 and 1999, the
weighted average rate on adjustable rate, long-term debt was 6.94% and 6.02%,
respectively.
The contractual maturities of long-term debt are as follows:
December 31,
2000 1999
----------------------------------------------------------- -----------
Fixed Adjustable Fixed Rate
Rate Rate Convertible Total Total
---------- ---------- ----------- ----------- -----------
Due in 2002 $5,000,000 $6,400,000 $ - $11,400,000 $11,400,000
Due in 2004 - - 5,000,000 5,000,000 -
Due in 2005 - - 10,000,000 10,000,000 10,000,000
Thereafter - - 15,000,000 15,000,000 10,000,000
---------- ---------- ----------- ----------- -----------
Total long-term debt $5,000,000 $6,400,000 $30,000,000 $41,400,000 $31,400,000
========== ========== =========== =========== ===========
F-17
The Bank also has daily advances outstanding which are classified as
short-term borrowings. These advances are repayable at the Bank's option at any
time and reprice daily. These advances totaled $12,975,000 and $3,000,000 at
December 31, 2000 and 1999, respectively.
Under the terms of an Agreement for Advances and Security Agreement
with Blanket Floating Lien, the Company maintains eligible collateral consisting
of 1 - 4 unit residential first mortgage loans, discounted at 75% of the unpaid
principal balance, equal to 100% at December 31, 2000 and 1999, of its total
outstanding long and short term Federal Home Loan Bank advances. These amounts
were $65,169,000 and $59,200,000 at December 31, 2000 and 1999, respectively. In
addition to eligible mortgage loans, the Bank has also pledged its Federal Home
Loan Bank stock of $2,961,300 and $2,220,000 at December 31, 2000 and 1999,
respectively, and securities with a carrying value of $50,646,000 at December
31, 2000, as collateral for these advances.
Other short-term borrowings consists of notes payable to the U.S.
Treasury, which are Federal treasury tax and loan deposits accepted by the Bank
and remitted on demand to the Federal Reserve Bank. At December 31, 2000 and
1999, such borrowings were $575,903 and $398,378, respectively. The Bank pays
interest on these balances at a slight discount to the Federal funds rate. The
notes are secured by investment securities with an amortized cost of
approximately $912,535 and $1,112,406 at December 31, 2000 and 1999,
respectively.
Information relating to short-term borrowings is as follows:
At or for the
Year Ended December 31,
-------------------------------
2000 1999
----------- -----------
Short-term borrowings outstanding at end of period $13,550,903 $13,398,378
Weighted average rate on outstanding short-term 6.35% 5.55%
Maximum oustanding short-term debt at any month end 35,100,000 16,500,000
Average outstanding short-term debt 25,810,000 9,129,000
Approximate weighted average rate paid on short-term debt 6.62% 5.39%
8. INCOME TAXES
Income tax expense was as follows:
2000 1999 1998
---------- ---------- ----------
Current:
Federal $1,307,000 $ 973,000 $1,317,000
State 18,000 109,000 271,000
---------- ---------- ----------
1,325,000 1,082,000 1,588,000
---------- ---------- ----------
Deferred:
Federal (97,000) (56,000) (107,000)
State (21,000) (12,000) (24,000)
---------- ---------- ----------
(118,000) (68,000) (131,000)
---------- ---------- ----------
Total income tax expense $1,207,000 $1,014,000 $1,457,000
========== ========== ==========
F-18
Total income tax expense differed from the amounts computed by
applying the federal income tax rate of 34% to income before income taxes as a
result of the following:
2000 1999 1998
-------------------------- ----------------------- -----------------------
Percent of Percent of Percent of
Pretax Pretax Pretax
Amount Income Amount Income Amount Income
---------- ------------ ---------- ----------- ---------- ----------
Expected income tax expense at
federal tax rate $1,205,000 34.0% $1,077,000 34.0% $1,307,000 34.0%
State taxes, net of federal benefit - .0 62,000 1.9 178,000 4.6
Nondeductible expenses 14,000 .4 14,000 .4 5,400 .1
Deduction for stock options exercised - .0 (90,000) (2.9) - .0
Other (12,000) (.3) (49,000) (1.4) (33,400) (.8)
---------- ---- ---------- ---- ---------- ----
Total income tax expense $1,207,000 34.1% $1,014,000 32.0% $1,457,000 37.9%
========== ==== ========== ==== ========== ====
The net deferred tax assets in the accompanying balance sheets
include the following components:
2000 1999
-------- --------
Deferred tax assets:
Deferred fees $ 48,073 $ 74,199
Allowance for loan losses 577,486 423,906
Deferred compensation 83,510 78,168
Unrealized loss on investment
securities available-for-sale 52,000 362,083
-------- --------
Total deferred assets 761,069 938,356
-------- --------
Deferred tax liabilities:
FHLB stock dividends 152,896 152,896
Depreciation 97,708 83,633
-------- --------
Total deferred liabilities 250,604 236,529
-------- --------
Net deferred assets $510,465 $701,827
======== ========
Retained earnings at December 31, 2000, include approximately $1.2
million of bad debt deductions allowed for federal income tax purposes (the
"base year tax reserve") for which no deferred income tax has been recognized.
If, in the future, this portion of retained earnings is used for any purpose
other than to absorb bad debt losses, it would create income for tax purposes
only and income taxes would be imposed at the then prevailing rates. The
unrecorded income tax liability on the above amount was approximately $458,000
at December 31, 2000.
F-19
Prior to January 1, 1996, the Bank computed its tax bad debt
deduction based upon the percentage of taxable income method as defined by the
Internal Revenue Code. The bad debt deduction allowable under this method
equaled 8% of taxable income determined without regard to the bad debt deduction
and with certain adjustments. The tax bad debt deduction differed from the bad
debt expense used for financial accounting purposes.
In August 1996, the Small Business Job Protection Act (the "Act")
repealed the percentage of taxable income method of accounting for bad debts
effective for years beginning after December 31, 1995. The Act required the Bank
to change its method of computing reserves for bad debts to the experience
method. This method is available to banks with assets less than $500 million and
allows the Bank to maintain a tax reserve for bad debts and to take bad debt
deductions for reasonable additions to the reserve. As a result of this change,
the Bank has to recapture into income a portion of its existing tax bad debt
reserve. This recapture occurs ratably over a six-taxable year period, beginning
with the 1998 tax year. For financial reporting purposes, this recapture does
not result in additional tax expense as the Bank adequately provided deferred
taxes in prior years. Furthermore, this change does not require the Bank to
recapture its base year tax reserve.
9. COMMITMENTS AND CONTINGENCIES
The Company is party to financial instruments with off-balance-sheet
risk in the normal course of business to meet the financing needs of its
borrowers. These financial instruments are commitments to extend credit. These
instruments may, but do not necessarily, involve, to varying degrees, elements
of credit and interest rate risk in excess of the amount recognized in the
balance sheets. The Company's exposure to credit loss in the event of
nonperformance by the other party to the financial instrument is represented by
the contractual amount of those instruments. The Company uses the same credit
policies in making commitments as it does for on-balance-sheet loans receivable.
As of December 31, 2000 and 1999, in addition to the undisbursed
portion of loans receivable approximately $3,708,000 and $3,763,000,
respectively, the Company had outstanding loan commitments approximating
$995,000 and $530,512, respectively.
Standby letters of credit written are conditional commitments issued
by the Company to guarantee the performance of a customer to a third party.
These guarantees are issued primarily to support construction borrowing
arrangements. The credit risk involved in issuing letters of credit is
essentially the same as that involved in extending loan facilities to customers.
The Company holds cash or a secured interest in real estate as collateral to
support those commitments for which collateral is deemed necessary. Standby
letters of credit outstanding amounted to $6,255,640 and $5,556,000 at December
31, 2000 and 1999, respectively.
10. STOCK OPTION AND INCENTIVE PLAN
The Company has a stock option and incentive plan to attract and
retain personnel and provide incentive to employees to promote the success of
the business. At December 31, 2000, 120,946 shares of stock have been authorized
for grants of options for this plan. The exercise price for options granted is
set at the discretion of the Board, but is not less than the market value of the
shares as of the date of grant. An option's maximum term is ten years and the
options generally vest immediately upon issuance.
F-20
The Company applies APB Opinion 25 and related Interpretations in
accounting for the stock option plan. Accordingly, no compensation cost has been
recognized. Had compensation cost for the Company's stock option plan been
determined based upon fair values at the grant dates for awards under the plan
consistent with the method prescribed by SFAS No. 123, the Company's net income
and earnings per share would have been adjusted to the pro forma amounts
indicated below:
2000 1999
---------- ----------
Net income As reported $2,336,119 $2,153,490
Pro forma 2,270,079 1,990,645
Basic earnings per share As reported 2.98 2.75
Pro forma 2.89 2.54
Diluted earnings per share As reported 2.85 2.59
Pro forma 2.76 2.39
For the purpose of computing the pro forma amounts indicated above,
the fair value of each option on the date of grant is estimated using the
Black-Scholes option pricing model with the following weighted-average
assumptions used for the grants:
2000 1999
-------- ---------
Dividend yield 0.75% 0.75%
Expected volatility 15.00% 15.00%
Risk-free interest rate 5.85% 5.72%
Expected lives (in years) 10 10
Weighted average fair value $12.28 $11.51
The following tables summarize activity in the plan:
2000 1999 1998
--------------------- ---------------------- --------------------
Weighted Weighted Weighted
Average Average Average
Exercise Exercise Exercise
Shares Price Shares Price Shares Price
------ -------- ------ -------- ------ --------
Outstanding at beginning of year 91,184 $12.61 101,818 $12.61 85,566 $ 9.19
Granted 9,179 26.66 14,143 25.24 22,006 24.18
Exercised (7,790) 14.61 (24,369) 7.61 (7,627) 5.69
Recission of exercise - .00 - .00 1,873 6.50
Forfeitures (1,537) 25.25 (408) 26.60 - .00
------ ------- -------
Outstanding at end of year 91,036 16.89 91,184 15.85 101,818 12.61
====== ======= =======
F-21
Options Outstanding Options Exercisable
------------------------------------- -------------------------------------
Weighted Weighted
Number Remaining Number Average
Outstanding Contractual Exercisable Exercise
12/31/00 Life 12/31/00 Price
------------ --------------- ------------- --------------
50,279 5 years 50,279 $10.28
775 7 years 775 21.51
26,128 8 years 26,128 24.31
8,151 9 years 8,151 26.60
5,703 10 years 5,703 26.70
11. EMPLOYEE BENEFIT PLANS
The Bank has an Employee Stock Ownership Plan (ESOP) which covers
substantially all of the Bank's employees. The ESOP acquires stock of the Bank's
parent corporation, Tri-County Financial Corporation. The Company accounts for
its ESOP in accordance with AICPA Statement of Position 93-6. Accordingly,
unencumbered shares held by the ESOP are treated as outstanding in computing
earnings per share. Shares issued to the ESOP but pledged as collateral for
loans obtained to provide funds to acquire the shares are not treated as
outstanding in computing earnings per share. Dividends on ESOP shares are
recorded as a reduction of retained earnings. The ESOP may acquire in the open
market up to 195,700 shares. At December 31, 2000, the Plan owns 60,035 shares.
The Company also has a 401(k) plan. Employee contributions are
matched by the Bank at a ratio determined annually by the Board of Directors,
currently one-half of an employee's 6% elective deferral. All employees who have
completed one year of service and have reached the age of 21 are covered under
this defined contribution plan. Contributions are determined at the discretion
of management and the Board of Directors. For the years ended December 31, 2000,
1999, and 1998, the Company charged $175,000, $342,000, and $186,000, against
earnings to fund the Plans.
12. DIVIDENDS
On January 31, 2001, the Board of Directors declared a $.40 per
share cash dividend to be distributed on April 9, 2001 to holders of record as
of March 26, 2001. On February 3, 2000, the Board of Directors declared a $.30
per share cash dividend which was distributed April 14, 2000 to holders of
record as of March 14, 2000. On January 22, 1999, the Board of Directors
declared a $.20 per share cash dividend which was distributed April 17, 2000 to
holders of record March 17, 2000.
13. REGULATORY MATTERS
The Company and the Bank are subject to various regulatory capital
requirements administered by the federal and state banking agencies. Failure to
meet minimum capital requirements can initiate certain mandatory and possible
additional discretionary actions by regulators that, if undertaken, could have a
direct material effect on the Company's and the Bank'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 classification are also subject to qualitative
judgments by the regulators about components, risk weightings, and other
factors.
F-22
Quantitative measures established by regulation to ensure capital
adequacy require the Company and the Bank to maintain minimum amounts and ratios
(set forth in the table below) of tangible and core capital (as defined in the
regulations) to total adjusted assets (as defined), and of risk-based capital
(as defined) to risk-weighted assets (as defined). Management believes, as of
December 31, 2000, that the Company and the Bank meet all capital adequacy
requirements to which they are subject.
As of December 31, 2000, the most recent notification from the
Federal Reserve categorized the Bank as well-capitalized under the regulatory
framework for prompt corrective action. To be categorized as well-capitalized,
the Bank must maintain minimum total risk-based, Tier 1 risk-based, and Tier 1
leverage ratios as set forth in the table. There are no conditions or events
since that notification that management believes have changed the Company's or
the Bank's category.
The Company's and the Bank's actual capital amounts and ratios for
2000 and 1999 are presented in the tables below: (dollar amounts in thousands)
To be Considered
Well Capitalized
Required for Under Prompt
Capital Adequacy Corrective Action
Actual Purposes Provisions
------------------- ------------------- --------------------
Amount Ratio Amount Ratio Amount Ratio
------ ------- ------ ------ ------ -------
At December 31, 2000:
Total capital (to risk-
weighted assets):
The Company $25,475 13.53% $15,069 8.0%
The Bank 25,227 13.40% 15,069 8.0% $18,837 10.0%
Tier 1 capital (to risk-
weighted assets):
The Company 23,545 12.50% 7,535 4.0%
The Bank 23,182 12.31% 7,535 4.0% 11,302 6.0%
Tier 1 capital (to
average assets):
The Company 23,545 9.61% 9,803 4.0%
The Bank 23,182 9.46% 9,803 4.0% 12,254 5.0%
At December 31, 1999:
Total capital (to risk-
weighted assets):
The Company 23,486 17.23% $10,906 8.0%
The Bank 22,936 16.82% 10,906 8.0% 13,633 10.0%
Tier 1 capital (to risk-
weighted assets):
The Company 21,833 16.02% 5,453 4.0%
The Bank 21,283 15.61% 5,453 4.0% 8,179 6.0%
Tier 1 capital (to
average assets):
The Company 21,833 9.86% 8,857 4.0%
The Bank 21,283 9.61% 8,857 4.0% 11,072 5.0%
F-23
14. EARNINGS PER SHARE
The calculations of basic and diluted earnings per share are as
follows:
2000 1999 1998
------------ ------------- -------------
Basic earnings per share:
Net income $2,336,196 $2,153,490 $2,381,847
Average common shares outstanding 784,605 782,950 793,458
Net income per common share - basic $2.98 $2.75 $3.00
Diluted earnings per share:
Net income 2,336,196 2,153,490 2,057,204
Average common shares outstanding 784,605 782,950 811,694
Stock option adjustment 36,534 49,333 55,809
Average common shares outstanding - diluted 821,139 832,283 867,503
Net income per common share - diluted $2.85 $2.59 $2.37
15. FAIR VALUE OF FINANCIAL INSTRUMENTS
The estimated fair value amounts have been determined by the Company
using available market information and appropriate valuation methodologies.
However, considerable judgment is necessarily required to interpret market data
to develop the estimates of fair value. Accordingly, the estimates presented
herein are not necessarily indicative of the amounts the Company could realize
in a current market exchange. The use of different market assumptions and/or
estimation methodologies may have a material effect on the estimated fair value
amounts. Therefore, any aggregate unrealized gains or losses should not be
interpreted as a forecast of future earnings or cash flows. Furthermore, the
fair values disclosed should not be interpreted as the aggregate current value
of the Company.
December 31, 2000 December 31, 1999
-------------------------------- ---------------------------------
Estimated Estimated
Carrying Fair Carrying Fair
Amount Value Amount Value
------------ ------------- ------------ -------------
Assets:
Cash and cash equivalents $ 645,817 $ 645,817 $ 3,469,304 $ 3,469,304
Interest-bearing deposits
with banks 5,975,314 5,975,314 3,063,279 3,063,279
Investment securities and
stock in FHLB and FRB 61,610,913 61,610,913 61,883,138 60,889,772
Loans receivable, net 174,795,647 175,551,335 146,710,367 -
Loans held for sale 355,000 355,000 773,099 773,099
Liabilities:
Savings, NOW and money
market accounts 96,251,723 96,251,723 84,530,443 84,530,443
Time certificates 71,199,037 71,209,125 70,501,000 70,439,300
Long-term debt and other borrowed funds 54,950,903 55,187,033 44,798,378 46,058,410
At December 31, 2000 and 1999, the Company had outstanding loan
commitments and standby letters of credit of $6.4 million and $6.1 million,
respectively. Based on the short-term lives of these instruments, the Company
does not believe that the fair value of these instruments differs significantly
from their carrying values.
F-24
Valuation Methodology
---------------------
Cash and Cash Equivalents - For cash and cash equivalents, the
carrying amount is a reasonable estimate of fair value.
Investment Securities - Fair values are based on quoted market
prices or dealer quotes. If a quoted market price is not available, fair value
is estimated using quoted market prices for similar securities.
Mortgage-Backed Securities - Fair values are based on quoted
market prices or dealer quotes. If a quoted market price is not available, fair
value is estimated using quoted market prices for similar securities.
Loans Receivable and Loans Held for Sale - For conforming
residential first-mortgage loans, the market price for loans with similar
coupons and maturities was used. For nonconforming loans with maturities similar
to conforming loans, the coupon was adjusted for credit risk. Loans which did
not have quoted market prices were priced using the discounted cash flow method.
The discount rate used was the rate currently offered on similar products. Loans
priced using the discounted cash flow method included residential construction
loans, commercial real estate loans, and consumer loans. The estimated fair
value of loans held for sale is based on the terms of the related sale
commitments.
Deposits - The fair value of checking accounts, saving
accounts, and money market accounts was the amount payable on demand at the
reporting date.
Time Certificates - The fair value was determined using the
discounted cash flow method. The discount rate was equal to the rate currently
offered on similar products.
Long-Term Debt and Other Borrowed Funds - These were valued
using the discounted cash flow method. The discount rate was equal to the rate
currently offered on similar borrowings.
The fair value estimates presented herein are based on
pertinent information available to management as of December 31, 2000 and 1999.
Although management is not aware of any factors that would significantly affect
the estimated fair value amounts, such amounts have not been comprehensively
revalued for purposes of these financial statements since that date and,
therefore, current estimates of fair value may differ significantly from the
amount presented herein.
F-25
16. CONDENSED FINANCIAL STATEMENTS - PARENT COMPANY ONLY
Financial information pertaining only to Tri-County Financial
Corporation is as follows:
Balance Sheets:
ASSETS
2000 1999
----------- -----------
Cash - noninterest-bearing $ 204,937 $ 151
Cash - interest-bearing 280,000 719,068
Accounts receivable 79,645 40,247
Investment securities available-for-sale 34,679 28,002
Investment in wholly owned subsidiary 23,067,087 20,564,441
----------- -----------
TOTAL ASSETS $23,666,348 $21,351,909
=========== ===========
LIABILITIES AND STOCKHOLDERS' EQUITY
2000 1999
----------- -----------
Current liabilities $ 236,526 $ 236,526
Stockholders' equity:
Common stock 7,777 7,882
Surplus 7,500,865 5,968,801
Retained earnings 16,175,708 16,033,763
Unearned ESOP shares (139,599) (176,565)
Accumulated other comprehensive income (114,929) (718,498)
----------- -----------
TOTAL LIABILITIES AND STOCKHOLDERS'
EQUITY $23,666,348 $21,351,909
=========== ===========
Condensed Statements of Income:
Year Ended December 31,
---------------------------------------------
2000 1999 1998
----------- ---------- ----------
Dividends from subsidiary $ 500,000 $1,000,000 $ 750,000
Interest income 27,510 42,675 13,882
Loss on sale of investment securities - (605) (391)
Amortization and miscellaneous expenses (90,391) (97,844) (76,671)
---------- ---------- ----------
Income (loss) before income taxes and equity
in undistributed net income of subsidiary 437,119 944,226 686,820
Federal and state income tax benefit - 21,000 10,350
Equity in undistributed net income of subsidiary 1,899,077 1,188,264 1,684,677
---------- ---------- ----------
NET INCOME $2,336,196 $2,153,490 $2,381,847
========== ========== ==========
F-26
Condensed Statements of Cash Flows:
2000 1999 1998
---------- ---------- ----------
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income $2,336,196 $2,153,490 $2,381,847
Adjustments to reconcile net income to net
cash provided by operating activities:
Increase in investment in wholly owned subsidiary (1,899,077) (1,188,264) (1,684,677)
Loss on sale of investment securities - 605 391
Increase in current assets (39,398) (28,513) (10,350)
Increase in current liabilities - 186,893 9,696
---------- ---------- ----------
Net cash provided by operating activities 397,721 1,124,211 696,907
----------- ---------- ----------
CASH FLOWS FROM INVESTING ACTIVITIES:
Net (increase) decrease interest-bearing deposits 439,068 (677,177) 77,829
Purchase of investment securities available-for-sale (6,677) (3,637) (633,861)
Maturity or redemption of investment
securities available-for-sale - 200,000 408,500
---------- ---------- ----------
Net cash provided (used) by investing activities 432,391 (480,814) (147,532)
---------- ---------- ----------
CASH FLOWS FROM FINANCING ACTIVITIES:
Dividends paid (236,595) (157,034) (102,498)
Exercise of stock options 53,676 126,160 41,835
Net change in ESOP loan 36,984 41,734 (12,600)
Redemption of common stock (479,391) (657,150) (473,636)
---------- ---------- ----------
Net cash used in financing activities (625,326) (646,290) (546,899)
---------- ---------- ----------
INCREASE (DECREASE) IN CASH 204,786 (2,893) 2,476
CASH AT BEGINNING OF YEAR 151 3,044 568
---------- ---------- ----------
CASH AT END OF YEAR $ 204,937 $ 151 $ 3,044
========== ========== ==========
F-27
17. QUARTERLY FINANCIAL RESULTS (UNAUDITED)
A summary of selected consolidated quarterly financial data for the
two years ended December 31, 2000 is reported as follows:
2000 1999
---------------------------------------------- ------------------------------------------------
Fourth Third Second First Fourth Third Second First
Quarter Quarter Quarter Quarter Quarter Quarter Quarter Quarter
------- ------- ------- -------- ------- ------- ------- -------
Interest and dividend income $4,829,400 $4,637,439 $4,487,475 $4,335,248 $4,027,289 $3,954,875 $3,953,604 $3,917,562
Interest expenses 2,619,502 2,470,503 2,289,364 2,048,121 1,992,563 1,873,664 1,805,625 1,769,327
---------- ---------- ---------- ---------- ---------- ---------- ---------- ----------
Net interest income 2,209,898 2,166,936 2,198,111 2,287,127 2,034,726 2,081,211 2,147,979 2,148,235
Provision for loan loss 90,000 90,000 90,000 90,000 60,000 60,000 60,000 60,000
---------- ---------- ---------- ---------- ---------- ---------- ---------- ----------
Net interest income after
provision for loan loss 2,119,898 2,076,936 2,108,111 2,197,127 1,974,726 2,021,211 2,087,979 2,088,235
Noninterest income 470,936 300,658 309,275 292,119 302,599 282,440 341,283 345,142
Noninterest expense 1,580,431 1,553,978 1,631,991 1,565,464 1,838,168 1,533,172 1,574,817 1,329,968
Income before income taxes 1,010,403 823,616 785,395 923,782 439,157 770,479 854,445 1,103,409
Provision for income taxes 352,000 279,000 276,000 300,000 7,248 271,752 315,000 420,000
Net income 658,403 544,616 509,395 623,782 431,909 498,727 539,445 683,409
Earnings per common share:
Basic $0.85 $0.69 $0.65 $0.79 $0.56 $0.72 $0.60 $0.87
===== ===== ===== ===== ===== ===== ===== =====
Diluted $0.82 $0.66 $0.62 $0.75 $0.54 $0.67 $0.57 $0.81
===== ===== ===== ===== ===== ===== ===== =====
F-28
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) 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.
TRI-COUNTY FINANCIAL CORPORATION
Date: March 28, 2001 By: /s/ Michael L. Middleton
----------------------------------------
Michael L. Middleton
President and Chief Executive Officer
(Duly Authorized Representative)
Pursuant to the requirement 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 on the dates indicated.
By: /s/ Michael L. Middleton By: /s/ William J. Pasenelli
------------------------------- --------------------------------
Michael L. Middleton William J. Pasenelli
(Director, President and Chief (Chief Financial and Accounting
Executive Officer) Officer
Date: March 28, 2001 Date: March 28, 2001
By: /s/ C. Marie Brown By: /s/ Herbert N. Redmond, Jr.
------------------------------- --------------------------------
C. Marie Brown Herbert N. Redmond, Jr.
(Director and Chief Operating Officer) (Director)
Date: March 28, 2001 Date: March 28, 2001
By: /s/ Beaman Smith By: /s/ W. Edelen Gough, Jr.
------------------------------- --------------------------------
Beaman Smith W. Edelen Gough, Jr.
(Director and Secretary/Treasurer) (Director)
Date: March 28, 2001 Date: March 28, 2001
By: /s/ Louis P. Jenkins, Jr. By: /s/ Catherine A. Askey
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Louis P. Jenkins, Jr. Catherine A. Askey
(Director) (Director)
Date: March 28, 2001 Date: March 28, 2001