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, 2004
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
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(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
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(Address of principal executive offices) (Zip Code)
(301) 843-0854
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(Registrant's telephone number, including area code)
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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 check mark whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Exchange Act) . Yes No X
--- ---
As of July 30, 2004, the registrant had outstanding 773,762 shares of Common
Stock.
1
TRI-COUNTY FINANCIAL CORPORATION
FORM 10-Q
INDEX
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PART I - FINANCIAL INFORMATION Page
Item 1 - Financial Statements (Unaudited)
Consolidated Balance Sheets - June 30, 2004
and December 31, 2003 3
Consolidated Statements of Income and Comprehensive Income -
Three and Six Months Ended June 30, 2004 and 2003 4-5
Consolidated Statements of Cash Flows - Six Months
Ended June 30, 2004 and 2003 6 -7
Notes to Consolidated Financial Statements 8 -9
Item 2- Management's Discussion and Analysis of Financial Condition 10-17
and Results of Operations
Item 3 - Quantitative and Qualitative Disclosure about Market Risk 17
Item 4 - Controls and Procedures 17
PART II - OTHER INFORMATION
Item 1 - Legal Proceedings 17
Item 2 - Changes in Securities, Use of Proceeds and Issuer Purchases of Equity Securities 17
Item 3 - Defaults Upon Senior Securities 18
Item 4 - Submission of Matters to a Vote of Security Holders 18
Item 5 - Other Information 19
Item 6 - Exhibits and Reports on Form 8-K 19
SIGNATURES 20
2
PART I. FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
TRI-COUNTY FINANCIAL CORPORATION
CONSOLIDATED BALANCE SHEETS JUNE 30, 2004 AND DECEMBER 31, 2003 (Unaudited)
ASSETS
June 30, 2004 December 31, 2003
------------- -----------------
Cash and due from banks $ 5,509,244 $ 2,319,300
Interest-bearing deposits with banks 8,875,581 8,912,332
Federal Funds sold 517,127 938,166
Investment securities available for sale - at fair value 25,284,673 38,290,074
Investment securities held to maturity - at amortized cost 76,626,553 61,605,175
Stock in Federal Home Loan Bank and Federal Reserve Bank - at cost 5,562,400 4,776,850
Loans held for sale -- 474,880
Loans receivable - net of allowance for loan losses
of $2,665,110 and $2,572,799 respectively 256,172,187 217,740,153
Premises and equipment, net 5,698,799 5,580,189
Foreclosed real estate 534,561 706,764
Accrued interest receivable 1,401,183 1,318,318
Investment in bank owned life insurance 6,069,240 5,921,544
Other assets 3,018,848 3,146,247
------------- -------------
Total assets $ 395,270,396 $ 351,729,992
============= =============
LIABILITIES AND STOCKHOLDERS' EQUITY
LIABILITIES:
Noninterest-bearing deposits $ 34,857,530 $ 29,270,007
Interest-bearing deposits 220,189,887 198,284,561
------------- -------------
Total deposits 255,047,417 227,554,568
Short-term borrowings 36,812,298 31,191,285
Long-term debt 72,947,302 63,051,176
Accrued expenses and other liabilities 1,818,542 2,021,053
------------- -------------
Total liabilities 366,625,559 323,818,082
------------- -------------
STOCKHOLDERS' EQUITY:
Common stock - par value $.01; authorized - 15,000,000 shares;
issued - 768,556 and 753,278 shares, respectively 7,685 7,533
Additional Paid in Capital 8,210,710 7,975,036
Retained earnings 21,021,934 20,071,630
Accumulated other comprehensive loss (501,656) (3,130)
Unearned ESOP shares (93,836) (139,159)
------------- -------------
Total stockholders' equity 28,644,837 27,911,910
------------- -------------
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $ 395,270,396 $ 351,729,992
============= =============
See notes to consolidated financial statements
3
TRI-COUNTY FINANCIAL CORPORATION
CONSOLIDATED STATEMENTS OF INCOME AND COMPREHENSIVE INCOME (UNAUDITED)
THREE AND SIX MONTHS ENDED JUNE 30, 2004 AND 2003
THREE MONTHS ENDED SIX MONTHS ENDED
JUNE 30, JUNE 30,
-------------------------- --------------------------
2004 2003 2004 2003
INTEREST INCOME:
Interest and fees on loans $ 3,819,949 $ 3,303,851 $ 7,366,494 $ 6,654,825
Taxable interest and dividends on investment securites 824,510 604,401 1,867,160 1,135,174
Interest on bank deposits 4,159 15,544 8,775 52,181
----------- ----------- ----------- -----------
Total interest income 4,648,618 3,923,796 9,242,429 7,842,180
----------- ----------- ----------- -----------
INTEREST EXPENSE:
Interest on deposits 747,742 722,708 1,447,912 1,470,135
Interest on long term debt 753,674 655,555 1,539,171 1,268,656
Interest on short term borrowings 100,619 481 179,241 1,247
----------- ----------- ----------- -----------
Total interest expense 1,602,035 1,378,744 3,166,324 2,740,038
----------- ----------- ----------- -----------
NET INTEREST INCOME 3,046,583 2,545,052 6,076,105 5,102,142
PROVISION FOR LOAN LOSSES 13,772 108,941 83,974 114,327
----------- ----------- ----------- -----------
NET INTEREST INCOME AFTER PROVISION FOR LOAN LOSSES 3,032,811 2,436,111 5,992,131 4,987,815
----------- ----------- ----------- -----------
NONINTEREST INCOME:
Loan appraisal, credit, and miscellaneous charges 81,748 102,583 147,952 129,979
Net gain on sale of loans held for sale -- 237,595 21,404 364,690
Income from bank owned life insurance 73,848 53,247 147,696 127,095
Service charges 305,933 57,242 540,705 211,729
Loss on the sale of available for sale investment securities (27,504) (27,504)
Other income -- 3,126 -- 8,254
----------- ----------- ----------- -----------
Total noninterest income 434,025 453,793 830,253 841,747
----------- ----------- ----------- -----------
See notes to consolidated financial statements
4
TRI-COUNTY FINANCIAL CORPORATION
CONSOLIDATED STATEMENTS OF INCOME AND COMPREHENSIVE INCOME (UNAUDITED)
THREE AND SIX MONTHS ENDED JUNE 30, 2004 AND 2003
continued
Three Months Ended Six Months Ended
June 30, June 30,
------------------ ----------------------
2004 2003 2004 2003
NONINTEREST EXPENSE:
Salary and employee benefits 1,317,544 1,095,727 2,615,924 2,225,053
Occupancy expense 208,267 203,530 390,140 371,847
Advertising 97,691 71,192 240,230 134,926
Data processing expense 137,222 108,728 289,220 194,033
Depreciation of furniture, fixtures, and equipment 93,000 114,839 180,200 229,739
Telephone communications 19,480 63,656 57,455 102,732
ATM expenses 83,775 67,989 163,873 126,469
Office supplies 22,346 52,373 61,765 75,838
Valuation allowance on foreclosed real estate 33,376 -- 147,203 --
Office equipment expense 19,294 34,631 45,685 79,973
Other 285,516 312,829 521,539 533,431
----------- ----------- ----------- -----------
Total noninterest expense 2,317,511 2,125,494 4,713,234 4,074,041
----------- ----------- ----------- -----------
INCOME BEFORE INCOME TAXES 1,149,325 764,410 2,109,150 1,755,521
INCOME TAXES 345,749 255,215 416,376 605,215
----------- ----------- ----------- -----------
NET INCOME 803,576 509,195 1,692,774 1,150,306
OTHER COMPREHENSIVE INCOME, NET OF TAX
Net unrealized holding gains (losses) arising during the
period (564,678) 110,800 (501,656) (248,253)
----------- ----------- ----------- -----------
COMPREHENSIVE INCOME $ 238,898 $ 619,995 $ 1,191,118 $ 902,053
=========== =========== =========== ===========
EARNINGS PER SHARE
Basic $ 1.05 $ 0.68 $ 2.22 $ 1.53
Diluted 1.01 0.65 2.12 1.45
See notes to consolidated financial statements
5
TRI-COUNTY FINANCIAL CORPORATION
CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)
SIX MONTHS ENDED JUNE 30, 2004 AND 2003
SIX MONTHS ENDED
JUNE 30,
--------------------------
2004 2003
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income 1,692,772 1,150,306
Adjustments to reconcile net income to net
cash used by operating activities:
Provision for loan losses 83,974 114,327
Depreciation and amortization 293,898 300,600
Net amortization of premium/discount on investment
securities 459,221 379,458
Decrease in federal funds sold 421,039 --
Deferred income tax benefit (135,000) (29,000)
Increase in accrued interest receivable (82,865) (106,228)
Increase (decrease) in deferred loan fees 28,617 (20,485)
Decrease in accounts payable, accrued expenses, and other
liabilities (202,511) (1,353,267)
Increase in other assets 371,520 345,004
Origination of loans held for sale -- (11,008,750)
Gain on sales of loans held for sale (21,404) (364,690)
Valuation allowance on foreclosed real estate 147,203 (103,553)
Proceeds from sale of loans held for sale 496,284 10,978,107
------------ ------------
Net cash provided by operating activities 3,552,748 281,829
------------ ------------
CASH FLOWS FROM INVESTING ACTIVITIES:
Net decrease in interest-bearing deposits with banks 36,751 6,760,553
Purchase of investment securities available for sale (23,764,267) (63,958,171)
Proceeds from sale, redemption or principal payments
of investment securities available for sale 35,625,436 37,559,698
Purchase of investment securities held to maturity (31,876,050) (1,188,207)
Gain/loss on investments 27,507 --
Proceeds from maturities or principal payments
of investment securities held to maturity 16,756,831 839,705
Net purchase of FHLB and FRB stock (785,550) (390,900)
Loans originated or acquired (100,578,289) (76,227,936)
Principal collected on loans 62,033,664 78,344,085
Purchase of Bank owned life insurance policies (5,700,000)
Purchase of premises and equipment (412,508) --
Proceeds from foreclosed real estate 25,000 10,000
------------ ------------
Net cash (used) provided in investing activities (42,911,475) (23,951,173)
------------ ------------
6
TRI-COUNTY FINANCIAL CORPORATION
CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)
SIX MONTHS ENDED JUNE 30, 2004 AND 2003
continued
SIX MONTHS ENDED
JUNE 30,
--------
2004 2003
CASH FLOWS FROM FINANCING ACTIVITIES:
Net increase in deposits 27,492,849 10,215,466
Proceeds from long-term borrowings 20,000,000 5,000,000
Payments of long-term borrowings (10,103,874) (103,260)
Net increase in other borrowed funds 5,621,013 5,166,822
Exercise of stock options 207,186 31,158
Net change in unearned ESOP shares 74,011 92,459
Dividends paid (541,633) (422,361)
Redemption of common stock (200,881) (510,293)
----------- -----------
Net cash provided (used) by financing activities 42,548,671 19,469,991
----------- -----------
INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS 3,189,944 (4,199,353)
CASH AND CASH EQUIVALENTS - JANUARY 1 2,319,300 10,356,932
----------- -----------
CASH AND CASH EQUIVALENTS - JUNE 30 5,509,244 6,157,579
=========== ===========
SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION:
Cash paid during the six months for:
Interest 3,282,864 2,721,647
=========== ===========
Income taxes 367,500 1,130,369
=========== ===========
See notes to consolidated financial statements
7
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
- ------------------------------------------
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.
The balances as of December 31, 2003 have been derived from audited
financial statements. There have been no significant changes to the
Company's accounting policies as disclosed in the 2003 Annual Report. The
results of operations for the three and six months ended June 30, 2004 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 2004 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, 2003.
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, 2004, there were 6,300 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. 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,
-------------------------- ------------------------
2004 2003 2004 2003
Basic 768,807 745,267 762,593 752,690
Diluted 797,996 786,774 797,455 795,236
8
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 stock options was recorded
during the three and six months ended June 30, 2004 and 2003. If the
Company had elected to recognize compensation cost based on fair value at
the grant dates for awards under the its stock option plans 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 three
and six months ended June 30.
THREE MONTHS ENDED SIX MONTHS ENDED
JUNE 30, JUNE 30,
-------------------------- -------------------------
2004 2003 2004 2003
---- ---- ---- ----
Net Income as reported $ 803,576 $509,195 $1,692,774 $1,150,306
Less pro forma stock based compensation
Expense determined under the fair
value method, net of tax effects. 163,579 173,261 223,579 173,261
--------- -------- ----------- ---------
Pro forma net income $ 639,997 $335,934 $ 1,469,195 $ 977,045
========= ======== =========== ========
Net Income per share
Basic - as reported $ 1.05 $ 0.68 $ 2.22 $ 1.53
Basic - pro forma $ 0.83 $ 0.45 $ 1.91 $ 1.30
Diluted - as reported $ 1.01 $ 0.65 $ 2.12 $ 1.45
Diluted - pro forma $ 0.80 $ 0.43 $ 1.84 $ 1.23
6. NEW ACCOUNTING STANDARDS
In January 2003, the FASB issued Interpretation No. 46, "Consolidation of
Variable Interest Entities" ("Interpretation No. 46"), which explains
identification of variable interest entities and the assessment of whether
to consolidate those entities. Interpretation No. 46 requires existing
unconsolidated variable interest entities to be consolidated by their
primary beneficiaries if the entities do not effectively disperse risks
among the involved parties. The provisions of Interpretation No. 46 are
effective for all financial statements issued after January 1, 2003. As
noted in its discussion of operations and financial conditions, the Company
completed an offering of trust preferred securities on July 22, 2004. This
offering would fall under the provisions of this interpretation. The
Company is evaluating its accounting treatment for this entity.
In May 2003, the FASB issued SFAS No. 150, "Accounting for Certain
Financial Instruments with Characteristics of Both Liabilities and Equity"
("SFAS No. 150"), effective for financial instruments entered into or
modified after May 31, 2003. This statement established standards for
classifying and measuring certain financial instruments with
characteristics of both liabilities and equity. It requires that an issuer
classify a financial instrument that is within the scope of the statement
as a liability rather than as an equity, such as obligations that a
reporting entity can or must settle by issuing its own equity shares. SFAS
No. 150 did not have an impact on the Company's earnings, financial
condition or equity.
9
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.
The Company does not undertake - and specifically disclaims any obligation - to
publicly release the result of any revisions that may be made to any forward
looking statement to reflect events or circumstances after the date of such
statements or to reflect the occurrence of anticipated or unanticipated events.
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 seven
branches located in Waldorf, Bryans Road, Dunkirk, Leonardtown, La Plata,
Charlotte Hall, and California, Maryland. 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, construction, 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 and investment securities 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 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 expectations as to future
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 10-Q, as well as the
relevant discussions in the Form 10-K and annual report for the year ended
December 31, 2003.
10
In the last several quarters, the national economy has recovered fitfully from a
mild recession. Our local economy has remained strong in relation to the
national and statewide economy. In the current quarter, this recovery is gaining
strength and appears to be solidly under way. Locally, the housing market has
appreciated strongly in the last several quarters in reaction to continued lower
interest rates and a strong local job market. National job markets also appear
to be strengthening. These economic factors have led to an overall consensus
that the recovery is now solid and that the Federal Reserve will likely raise
rates again during the next several quarters. The Federal Reserve raised the
discount rate on June 30, 2004 and this change was reflected in a change to the
prime rate in July of 2004. A series of sharp rate increases could negatively
impact the Bank's financial performance. This would be particularly true if
these rate increases were more rapid and sustained than the corresponding
increases in the Bank's yield on assets. Other negative effects of a sharply
higher interest rate environment could include a drop in real estate values. A
large sustained drop in real estate values would negatively impact the Bank's
collateral on many of our loans and could lead to asset quality problems.
During the last two years, loan customers have reacted to lower interest rates
by continuing to refinance higher rate loans. This refinance activity has
decreased the interest rates earned on loans. In the last quarter longer term
rates have increased slightly. These increases will have the effect of
decreasing refinance activity. If rates continue to rise, the Bank may also see
an increase in the popularity of adjustable rate mortgages in the residential
housing market. Higher rates will also decrease prepayments from our investment
portfolio. The Bank has been able to increase net interest income from the prior
year through growth in its balance sheet which offset a lower interest margin.
Noninterest income decreased slightly during the period, lower gains on the sale
of loans and losses on the sale of investments were mostly offset by higher
service charge, loan fee, and Bank Owned Life Insurance income. Noninterest
expense increased primarily from increases in the Bank's size. An increase in
the valuation allowance on foreclosed real estate also increased expenses.
Finally, the effective tax rate paid by the Company decreased due to the
donation of certain foreclosed property.
SELECTED FINANCIAL DATA
SIX MONTHS ENDED
JUNE 30,
-----------------------------
2004 2003
---- ----
Condensed Income Statement
Interest Income $ 9,242,429 $ 7,842,180
Interest Expense 3,166,324 2,740,038
Net Interest Income 6,076,105 5,102,142
Provision for Loan Loss 83,974 114,327
Noninterest Income 830,253 841,747
Noninterest Expense 4,713,234 4,074,041
Income Before Income Taxes 2,109,150 1,755,521
Income Taxes 416,376 605,215
Net Income 1,692,774 1,150,306
Per Common Share
Basic Earnings $ 2.22 $ 1.53
Diluted Earnings 2.12 1.45
Book Value 37.27 35.86
RESULTS OF OPERATIONS - YEAR TO DATE
Net income for the six month period ended June 30, 2004 totaled $1,692,774
($2.22 basic and $2.12 diluted earnings per share) compared with net income of
$1,150,306 ($1.53 basic and $1.45 diluted earnings per
11
share) for the same period in the prior year. This increase of $542,468 or 47.2%
was caused by an increase in net interest income, a reduction in provision for
loan losses, and a reduction in income tax expense, which was partially offset
by an increase in noninterest expenses and a slight decrease in noninterest
income. For the six month period ended June 30, 2004, interest income increased
by $1,400,249 or 17.9% to $9,242,429. The increase was due to higher average
interest earning asset balances, including investments and loans which was
partially offset by lower average rates on loans. Interest expense also
increased to $3,166,324 in the six month period ending June 30, 2004 as compared
to $2,740,038 in the same period in the prior year an increase of $426,286 or
15.6%. The increase was the result of higher average balances which more than
offset lower average rates paid on advances. Rates on deposits increased
slightly from the prior period. The changes in average interest rates reflected
several factors including a slight increase in short term interest rates,
changes in the composition of borrowings, and continued growth in certain loan
products.
Provision for loan losses decreased from prior year levels to $83,974 from
$114,327 for the six month period ending June 30, 2004 and 2003, respectively.
The decrease was caused in by the Bank's continued low levels of delinquency and
charge offs which lowered the Bank's estimate of average losses per dollar of
loan. These decreases in loss estimates were partially offset by higher ending
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 decreased slightly to $830,253 for the six month period
ending June 30, 2004, a decrease of $11,494 or 1.4% from the prior year total of
$841,747. Loan appraisal, credit, and miscellaneous charges increased by $17,973
to $147,952. This increase was offset by a decrease in gains from selling loans
which decreased to $21,404 from $364,690, a decrease of $343,286 or 94.1%. This
change reflects the Bank's preference to keep a higher proportion of loans in
its portfolio because the Bnak felt that the immediate profits from selling
loans did not sufficiently offset the loss of future interest income caused by
the sale. The Bank also recorded $147,696 in income from Bank Owned Life
Insurance ("BOLI"), compared to $127,095 in 2003, an increase of $20,601 or
16.2%. This increase was the result of a BOLI purchase at the end of the first
quarter of 2003. Service charges increased by $328,976 or 155.4% form the prior
year amount. The increase was due to strong increases in deposits as well as
increases in sales of nondeposit products. In the prior year, service charges
were also reduced by a write-down of OMSR's. A loss of $27,504 on the sale of
certain short term securities was recorded in the current year. In the prior
year, other income resulted from the rental of certain properties, in the
current year no property was rented to others.
Noninterest expense for the six month period ended June 30, 2004 increased by
$639,193 or 15.7% to $4,713,234 from $4,074,041 in the same period for the prior
year. Salary and employee benefits increased by 17.6% to $2,615,924 from
$2,225,053 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. Benefits costs also increased due to increases in insurance costs as
well as the addition of certain benefits. Occupancy expense increased from
$371,847 to $390,140, an increase of 4.9% due to additional locations and
increased costs at certain locations. Advertising increased to $240,230 from
$134,926, an increase of $105,304 or 78.1%. Advertising increased due to an
increase in certain sales efforts. Data processing expense increased to $289,220
from a prior year total of $194,033 an increase of $95,187 or 49.1%. This
increase was due to certain nonrecurring expenses to further improve data
processing capability. Depreciation of furniture fixtures and equipment
decreased to $180,200 from the prior year total of $229,739 a decrease of
$49,539 or 21.6%. This decrease was the result of certain assets being fully
depreciated at the end of 2003. Telephone communications declined to $57,455
from $102,732 in the prior year, a decline of $45,277 or 44.1%. This decline
reflected a change in service providers which was offset by higher usage. ATM
related expenses increased by $37,404 to $163,873 for the period ending June 30,
2004, an increase of 29.6% due to higher levels of activity, more ATM's, and
certain price increases by ATM service providers. Office supplies expense
decreased to $61,765 from the prior year amount of $75,838, a decrease of
$14,073 or 18.6%. Prior year totals were increased by several initiatives in the
second quarter of 2003. The provision for valuation allowances on foreclosed
real estate increased to $147,203 as of June 30, 2004 from none in 2003. The
increase in 2004 was due to an adverse zoning
12
restriction placed on a foreclosed property. This zoning changed the value of
the property. The Bank is appealing this decision, however the Bank has
increased the valuation allowance pending this appeal. Office equipment expenses
decreased to $45,685 from 2003's level of $79,973, a decrease of $34,288 or
42.9%. This decrease was caused by the retirement of certain equipment. Other
expenses decreased to $521,539 from $533,431 a decrease of $11,892 or 2.2%,
reflecting some small cost reductions. Income taxes decreased to $416,376 or
19.7% of pretax income in the current year compared to $605,215 or 34.5% of
pretax income in the prior year. The decrease in the tax rate was primarily
attributable to the contribution of a foreclosed property to an environmental
organization which generated a current income tax deduction.
RESULTS OF OPERATIONS - SECOND QUARTER
The Company recorded net income for the second quarter of 2004 of $803,576
compared to $509,195 for the same period in 2003. The increase was the result of
an increase in net interest and noninterest income partially offset by an
increase in noninterest expense compared to the same period in 2003. Net
interest income increased by 19.7% to $3,046,583 in 2003 from $2,545,052 as a
result of increased asset size offset by a slightly lower net interest margin.
The provision for loan losses decreased by 87.4% to $13,772 in 2004 from
$108,941 in 2003 due to continued low loan write-offs which lowered the estimate
of loan losses present in our portfolio. Loan appraisal, credit and
miscellaneous charges decreased by $20,835 or 20.3% to $81,748 due to a
continued trend in the market toward low or no fee loans. Gain on the sale of
mortgage loans decreased from $237,595 to nothing because the Bank has not sold
loans in the current quarter. Service charges in 2003 were lower than in 2004,
due to write-offs of originated mortgage servicing rights in 2003. Other income
amounts declined due to a decline in rental income.
Salary and employee expense increased to $1,317,544 from $1,095,727, an increase
of $221,817 or 20.2% due to an increased average salary per employee, higher
number of employees, and the addition of certain benefits. Occupancy expense was
comparable to the prior year. Advertising expenses increased by $26,499 or 37.2%
to $97,691, this increase was the result of delaying of certain advertising
efforts in 2003. Data processing expense increased to $137,222, an increase of
$28,494 or 26.2% over the prior year total of $108,728. The increase reflects
the addition of certain capabilities such as internet banking in the past year.
Depreciation of furniture, fixtures and equipment declined due to the write down
of large amounts of equipment in the prior year. These expenses decreased by
$21,839 or 19.0%. Telephone communications also decreased to $19,480 or by 69.4%
from $63,656 due to changes in phone service providers. ATM expenses increased
by $15,786 or 23.2% to $83,775 in the current year due to changes in ATM
operations. Office supplies expense decreased to $22,346 from $52,373 a decrease
of $30,027 or 57.3% as prior year expenses were increased by the need to change
some supplies in connection with the introduction of internet banking. Office
equipment and other expense was similarly reduced by the retirement of certain
equipment. The provision for valuation allowance on foreclosed real estate
increased to $33,376 in 2004 based on the write down of certain property in
2004. Other expenses declined by 8.7% The income tax rate was 30.1% compared to
33.4% for the same period in the prior year. This was caused by an increase in
nontaxable income.
FINANCIAL CONDITION
Assets
Total assets as of June 30, 2004 increased by $43,540,404 to $395,270,396 from
the December 31, 2003 level of $351,729,992. Cash and due from banks increased
by $3,189,944 or 137.5% from December 31, 2003's total. Interest-bearing
deposits with banks decreased by $36,751 or .4% during the period to $8,875,581
at June 30, 2004. Federal funds sold declined to $517,127 or by $421,039 from
the December 31, 2003 total of $938,166. Investment securities, including both
the available for sale and held to maturity portfolios, increased from
$99,895,249 to $101,911,226 an increase of $2,015,977 or 2.0%. Increases were
primarily the result of additional purchases of investments and the conversion
of Fed funds sold and interest bearing deposits to investments. Stock in the
Federal Home Loan Bank and Federal Reserve Banks increased due to increased
borrowing from the Federal Home Loan Bank system. Loans held for sale declined
to nothing from $474,880 at December 31, 2003. This decline was caused by the
13
Bank's decision to keep most of its current loan production in its portfolio.
The Bank's loan portfolio increased by $38,432,034 or 17.7% during the six month
period ending June 30, 2004 to $256,172,187 from December 2003's total of
$217,740,153. The increase was primarily the result of an increase in its
portfolio of commercial real estate loans. The increase in commercial real
estate lending is a reflection of the strong local economy and continuing sales
efforts by the Bank in this area. At June 30, 2004 the Bank's allowance for loan
losses totals $2,665,110 or 1.03% of loan balances as compared to $2,572,799 or
1.16% of loan balances at December 31, 2003. 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. Additional loan information for prior
years is presented in the Form 10-K for the year ended December 31, 2003. The
following tables set forth the composition of the Bank's loan portfolio, the
activity in the Bank's allowance for loan losses, and information about the
Bank's nonperforming loans for the periods indicated:
Loan Portfolio June 30, December 31,
2004 2003
------------------------- --------------------------
Amount % Amount %
------ --- ------ ---
Real Estate Loans
Commercial $ 113,141,635 43.60% $ 93,824,812 42.46%
Residential first mortgage 51,394,409 19.80% 42,971,076 19.45%
Construction and land development 21,422,608 8.25% 19,598,992 8.87%
Home equity and second mortgage 22,265,518 8.58% 19,561,771 8.85%
Commercial loans 47,391,119 18.26% 40,909,132 18.51%
Consumer loans 3,900,381 1.50% 4,096,926 1.85%
------------- ------ ------------- ------
Total loans 259,515,670 100.00% 220,962,709 100.00%
Less: Deferred loan fees 678,373 0.26% 649,756 0.29%
Allowance for loan losses 2,665,110 1.03% 2,572,799 1.16%
------------- ------ ------------- ------
Loans receivable net $ 256,172,187 $ 217,740,154
------------- -------------
Loan Loss Allowance
6 Months Ended 6 Months Ended
June 30, 2004 June 30, 2003
-------------- --------------
Beginning Balance $ 2,572,799 $ 2,314,074
Charge Offs (1,040) (51,233)
Recoveries 9,377 539
------------- -------------
Net Charge offs 8,337 (50,694)
Additions charged to operations 83,974 114,327
-------------
Balance at end of period $ 2,665,110 $ 2,377,707
============= =============
Ratio of net charge-offs during the period to
loans 0.0004% 0.0474%
============= =============
14
Balances as of Balances as of
June 30, 2004 December 31, 2003
-------------- -----------------
Restructured Loans $ -- $ --
--------- ---------
Accruing loans which are contractually
past due 90 days or more: $ -- $ --
--------- ---------
Loans accounted for on a nonaccrual basis $ 524,619 $ 379,544
--------- ---------
Total non-performing loans $ 524,619 $ 379,544
Non-performing loans to total loans 0.20% 0.17%
==== ====
Allowance for loan losses to non-performing
loans 508.01% 626.46%
====== ======
Premises and equipment increased due to the renovation of parts of the home
office building. These improvements were partially offset by depreciation.
Foreclosed real estate declined to $534,561 at June 30, 2004 from $706,764 at
December 31, 2003 due to the donation of one property and an increase in the
valuation allowance.
Liabilities
Deposit balances increased by $27,492,849 or 12.1% for the six months ended June
30, 2004. This increase was primarily in interest bearing deposits including
several types of interest bearing checking accounts. Management believes that
ongoing stock market volatility combined with questions about certain Mutual
Fund operations has made bank deposits more attractive to the general public.
The Bank has also increased marketing efforts for all deposit products in the
current year. Short term borrowings increased to $36,812,298, an increase of
$5,621,013, primarily to serve as a funding for loan growth. Long term debt
increased to $72,947,302 at June 30, 2004, from $63,051,176 at December 31,
2003, to fund loan growth as noted above.
Stockholders' Equity
Stockholders' equity increased $732,927 or 2.6% to $28,644,837 at June 30, 2004
compared to $27,911,910 at December 31, 2003. This reflects the net income of
$1,692,774 and the exercise of stock options of $207,185 for the six month
period. These increases in equity were offset by a cash dividend of $541,633,
using $200,882 to purchase shares in the open market and retire them, an
increase in the accumulated other comprehensive loss of $501,656, and activity
related to the ESOP shares of $74,011. Book value on a per share basis, $37.27
at June 30, 2004, as compared to $37.05 at December 31, 2003, reflects a .2%
increase, with a slight increase in outstanding shares, partially offsetting the
gains noted previously.
LIQUIDITY AND CAPITAL RESOURCES
On July 22, 2004, the Company completed its offering of trust preferred
securities. The securities were issued by a special purpose business trust
formed by the Company and sold in a private transaction pursuant to an
applicable exemption from registration under the Securities Act of 1933, as
amended. The Interest rate on the trust preferred securities is variable and
adjustable quarterly at 2.60% over LIBOR with an initial rate of 4.29%. These
securities are callable at par at the Company's option after 5 years. The
Company intends to use the proceeds of the offering for general corporate
purposes, to fund dividends to
15
shareholders and for contribution to the capital of Community Bank of Tri
County.
The Company currently has no business other than that of the Bank and does not
currently have any material funding commitments other than dividend payments on
the trust preferred securuties. 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, short and long term
wholesale borrowings, 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 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 35% of consolidated Bank assets on a line of credit
available from the FHLB. As of June 30, 2004, the maximum available under this
line would be $138 million, while current outstanding advances totaled $110
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, 2004, the
Bank's tangible, leverage and risk-based capital ratios were 7.53%, 9.75% and
10.67%, 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 No. 5, "Accounting for Contingencies", which requires
that losses be accrued when they are probable of occurring and estimable and (2)
SFAS No. 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
16
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.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET RISK
Not applicable. The Company qualifies as a "small business issuer."
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.
PART II - OTHER INFORMATION
---------------------------
ITEM 1 - LEGAL PROCEEDINGS - The Company is not involved in any legal
proceedings, other than routine legal proceedings occurring in the normal course
of business. Such routine proceedings, in the aggregate are believed by
management to be immaterial to the Company's financial condition and results of
operations.
ITEM 2 - CHANGE IN SECURITIES, USE OF PROCEEDS AND ISSUER PURCHASES OF EQUITY
SECURITIES
(a) Not applicable
(b) Not applicable
(c) Not applicable
(d) Not applicable
17
The following table sets forth information regarding the Company's repurchases
of its Common Stock during the three months ended June 30, 2004:
(c)
TOTAL NUMBER
OF SHARES (d)
PURCHASED MAXIMUM
(a) AS PART OF NUMBER OF SHARES
TOTAL (b) PUBLICLY THAT MAY YET BE
NUMBER OF AVERAGE ANNOUNCED PLANS PURCHASED UNDER
SHARES PRICE PAID OR THE PLANS OR
PERIOD PURCHASED PER SHARE PROGRAMS PROGRAMS
------ --------- ---------- --------------- -----------------
April 2004
Beginning Date: April 1
Ending Date: April 30 553 $ 42.36 553 5,296
May 2004
Beginning Date: May 1
Ending Date: May 31 309 44.82 309 4,987
June 2004
Beginning Date: June 1
Ending Date: June 30 250 44.20 250 4,737
----- -----
Total 4,730 $ 42.47 4,730
===== =====
In an 8-K dated July 25, 2002, and in a press release dated July 23, 2002; the
Company announced a plan to buy up to 38,000 shares of its stock through open
market purchases. This offer was contingent upon market conditions and will
continue until it is completed or terminated by the Board of Directors. There
were 8,236 shares purchased under this plan in 2002 and 20,297 in 2003. The
Company intends to continue to purchase shares under this plan.
ITEM 3. - DEFAULT UPON SENIOR SECURITIES -- None
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
The Annual Meeting of the Stockholders of the Company was held on May 5,
2004. The results of the vote were as follows:
1. The following individuals were elected as directors, each for a
three-year term:
VOTES FOR VOTES WITHHELD
--------- --------------
C. Marie Brown 533,639 4,443
Louis P. Jenkins, Jr. 533,639 4,443
Michael L. Middleton 533,496 4,586
The following individual was elected as a director for a one-year
term:
VOTES FOR VOTES WITHHELD
--------- --------------
James R. Shepard 527,205 10,877
18
ITEM 5. - OTHER INFORMATION -- None
ITEM 6. - EXHIBITS AND REPORTS ON FORM 8-K
(a)Exhibits - The following exhibits are being filed with this Form 10-Q:
Exhibit 3.1 Articles of Incorporation of Tri-County Financial
Corporation*
Exhibit 3.2 Amended and Restated Bylaws of Tri-County Financial
Corporation*
Exhibit 31.1 Rule 13a-14(a) Certification of Chief Executive Officer
Exhibit 31.2 Rule 13a-14(a) Certification of Chief Financial Officer
Exhibit 32 Rule 1350 Certifications
(b)Reports on Form 8-K - Not applicable
-----------
* Incorporated by reference to the Registrant's Registration Statement
on Form S-4 (File No. 33-31287).
** Incorporated by reference to the Registrant's Form 10-K for the
fiscal year ended December 31, 2001.
19
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, 2004 By: /s/Michael L. Middleton
-------------------------------------
Michael L. Middleton, President,
CEO, and Chairman of the Board
Date: August 12, 2004 By: /s/ William J. Pasenelli
-------------------------------------
William J. Pasenelli, Executive
Vice President and Chief
Financial Officer
20