UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
(Mark One)
( X ) QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the Quarterly Period Ended June 30, 2003
OR
( ) TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from ___________ to ________
Commission File Number 0-18279
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TRI-COUNTY FINANCIAL CORPORATION
--------------------------------
(Exact name of registrant as specified in its charter)
Maryland 52-1652138
- -------- ----------
(State of 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)
(301) 843-0854
--------------
(Registrant's telephone number, including area code)
N/A
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(Former name, former address and former fiscal year,
if changed since last report)
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes x No
--- ---
Indicate by checkmark whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Exchange Act). Yes No X
--- ---
Indicate the number of shares outstanding of each of the issuer's classes
of common stock, as of the latest practical date.
As of July 31, 2003 registrant had outstanding 756,636 shares of Common
Stock.
TRI-COUNTY FINANCIAL CORPORATION
FORM 10-Q
INDEX
- -----
PART I - FINANCIAL INFORMATION PAGE
Item 1 - Financial Statements (Unaudited)
Consolidated Balance Sheets - June 30, 2003
and December 31, 2002 3
Consolidated Statements of Income and Comprehensive Income -
Three and Six Months Ended June 30, 2003 and 2002 4
Consolidated Statements of Cash Flows - Six Months
Ended June 30, 2003 and 2002 5 - 6
Notes to Consolidated Financial Statements 7
Item 2- Management's Discussion and Analysis of Financial Condition
and Results of Operations 9-13
Item 3 - Quantitative and Qualitative Disclosure about Market Risk 15
Item 4 - Controls and Procedures 15
PART II - OTHER INFORMATION
Item 1 - Legal Proceedings 15
Item 2 - Changes in Securities and Use of Proceeds 15
Item 3 - Default Upon Senior Securities 15
Item 4 - Submission of Matters to a Vote of Security Holders 15
Item 5 - Other Information 15
Item 6 - Exhibits and Reports on Form 8-K 16
SIGNATURES 17
2
PART I. FINANCIAL INFORMATION
ITEM I. FINANCIAL STATEMENTS
TRI-COUNTY FINANCIAL CORPORATION
CONSOLIDATED BALANCE SHEETS JUNE 30, 2003 (UNAUDITED) AND DECEMBER 31, 2002
ASSETS
June 30, 2003 December 31, 2002
Cash and due from banks $ 6,157,579 $ 10,356,932
Interest-bearing deposits with banks 8,419,298 15,179,851
Investment securities available for sale - at fair value 67,456,170 41,826,113
Investment securities held to maturity - at amortized cost 3,190,309 2,841,807
Stock in Federal Home Loan Bank and Federal Reserve Bank - at cost 3,127,650 2,736,750
Loans held for sale 1,658,000 1,262,667
Loans receivable - net of allowance for loan losses
of $2,377,707 and $2,314,074, respectively 195,239,291 197,449,282
Premises and equipment, net 5,539,348 5,736,395
Foreclosed real estate 706,014 716,014
Accrued interest receivable 1,148,681 1,042,453
Other assets 8,550,133 3,025,431
------------- -------------
Total assets $ 301,192,473 $ 282,173,695
============= =============
LIABILITIES AND STOCKHOLDERS' EQUITY
LIABILITIES:
Noninterest-bearing deposits $ 30,507,800 $ 33,045,310
Interest-bearing deposits 182,732,778 169,979,802
------------- -------------
Total deposits 213,240,578 203,025,112
Short-term borrowings 5,919,120 752,298
Long-term debt 53,066,740 48,170,000
Accrued expenses and other liabilities 2,000,253 3,353,520
------------- -------------
Total liabilities 274,226,691 255,300,930
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STOCKHOLDERS' EQUITY:
Common stock - par value $.01; authorized - 15,000,000 shares;
issued - 752,054 and 759,778 shares, respectively 7,521 7,598
Additional Paid in Capital 7,787,567 7,716,906
Retained earnings 19,035,399 18,817,615
Accumulated other comprehensive income 245,438 493,691
Unearned ESOP shares (110,143) (163,045)
------------- -------------
Total stockholders' equity 26,965,782 26,872,765
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TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $ 301,192,473 $ 282,173,695
============= =============
See notes to consolidated financial statements
3
TRI-COUNTY FINANCIAL CORPORATION
CONSOLIDATED STATEMENTS OF INCOME AND COMPREHENSIVE INCOME (UNAUDITED)
SIX MONTHS ENDED JUNE 30, 2003 AND 2002
THREE MONTHS ENDED SIX MONTHS ENDED
JUNE 30, JUNE 30,
------------------------- --------------------------
2003 2002 2003 2002
INTEREST INCOME:
Interest and fees on loans $ 3,303,851 $ 3,577,700 $ 6,654,825 $ 7,067,360
Taxable interest and dividends on investment securities 604,401 603,868 1,135,174 1,258,565
Interest on bank deposits 15,544 25,578 52,181 48,820
----------- ----------- ----------- -----------
Total interest income 3,923,796 4,207,146 7,842,180 8,374,745
----------- ----------- ----------- -----------
INTEREST EXPENSE:
Interest on deposits 722,708 865,181 1,470,135 1,774,904
Interest on long-term debt 655,555 630,618 1,268,656 1,270,883
Interest on other borrowings 481 -- 1,247 --
----------- ----------- ----------- -----------
Total interest expense 1,378,744 1,495,799 2,740,038 3,045,787
----------- ----------- ----------- -----------
NET INTEREST INCOME 2,545,052 2,711,347 5,102,142 5,328,958
PROVISION FOR LOAN LOSSES 108,941 30,000 114,327 100,000
----------- ----------- ----------- -----------
NET INTEREST INCOME AFTER PROVISION FOR LOAN LOSSES 2,436,111 2,681,347 4,987,815 5,228,958
----------- ----------- ----------- -----------
NONINTEREST INCOME:
Loan appraisal, credit, and miscellaneous charges 102,583 16,560 129,979 88,348
Net gain on sale of loans held for sale 237,595 105,224 364,690 207,982
Service charges 110,489 267,027 338,824 485,369
Other income 3,126 9,248 8,254 13,709
----------- ----------- ----------- -----------
Total noninterest income 453,793 398,059 841,747 795,408
----------- ----------- ----------- -----------
NONINTEREST EXPENSE:
Salary and employee benefits 1,095,727 1,035,309 2,225,053 2,098,178
Occupancy expense 203,530 224,141 371,847 391,668
Advertising 71,192 90,422 134,926 162,966
Data processing expense 108,728 234,933 194,033 338,456
Depreciation of furniture, fixtures, and equipment 114,839 177,197 229,739 221,196
Telephone communications 63,656 149,192 102,732 193,350
ATM expenses 67,989 73,127 126,469 123,638
Office supplies 52,373 58,150 75,838 94,371
Valuation allowance on foreclosed real estate -- 1,044,070 -- 1,044,070
Office equipment expense 34,631 64,882 79,973 124,544
Other 312,829 305,639 533,431 593,919
----------- ----------- ----------- -----------
Total noninterest expense 2,125,494 3,457,062 4,074,041 5,386,356
----------- ----------- ----------- -----------
INCOME (LOSS) BEFORE INCOME TAXES 764,410 (377,656) 1,755,521 638,010
INCOME TAX EXPENSE (BENEFIT) 255,215 (134,600) 605,215 230,000
----------- ----------- ----------- -----------
NET INCOME (LOSS) 509,195 (243,056) 1,150,306 408,010
OTHER COMPREHENSIVE INCOME (LOSS), NET OF TAX
Net unrealized holding gains (losses) arising
during the period 110,800 135,220 (248,253) (22,428)
----------- ----------- ----------- -----------
COMPREHENSIVE INCOME (LOSS) $ 619,995 $ (107,836) $ 902,053 $ 385,582
=========== =========== =========== ===========
EARNINGS (LOSS) PER SHARE
Basic $ 0.68 $ (0.32) $ 1.53 $ 0.54
Diluted 0.65 (0.32) 1.45 0.51
See notes to consolidated financial statements
4
TRI-COUNTY FINANCIAL CORPORATION
CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)
SIX MONTHS ENDED JUNE 30, 2003 AND 2002
SIX MONTHS ENDED
JUNE 30,
--------
2003 2002
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income $ 1,150,306 $ 408,010
Adjustments to reconcile net income to net
cash used by operating activities:
Valuation allowance on foreclosed real estate -- 1,044,070
Provision for loan losses 114,327 100,000
Depreciation and amortization 300,600 246,092
Loss on disposal of obsolete equipment -- 65,104
Net amortization of premium/discount on investment securities 379,458 7,401
Deferred income tax benefit (29,000) (90,000)
Increase in accrued interest receivable (106,228) (129,818)
(Increase) decrease in deferred loan fees (20,485) 16,173
Decrease in accounts payable, accrued expenses, and other liabilities (1,353,267) 434,579
Decrease (Increase) in other assets 345,004 (1,099,337)
Origination of loans held for sale (11,008,750) (9,908,946)
Gain on sales of loans held for sale (364,690) (207,982)
Gain on disposal of premises and equipment -- (4,458)
Proceeds from sale of loans held for sale 10,978,107 8,485,893
------------ ------------
Net cash used by operating activities 385,382 (633,219)
------------ ------------
CASH FLOWS FROM INVESTING ACTIVITIES:
Net decrease (increase) in interest-bearing deposits with banks 6,760,553 (612,007)
Purchase of investment securities available for sale (63,958,171) (26,341,167)
Proceeds from sale, redemption or principal payments
of investment securities available for sale 37,559,698 24,565,938
Purchase of investment securities held to maturity (1,188,207) (1,201,212)
Proceeds from maturities or principal payments
of investment securities held to maturity 839,705 839,091
Net purchase of FHLB and FRB stock (390,900) --
Loans originated or acquired (76,227,936) (42,594,970)
Principal collected on loans 78,344,085 42,829,415
Proceeds from disposal of premises and equipment -- 13,000
Purchase of Bank owned life insurance policies (5,700,000)
Purchase of premises and equipment (103,553) (1,023,999)
Proceeds from foreclosed real estate 10,000 309,046
------------ ------------
Net cash used in investing activities (24,054,726) (3,216,865)
------------ ------------
5
TRI-COUNTY FINANCIAL CORPORATION
CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)
SIX MONTHS ENDED JUNE 30, 2003 AND 2002 (Continued)
SIX MONTHS ENDED
JUNE 30,
--------
2003 2002
CASH FLOWS FROM FINANCING ACTIVITIES:
Net increase (decrease) in deposits $ 10,215,466 $ 10,469,086
Proceeds from long-term borrowings 5,000,000 --
Payments of long-term borrowings (103,260) (1,400,000)
Net decrease in other borrowed funds 5,166,822 (1,117,424)
Exercise of stock options 31,158 39,629
Net change in unearned ESOP shares 92,459 61,452
Dividends paid (422,361) (385,129)
Redemption of common stock (510,293) (48,327)
------------ ------------
Net cash provided by financing activities 19,469,991 7,619,287
------------ ------------
INCREASE IN CASH AND CASH EQUIVALENTS (4,199,353) 3,769,203
CASH AND CASH EQUIVALENTS - JANUARY 1 10,356,932 693,439
------------ ------------
CASH AND CASH EQUIVALENTS - JUNE 30 $ 6,157,579 $ 4,462,642
============ ============
SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION:
Cash paid during the three months for:
Interest $ 2,721,647 $ 3,241,936
============ ============
Income taxes $ 1,130,369 $ 1,040,000
============ ============
See notes to consolidated financial statements
6
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
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1. BASIS OF PRESENTATION
General - The consolidated financial statements of Tri-County Financial
Corporation (the "Company") and its wholly owned subsidiary, Community Bank
of Tri-County (the "Bank") included herein are unaudited; however, they
reflect all adjustments consisting only of normal recurring accruals that,
in the opinion of Management, are necessary to present fairly the results
for the periods presented. Certain information and note disclosures
normally included in financial statements prepared in accordance with
accounting principles generally accepted in the United States of America
have been condensed or omitted pursuant to the rules and regulations of the
Securities and Exchange Commission. The Company believes that the
disclosures are adequate to make the information presented not misleading.
There have been no significant changes to the Company's Accounting Policies
as disclosed in the 2002 Annual Report. The results of operations for the
six months ended June 30, 2003 are not necessarily indicative of the
results of operations to be expected for the remainder of the year. Certain
previously reported amounts have been restated to conform to the 2003
presentation.
It is suggested that these consolidated financial statements be read in
conjunction with the consolidated financial statements and notes included
in the Company's Annual Report for the year ended December 31, 2002.
2. NATURE OF BUSINESS
The Company, through its bank subsidiary, provides domestic financial
services primarily in southern Maryland. The primary financial services
include real estate, commercial and consumer lending, as well as
traditional demand deposits and savings products.
3. INCOME TAXES
The Company uses the liability method of accounting for income taxes as
required by SFAS No. 109, "Accounting for Income Taxes." Under the
liability method, deferred-tax assets and liabilities are determined based
on differences between the financial statement carrying amounts and the tax
bases of existing assets and liabilities (i.e., temporary differences) and
are measured at the enacted rates that will be in effect when these
differences reverse.
4. EARNINGS PER SHARE
Earnings per common share are computed by dividing net income by the
weighted average number of common shares outstanding during the period.
Diluted net income per common share is computed by dividing net income by
the weighted average number of common shares outstanding during the period,
including any potential dilutive common shares outstanding, such as options
and warrants. As of June 30, 2003 there were 7,916 shares excluded from the
diluted net income per share computation because the option price exceeded
the average market price and therefore, their effect would be
anti-dilutive.
5. STOCK-BASED COMPENSATION
The Company has adopted the disclosure-only provisions of SFAS No. 123
"Accounting for Stock-Based Compensation" and SFAS No. 148 "Accounting for
Stock-Based Compensation-Transition and Disclosure", but applies Accounting
Principles Board Opinion No. 25 and related interpretations in accounting
for its Plan. No compensation expense related to the Plan was recorded
during the six months ended June 30, 2003 and 2002. If the Company had
elected to recognize compensation cost based on fair value at the grant
dates for awards under the Plan consistent with the method prescribed by
SFAS No. 123, net income and earnings per share would have been changed to
the pro forma amounts as follows for the six months ended June 30.
7
2003 2002
---- ----
Net Income as reported $1,150,306 $ 408,010
Less pro forma stock based compensation
expense determined under the fair value
method , net of related tax effects 173,261 109,390
---------- ----------
Pro forma net income $ 977,045 $ 298,620
========== ==========
Net income per share
Basic - as reported $ 1.53 $ 0.54
Basic - pro forma $ 1.30 $ 0.39
Diluted - as reported $ 1.45 $ 0.51
Diluted - pro forma $ 1.23 $ 0.38
6. EARNINGS PER SHARE
Basic and diluted earnings per share, have been computed based on
weighted-average common and common equivalent shares outstanding as
follows:
THREE MONTHS ENDED SIX MONTHS ENDED
JUNE 30, JUNE 30,
------------------ -------------------
2003 2002 2003 2002
Basic 745,267 762,721 752,690 760,760
Diluted 786,774 762,721 795,236 792,699
8
ITEM 2
MANAGEMENT'S DISCUSSION AND ANALYSIS OF OPERATIONS AND FINANCIAL CONDITION
This document contains forward-looking statements within the meaning of the
Private Securities Litigation Reform Act of 1995, including discussions of
Tri-County Financial Corporation's (the "Company's") goals, strategies and
expected outcomes; estimates of risks and future costs; and reports of the
Company's ability to achieve its financial and other goals. These
forward-looking statements are subject to significant known and unknown risks
and uncertainties because they are based upon future economic conditions,
particularly interest rates, competition within and without the banking
industry, changes in laws and regulations applicable to the Company and various
other matters. Because of these uncertainties, there can be no assurance that
actual results, performance or achievements of the Company will not differ
materially from any future results, performance or achievements expressed or
implied by these forward-looking statements.
GENERAL
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 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,
Charlotte Hall, 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. The Bank accepts demand and time
deposits, and originates loans to individuals, associations, partnerships and
corporations. The Bank makes real estate loans including residential first and
second mortgage loans, home equity lines of credit and commercial mortgage
loans. The Bank makes commercial loans including secured and unsecured loans.
The Bank is a member of the Federal Reserve and Federal Home Loan Bank ("FHLB")
Systems. The Savings Association Insurance Fund ("SAIF") of the Federal Deposit
Insurance Corporation ("FDIC") provides deposit insurance coverage up to
applicable limits.
Since its conversion to a state chartered commercial bank in 1997, the Bank has
sought to increase its commercial, commercial real estate, construction, second
mortgage, home equity, and consumer lending business as well as the level of
transactional deposits to levels consistent with similarly sized commercial
banks. As a result of this emphasis, the Bank's percentage of assets invested in
residential first mortgage lending has declined since 1997. Conversely, targeted
loan types have increased. The Bank has also seen an increase in transactional
deposit accounts while the percentage of total liabilities represented by
certificates of deposits has also declined. Management believes that these
changes will enhance the Bank's overall long-term financial performance.
Management recognizes that the shift in composition of the Bank's loan portfolio
will tend to increase its exposure to credit losses. The Bank has continued to
evaluate its allowance for loan losses and the associated provision to
compensate for the increased risk. Any evaluation of the allowance for loan
losses is inherently inexact and reflects management's assessment of economic
conditions in the Southern Maryland area as well as individual borrower's
circumstances. Management believes that its allowance for loan losses is
adequate. For further information on the Bank's allowance for loan losses see
the discussion in the financial condition section of this form and in the
section titled "Critical Accounting Policies," as well as the relevant
discussions in the Form 10-K and annual report for the year ended December 31,
2002.
During the second quarter of 2002, the Bank recorded a valuation allowance on
certain foreclosed real estate. In addition the Bank incurred certain expenses
related to its core data system conversion during the same period. These
expenses did not recur in 2003,which had the effect of decreasing noninterest
expense in the current year when compared to the same period in 2002.
In the last several quarters, the national economy has recovered fitfully from a
mild recession while our local economy has remained strong in relation to the
national and statewide economy. Prospects for growth appear to be steady, and
local employment remains strong. The Bank remains exposed to asset deterioration
should the local
9
economy experience a prolonged period of economic decline. In addition, any
Federal Reserve action on interest rates may affect the Bank's financial
performance.
Residential first mortgage loan customers have reacted to lower interest rates
by continuing to refinance higher rate loans. Because the Bank does not wish to
keep low rate, long term, fixed rate residential first mortgages in its
portfolio, these loans are then sold to third parties with the Bank retaining
servicing. These transactions have led to a reduction in residential first
mortgage loan balances. The Bank continues to generate a high level of
noninterest income from these transactions. Other types of loans particularly
commercial real estate and commercial lines of credit have increased. The Bank
continues to generate a high level of non-interest income from the sale of
loans.
Although the Bank's net interest income had grown for several quarters due to
increased assets and an increase in net interest margin, in the past quarter the
Bank's net interest margin narrowed. This was caused by continuing decreases in
short term interest rates. These decreases in short term rates were reflected in
the Bank's interest rates on loans, however, because cost of funds has already
approached a historical low point, the Bank was unable to reduce its cost of
funds by an equal amount resulting in a lower net interest income. Income tax
rates were comparable to the prior year.
It is anticipated that any further reductions in interest rates will have a
significant adverse effect on earnings as rates paid on interest bearing
liabilities, which are as low as 0.10% on NOW accounts, cannot continue to
decline at the same rate as yields on loans and investments.
SELECTED FINANCIAL DATA
SIX MONTHS ENDED
JUNE 30,
------------------------
2003 2002
Condensed Income Statement
Interest Income $7,842,180 $8,374,745
Interest Expense 2,740,038 3,045,787
Net Interest Income 5,102,142 5,328,958
Provision for Loan Loss 114,327 100,000
Noninterest Income 841,747 795,408
Noninterest Expense 4,074,041 5,386,356
Income Before Income Taxes 1,755,521 638,010
Income Taxes 605,215 230,000
Net Income 1,150,306 408,010
Per Common Share
Basic Earnings $ 1.53 $ 0.54
Diluted Earnings 1.45 0.51
Book Value 35.86 33.62
10
RESULTS OF OPERATIONS
Net income for the six month period ended June 30, 2003 totaled $1,150,306
($1.53 basic and $1.45 diluted earnings per share) compared with a total of
$408,010 ($.54 basic and $.51 diluted earnings per share) for the same period in
the prior year. This increase of $742,296 or 181.9% was caused primarily by the
reduction in noninterest expense and increases in noninterest income, these
positive changes were partially offset by the decrease in net interest income
and an increase in provision for loan losses.
For the six month period ended June 30, 2003, interest income declined by
$532,565 or 6.4% to $7,842,180. This decline was caused by the continued decline
in interest rates particularly the declines in the Prime Rate, and one, three,
and five year U.S. Treasury rates. Many loan products are priced based on these
rates. This decline in interest rates was partially offset by higher average
asset balances.
Interest expense also decreased to $2,740,038 in the six month period ending
June 30, 2003 as compared to $3,045,787 in the same period in the prior year a
decrease of $305,749 or 10.0%. This decrease was a reflection of the declining
interest rate environment experienced during the last year. Interest expense
also declined as a result of the Bank's increase in the average balances of
noninterest bearing deposit accounts in the current period compared to the prior
year. The Bank's ability to cut interest expense was inhibited by the
historically low rates paid on deposits prior to the current quarter. As
interest rates have continued to fall on loans and investments, the Bank was
unable to reduce interest expense by the same amount as interest income fell.
Provision for loan losses increased from prior year levels to $114,327 from
$100,000 for the six month period ending June 30, 2003 and 2002, respectively.
The increase in provision expense was caused by a continuing concentration of
the Bank's loan portfolio in commercial loan categories that have higher levels
of risk than residential mortgages, which more than offset a slight decline in
total loan balances. Management will continue to periodically review its
allowance for loan losses and the related provision and adjust as deemed
necessary. This review will include a review of economic conditions nationally
and locally, as well as a review of the performance of significant major loans
and the overall portfolio.
Noninterest income increased to $841,747 for the six month period ending June
30, 2003, an increase of $46,339 or 5.8% over the prior year total of $795,408.
Loan appraisal, credit, and miscellaneous charges increased by $41,631 to
$129,979. Net gain on sale of loans also increased to $364,690 from the prior
year total of $207,982, an increase of $156,708 or 75.4%. These increases were
caused by the high volume of loan originations, caused by lower mortgage
interest rates. Income from service charges declined from the prior year to
$338,824 from the prior year total of $485,369 a decline of $146,545 or 30.2%.
This decline was caused by a write off of certain originated mortgage servicing
rights and by an increased rate of amortization of these rights in the current
year. The write off and higher rate of amortization were the result of the
effect of lower mortgage loan interest rates on our originated mortgage
servicing right ("OMSR") balances. The lower rates had the effect of shortening
the projected lives of the servicing assets, reducing their fair value. This
reduction in fair value was recognized through a $95,000 reduction in OMSR
balances and a corresponding reduction in mortgage servicing income. In addition
average lives for all OMSR's were reduced resulting in higher amortization
expense related to these rights. The higher amortization is reflected in a lower
servicing income. Other noninterest income was comparable from year to year.
Noninterest expense for the six month period decreased by $1,312,315 or 24.4% to
$4,074,041 from $5,386,356 in the same period for the prior year. Salary and
employee benefits expense increased by 6.1% or 126,875, to $2,225,053 from
$2,098,178 for the same period in the prior year. The increase was attributable
to an increase in employees and to increases in average salary costs per
employee. Occupancy expense decreased slightly from $391,668, to $371,847, a
decrease of 5.1% attributable to certain nonrecurring expenses in 2002.
Advertising declined to $134,926 from $162,966, a decline of $28,040 or 17.2%.
Advertising declined due to a reduction in certain sales efforts in anticipation
of being increased in the third and fourth quarters. Data processing expense
also declined to $194,033 from a prior year total of $338,456 a decline of
$144,423 or 42.7%. In 2002, additional expenses were incurred related to the
systems conversion in May 2002. Depreciation of furniture fixtures and equipment
increased to $229,739 from the prior year total of $221,196 an increase of
$8,543 or 3.9%. This increase was due to large investments in equipment added
during the prior year, mostly related to the addition of new branches and new
equipment added for the 2002 system conversion. Telephone communications expense
declined
11
to $102,732 from $193,380 in the prior year, a decline of $90,648 or 46.9%. In
2002, extensive testing of the systems for conversion required the use of phone
lines increasing costs. Also in 2003 cost control and efficiency efforts by the
Bank helped to reduce costs. Office supplies expense decreased to $75,838 from
the prior year amount of $94,371, a decline of $18,533 or 19.6%. This decline
was caused by additional supplies expenses incurred in 2002 related to the
systems conversion. The provision for valuation allowances on foreclosed real
estate declined from $1,044,070 as of June 30, 2003 to zero in 2003 as no
further increases to the valuation allowance were necessary. ATM related
expenses increased by $2,831 to $126,469 for the period ending June 30, 2003, an
increase of 2.3% due to higher levels of activity and additional offsite
machines. Office equipment expenses decreased to $79,973 from 2002's level of
$124,544, a decrease of $44,571 or 35.8%. This decrease was caused by the
retirement of certain equipment due to the systems conversion in 2002. Other
expenses declined to $533,431 from $593,919 a decline of $60,488 or 10.2%. These
expenses were lower based on certain cost control measures in 2003. Income taxes
increased to $605,215 or 34.5% of pretax income in the current year compared to
$230,000 or 42.7% of pretax income in the prior year. The decrease in the tax
rate was primarily attributable to an increase in certain tax exempt interest.
RESULTS OF OPERATIONS - SECOND QUARTER
The Company recorded net income for the second quarter of 2003 of $509,195
compared to a net loss for the same period in 2003 of $243,656. The increase was
the result of the factors noted above especially the provision for valuation
allowance in the prior year as well as certain data processing conversion costs
in the prior year. In addition, noninterest income increased to $453,793 in 2003
an increase of $55,734 or 14.0% from the prior year total of $398,059. These
items were partially offset by a decrease in net interest income to $2,545,052
in 2003, from $2,711,347, a decrease of $245,236 or 9.2%, and an increase in
provision for loan losses to $108,941 from $30,000 an increase of 263.1%.
Net interest income declined by 6.1% to $2,545,052 in 2003 from $2,711,347 as a
result of the continued decline in interest rates noted above. The provision for
loan losses increased by 263.1% to $108,941 in 2003 from $30,000 in 2002
primarily because of the continued concentration of lending in higher credit
risk products. Loan appraisal, credit and miscellaneous charges and net gain on
sale of loans held for sale increased by 519.5% and 125.8%, to $102,583 and
$237,595 respectively as a result of the lower interest rate environment noted
earlier. Service charges declined to $110,489 from $267,027, a decline of
$156,538 or 58.6%, as a result of the write off and higher amortization related
to the lower interest rates and shorter lives of the servicing assets as noted
above. Other income amounts were comparable.
Salary and employee expense increased to $1,095,727 from $1,035,309, an increase
of $60,418 or 5.8% due to an increased average salary per employee and a
slightly higher number of employees. Occupancy expense declined by $20,611 to
$203,530 from the prior year's total of $224,141 a decline of 9.2% due to the
nonrecurring costs of 2002 noted above. Advertising expenses also declined by
$19,230 or 21.3% to $71,192, this decline was the result of delaying certain
advertising expenses in 2003. Data processing expense decreased to $108,728, a
decrease of $126,205 or 53.7% over the prior year total of $234,933. This
decrease reflects conversion and other expenses in the prior year. Depreciation
of furniture, fixtures and equipment also declined as many equipment items were
written off in the prior year. These expenses decreased by $63,358 or 35.2%.
Telephone communications also decreased to $63,656 or by 57.3% under the prior
year total of $149,192 due to expenses in testing and installing the core data
system in 2002. ATM expenses decreased by $5,138 or 7.0% to $67,989 in the
current year due changes in ATM operations. Office supplies expense decreased to
$52,331 from $58,150 a decrease of $5,777 or 9.9% as prior year expenses were
increased by the need to change some supplies prior to conversion. As noted
above, in 2002 the Bank established a valuation allowance on foreclosed real
estate, no provision for this allowance was recorded in 2003. Office equipment
expense was similarly reduced by the absence of conversion related items in
2003. Other expense amounts were comparable.
FINANCIAL CONDITION
Assets
Total assets as of June 30, 2003 increased by $19,018,778 to $301,192,473 from
the December 31, 2002 level of $282,173,695. Cash and due from banks decreased
by $4,199,353, or 40.6% from December 31, 2002's total.
12
Interest-bearing deposits with banks decreased by $6,760,553 or 44.5% during the
period to $8,419,298 at June 30, 2003. Investment securities, including both the
available for sale and held to maturity portfolios, increased from $44,667,920
to $70,646,479 an increase of $25,978,559 or 58.2%. Increases were primarily the
result of additional purchases of investments using the proceeds of loan
prepayments, additional short and long term borrowings, and the conversion of
interest bearing deposits to investments.
Loans held for sale increased to $1,658,000 from $1,262,667 at December 31,
2001. Additional loan information for prior years is presented in the Form 10-K
for the year ended December 31, 2002. The Bank's loan portfolio decreased by
$2,209,991 or 1.1% during the six month period ending June 30, 2003 to
$195,239,291 from December 2002's total of $197,449,282. The decrease was
primarily the result of large amounts of loan prepayments on the Bank's existing
residential first mortgage portfolio. The Bank did increase its portfolio of
commercial real estate loans in the six month period ending June 30, 2003, but
these increases were smaller than the decreases in other parts of the loan
portfolio. At June 30, 2003 the Bank's allowance for loan losses totals
$2,377,707 or 1.19% of loan balances as compared to $2,314,074 or 1.15% of loan
balances at December 31, 2002. Management's determination of the adequacy of the
allowance is based on a periodic evaluation of the portfolio with consideration
given to the overall loss experience; current economic conditions; volume,
growth and composition of the loan portfolio; financial condition of the
borrowers; and other relevant factors that, in management's judgment, warrant
recognition in providing an adequate allowance. Management believes that the
allowance is adequate.
Premises and equipment decreased due to depreciation in the current quarter.
Foreclosed real estate declined to $706,014 at June 30, 2003 from $716,014 at
December 31, 2002 due to partial settlement of one property. Other assets
increased to $8,550,133 from $3,025,431 at December 31, 2002. This increase was
primarily the result of the Bank investing $5,000,000 in certain life insurance
instruments which will provide supplemental benefits to certain key executives
and provide additional interest income to the Bank.
Liabilities
Deposit balances increased by $10,215,466 or 5.0% for the six months ended June
30, 2003. This increase was primarily in interest bearing deposits. Management
believes that ongoing stock market volatility has made bank deposits more
attractive to the general public. Short term borrowings increased to $5,919,120,
an increase of $5,166,822, while long term borrowings increased by $4,896,740.
Proceeds of these borrowings were used to purchase investment securities.
Stockholders' Equity
Stockholders' equity increased $93,017 or .35% to $26,965,782 at June 30, 2003
compared to $26,872,765 at December 31, 2002. This reflects the net income of
$1,150,305 for the six month period partially offset by the $248,253 decline in
accumulated other comprehensive income, and $422,361 in cash dividends. Other
changes in equity occurred as a result of using $510,293 for the purchase and
retirement of shares, the exercise of stock options of $31,158, and activity
related to the ESOP shares of $92,459. Book value on a per share basis, $35.86
at June 30, 2003, as compared to $35.37 at December 31, 2002, reflects a .8%
increase, with a slight increase in outstanding shares, partially offsetting the
gains noted previously.
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 a primary source of funds supporting the Bank's lending and
investment activities.
The Bank's most liquid assets are cash and cash equivalents, which are cash on
hand, amounts due from financial
13
institutions, federal funds sold, and money market mutual funds. 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.
The Bank may borrow up to 45% of consolidated Bank assets on a line of credit
available from the FHLB. As of June 30, 2003, the maximum available under this
line would be $136 million, while current outstanding advances totaled $53
million. In order to draw on this line the Bank must have sufficient collateral.
Qualifying collateral includes residential 1-4 family first mortgage loans,
certain second mortgage loans, certain commercial real estate loans, and various
investment securities.
REGULATORY MATTERS
The Bank is subject to Federal Reserve Board capital requirements as well as
statutory capital requirements imposed under Maryland law. At June 30, 2003, the
Bank's tangible, leverage and risk-based capital ratios were 8.49%, 8.48% and
12.84%, respectively. These levels are well in excess of the required 4.0%, 4.0%
and 8.0% ratios required by the Federal Reserve Board.
CRITICAL ACCOUNTING POLICIES
The Company's financial statements are prepared in accordance with accounting
principles generally accepted in the United States of America (GAAP). The
financial information contained within the financial statements is, to a
significant extent, financial information that is based on measures of financial
effects of transactions and events that have already occurred. A variety of
factors could affect the ultimate value that is obtained when earning of income,
recognizing an expense, recovering an asset or relieving a liability. We use
historical loss factors as one in determining the inherent loss that may be
present in our loan portfolio. Actual losses could differ significantly from the
historical factors that we use. In addition GAAP itself may change from one
previously acceptable method to another method. Although the economics of our
transactions would be the same, the timing of events that would impact our
transactions could change.
The Company considers the allowance for loan losses to be a critical accounting
policy. The allowance for loan losses is an estimate of the losses that may be
sustained in our loan portfolio. The allowance is based on two basic principles
of accounting : (1) SFAS 5, "Accounting for Contingencies", which requires that
losses be accrued when they are probable of occurring and estimable and (2) SFAS
114, "Accounting by Creditors for Impairment of a Loan", which requires that
losses be accrued based on the differences between the value of collateral,
present value of future cash flows or values that are observable in the
secondary market and the loan balance.
Management has significant discretion in making the judgments inherent in the
determination of the provision and allowance for loan losses, including in
connection with the valuation of collateral, a borrower's prospects of
repayment, and in establishing allowance factors on the formula allowance. The
establishment of allowance factors is a continuing exercise, based on
management's continuing assessment of the global factors such as delinquencies,
loss history, trends in the volume and term of loans, national and local
economic trends, concentration of credit, loan classification, and other
factors. Changes in allowance factors will have a direct impact on the amount of
the provision and a corresponding effect on net income. Errors in management's
perception and assessment of the global factors and their impact on the
portfolio could result in the allowance not being adequate to cover losses in
the portfolio, and may result in additional provisions or chargeoffs.
14
ITEM 3 Quantitative and qualitative Disclosure about Market Risk
Not applicable.
ITEM 4 CONTROLS AND PROCEDURES
As of the end of the period covered by this report, management of the Company
carried out an evaluation, under the supervision and with the participation of
the Company's principal executive officer and principal financial officer, of
the effectiveness of the Company's disclosure controls and procedures. Based on
this evaluation, the Company's principal executive officer and principal
financial officer concluded that the Company's disclosure controls and
procedures are effective in ensuring that information required to be disclosed
by the Company in reports that it files or submits under the Securities Exchange
Act of 1934, as amended, is recorded, processed, summarized and reported, within
the time periods specified in the Securities and Exchange Commission's rules and
forms. It should be noted that the design of the Company's disclosure controls
and procedures is based in part upon certain reasonable assumptions about the
likelihood of future events, and there can be no reasonable assurance that any
design of disclosure controls and procedures will succeed in achieving its
stated goals under all potential future conditions, regardless of how remote,
but the Company's principal executive and financial officers have concluded that
the Company's disclosure controls and procedures are, in fact, effective at a
reasonable assurance level.
In addition, there have been no changes in the Company's internal control over
financial reporting (to the extent that elements of internal control over
financial reporting are subsumed within disclosure controls and procedures)
identified in connection with the evaluation described in the above paragraph
that occurred during the Company's last fiscal quarter, that has materially
affected, or is reasonably likely to materially affect, the Company's internal
control over financial reporting.
PART II - OTHER INFORMATION
---------------------------
ITEM 1 - LEGAL PROCEEDINGS
None.
ITEM 2 - CHANGES IN SECURITIES AND USE OF PROCEEDS
Not applicable.
ITEM 3 - DEFAULTS UPON SENIOR SECURITIES
None.
ITEM 4 - SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
On May 7, 2003, the Company held its Annual Meeting of Shareholders. The only
matter voted on was the election of two directors. Set forth below are the
results of the voting in the election of directors.
Nominee For Against
------- --- -------
Herbert N. Redmond 504,046 27,704
Joseph Slater 524,761 6,989
There were no broker non-votes. The terms of directors Michael L. Middleton, C.
Marie Brown, Louis P. Jenkins, Jr. and H. Beaman Smith continued after the
meeting.
ITEM 5 - OTHER INFORMATION
Not applicable.
15
ITEM 6 - EXHIBITS AND REPORTS ON FORM 8-K
A. Exhibits- The following exhibits are being filed with this Form 10-Q
Exhibit 31 Certifications pursuant to Rule 13a-14(a) of the
Exchange Act
Exhibit 32 Certifications pursuant to Section 1350
B. During the quarter for which this Form 10-Q is being filed, the registrant
did not file any reports on Form 8-K.
16
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
TRI-COUNTY FINANCIAL CORPORATION:
Date: August 12, 2003 By:/s/ Michael L. Middleton
-------------------------------------
Michael L. Middleton, President
and Chairman of the Board
Date: August 12, 2003 By: /s/ William J. Pasenelli
-------------------------------------
William J. Pasenelli, Executive
Vice President and Chief
Financial Officer
17