SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 FORM 10-Q Quarterly Report Under Section 13 or 15(d) of the Securities Exchange Act of 1934 For the Quarter Ended: Comission File Number 0-18279 ------- June 30, 1996 MARYLAND 52-0692188 - --------------------------------- ---------------------------------------- (State or Other Jurisdiction of (I.R.S. Employer Identification Number Incorporation or Organization) Tri-County Financial Corporation --------------------------------------------------- (Exact Name of Registrant as Specified in Charter) 3035 Leonardtown Road Waldorf, Maryland 20601 - ------------------------- (Address of Principal Executive Offices) Registrant's Telephone Number: (301) 645-5601 Securities Registered Pursuant to Section 12(g) of Act: CAPITAL STOCK, PAR VALUE $.01 PER SHARE --------------------------------------- (Title Of Class) 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 ---- ---- Number of Shares of Capital Stock Outstanding as of July 31, 1996 740,854 TRI-COUNTY FINANCIAL CORPORATION TABLE OF CONTENTS - -------------------------------------------------------------------------------- Page Index PART I - FINANCIAL INFORMATION Item 1 - Financial Statements Consolidated Statements of Financial Condition at June 30, 1996 and December 31, 1995 2 Consolidated Statements of Operations for the Six-Month and the Three-Month Periods Ended June 30, 1996 and 1995 3 Consolidated Statements of Cash Flows for the Six-Month Periods Ended June 30, 1996 and 1995 4-5 Notes to Unaudited Consolidated Financial Statements 6-7 Management's Discussion and Analysis of Operations 8-10 PART II - OTHER INFORMATION 11 SIGNATURES 12 TRI-COUNTY FINANCIAL CORPORATION CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION JUNE 30, 1996 AND DECEMBER 31, 1995 - ------------------------------------------------------------------------------- June 30, December 31, 1996 1995 ASSETS CASH AND CASH EQUIVALENTS: Noninterest-bearing $ 805,907 786,113 Interest-bearing 3,935,102 3,264,106 ------------ ------------- Total cash and cash equivalents 4,741,009 4,050,219 INVESTMENT SECURITIES AVAILABLE FOR SALE--At fair value 12,295,324 14,903,798 INVESTMENT SECURITIES HELD TO MATURITY--At amortized cost 881,600 881,600 MORTGAGE-BACKED SECURITIES AVAILABLE FOR SALE--At fair value 33,270,559 30,793,682 MORTGAGE-BACKED SECURITIES HELD TO MATURITY--At amortized cost 1,030,283 1,160,672 LOANS RECEIVABLE--Net 108,642,609 107,340,325 LOANS HELD FOR SALE 90,000 476,750 NET PREMISES AND EQUIPMENT 3,349,767 3,178,806 ACCRUED INTEREST RECEIVABLE 1,147,932 1,093,113 OTHER ASSETS 715,337 383,678 ------------ ------------- TOTAL ASSETS $166,164,420 $164,262,643 ============ ============= LIABILITIES AND STOCKHOLDERS' EQUITY LIABILITIES: Deposits $133,408,867 $129,348,276 Advances from Federal Home Loan Bank 13,000,000 13,250,000 Notes payable and other borrowings 1,100,109 4,302,845 Advance payments by borrowers for taxes and insurance 1,451,127 685,767 Current and deferred income taxes 49,190 89,655 Accounts payable, accrued expenses, and other liabilities 643,363 614,952 ------------ ------------- Total liabilities 149,652,656 148,291,495 ------------ ------------- STOCKHOLDERS' EQUITY: Common stock 7,408 6,851 Capital in excess of par 5,650,196 5,021,350 Net unrealized (loss) gain on investment securities and mortgage-backed securities available for sale (192,082) 232,123 Retained earnings 11,046,242 10,710,824 ------------ ------------- Total stockholders' equity 16,511,764 15,971,148 ------------ ------------- TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $166,164,420 $164,262,643 ============ ============= See notes to consolidated financial statements. 2 TRI-COUNTY FINANCIAL CORPORATION CONSOLIDATED STATEMENTS OF OPERATIONS SIX-MONTH AND THREE-MONTH PERIODS ENDED JUNE 30, 1996 AND 1995 - ------------------------------------------------------------------------- SIX MONTHS ENDED THREE MONTHS ENDED JUNE 30, JUNE 30, ---------------------- ----------------------- 1996 1995 1996 1995 INTEREST REVENUES: Interest on loans $4,974,819 $4,849,445 $2,444,209 $2,423,152 Interest on mortgage-backed securities 1,154,274 999,375 593,900 497,079 Interest and dividends on investment securities 460,957 568,216 204,960 294,363 ---------- ---------- ---------- ---------- Total interest revenues 6,590,050 6,417,036 3,243,069 3,214,594 ---------- ---------- ---------- ---------- INTEREST EXPENSES: Deposits 2,707,374 2,479,998 1,354,635 1,285,704 Federal Home Loan Bank advances 365,407 227,484 183,694 111,043 Notes payable and other borrowings 110,463 223,411 27,858 95,860 ---------- ---------- ---------- ----------- Total interest expenses 3,183,244 2,930,893 1,566,187 1,492,607 ---------- ---------- ---------- ----------- NET INTEREST INCOME 3,406,806 3,486,143 1,676,882 1,721,987 LOAN LOSS PROVISION 120,000 80,000 60,000 44,000 ---------- ---------- ---------- ----------- Net interest income after loan loss provision 3,286,806 3,406,143 1,616,882 1,677,987 ---------- ---------- ---------- ----------- OTHER INCOME: Loan service charges 134,046 129,372 66,290 70,062 Gain on sale of investment and mortgage-backed securities available for sale -- 17,625 -- -- Gain (loss) on sale of loans held for sale 71,312 (919) 30,092 (919) Service charges 174,492 171,152 100,618 94,769 Other 42,058 3,006 24,054 19,603 ---------- ---------- ---------- ----------- Total other income 421,908 321,155 221,054 183,515 ---------- ---------- ---------- ----------- OPERATING EXPENSES: Employee compensation and benefits 1,179,368 1,017,216 642,792 502,316 Occupancy expense 173,450 151,454 80,758 77,597 Federal insurance premium and surety bond premiums 173,914 173,445 86,860 88,369 Data processing expense 116,903 93,888 57,601 49,441 Other 562,076 499,554 270,543 272,488 ---------- ---------- ---------- ----------- Total operating expenses 2,205,711 1,935,557 1,138,554 990,211 ---------- ---------- ---------- ----------- INCOME BEFORE INCOME TAXES 1,503,003 1,791,741 699,382 871,291 INCOME TAXES 567,700 697,505 281,766 365,883 ---------- ---------- ---------- ---------- NET INCOME $ 935,303 $1,094,236 $ 417,616 $ 505,408 ---------- ---------- ---------- ---------- EARNINGS PER SHARE (Note 2): Primary $ 1.21 $ 1.49(1) $ 0.54 $ 0.69(1) On a fully diluted basis 1.21 1.46(1) 0.54 0.67(1) (1) Restated to reflect 1996 stock dividends See notes to consolidated financial statements. -3- TRI-COUNTY FINANCIAL CORPORATION CONSOLIDATED STATEMENTS OF CASH FLOWS SIX-MONTH PERIODS ENDED JUNE 30, 1996 AND 1995 - ----------------------------------------------------------------------------- SIX MONTHS ENDED JUNE 30, --------------------------- 1996 1995 CASH FLOWS FROM OPERATING ACTIVITIES: Net income $ 935,303 $ 1,094,236 Adjustments to reconcile net income to net cash provided by operating activities: Provision for loan losses 120,000 48,573 Net loan charge-offs and recoveries (18,081) -- Provision for depreciation and amortization 120,979 133,261 Amortization of premium/discount on mortgage-backed securities and investments (48,308) (41,062) Capitalization of interest expense on notes payable -- 38,553 Provision for deferred income tax (benefit) (300) 40,311 Increase in interest receivable (54,819) (62,785) Decrease in deferred loan fees (31,966) (68,588) Increase in accounts payable, accrued expenses, and other liabilities 149,086 105,864 (Increase) decrease in other assets (70,592) 312,448 (Gain) loss on sale of premises and equipment (9,610) 33,595 Origination of loans available for sale (3,930,155) (1,461,000) Gain on sale of investment and mortgage-backed securities available for sale -- (18,544) (Gain) loss on sales of loans available for sale (71,312) 919 Proceeds from sale of loans available for sale 5,006,312 1,303,000 Federal Home Loan Bank stock dividends -- (10,200) ------------ ------------ Net cash provided by operating activities 2,096,537 1,448,581 ------------ ------------ CASH FLOWS FROM INVESTING ACTIVITIES: Purchase of investment securities available for sale (9,851,574) (2,962,012) Principal collected on loans 23,515,339 20,751,338 Principal collected on mortgage-backed securities 2,126,215 620,915 Loans originated or acquired (25,505,670) (26,783,963) Purchase of mortgage-backed securities available for sale (5,030,000) -- Proceeds from sale or redemption of mortgage-backed securities available for sale -- 1,805,572 Proceeds from maturities of investment securities held to maturity -- 3,165 Proceeds from sale or maturity of investment securities available for sale 12,427,478 1,776,941 (Continued) 4 TRI-COUNTY FINANCIAL CORPORATION CONSOLIDATED STATEMENTS OF CASH FLOWS SIX-MONTH PERIODS ENDED JUNE 30, 1996 AND 1995 - ----------------------------------------------------------------------------- SIX MONTHS ENDED JUNE 30, --------------------------- 1996 1995 Purchase of mortgage-backed securities held to maturity -- (1,000,000) Purchase of premises and equipment (266,754) (52,105) Proceeds from sales of premises and equipment 9,610 -- Investment in real estate (207,936) (284,336) Proceeds from sale of foreclosed real estate -- 53,833 ------------ ----------- Net cash used in investing activities (2,783,292) (6,070,652) ------------ ----------- CASH FLOWS FROM FINANCING ACTIVITIES: Net increase in deposits 4,060,591 515,629 Proceeds from Federal Home Loan Bank advances 41,500,000 9,500,000 Payments of maturing Federal Home Loan Bank advances (41,750,000) (8,000,000) Net (decrease) increase in other short-term borrowings (3,038,351) 2,090,308 Net increase in advance payments by borrowers for taxes and insurance 765,360 767,127 Dividends paid (74,046) (69,014) Exercise of stock options 103,562 30,750 Payments on notes payable (189,571) (174,159) ------------ ----------- Net cash provided by financing activities 1,377,545 4,660,641 ------------ ----------- INCREASE IN CASH AND CASH EQUIVALENTS 690,790 38,750 CASH AND CASH EQUIVALENTS--JANUARY 1, 4,050,219 3,471,953 ------------ ----------- CASH AND CASH EQUIVALENTS--JUNE 30, $ 4,741,009 $ 3,510,703 ============ =========== SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION: Accounting Policies: Cash equivalents include short-term amounts due from banks. Noncash transactions: Cash paid during the six months for: Interest $ 3,224,332 $ 2,906,568 Income taxes 470,000 236,384 Tri-County Financial Corporation declared a 5% stock dividend payable April 15, 1996, and April 17, 1995, to shareholders of record on March 4, 1996, and March 3, 1995, respectively. Retained earnings in the amount of $525,840 in 1996 and $708,004 in 1995 was transferred to capital in excess of par and common stock to reflect these dividends. See notes to consolidated financial statements. (Concluded) 5 TRI-COUNTY FINANCIAL CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS JUNE 30, 1996 - ----------------------------------------------------------------------------- 1. BASIS OF PRESENTATION General-The consolidated financial statements of Tri-County Financial Corporation (the Company) and its wholly owned subsidiary, Tri-County Federal Savings Bank (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 Generally Accepted Accounting Principles have been condensed or omitted pursuant to the rules and regulations of the Securities and Exchange Commission and the Office of Thrift Supervision. The Company believes that the disclosures are adequate to make the information presented not misleading. The results of operations for the six months ended June 30, 1996, are not necessarily indicative of the results of operations to be expected for the remainder of the year. It is suggested that these consolidated financial statements be read in conjunction with the consolidated financial statements and notes thereto included in the Company's Annual Report for the year ended December 31, 1995. 2. EARNINGS PER SHARE Primary and fully diluted earnings per share, as adjusted for the stock dividend, have been computed based on weighted-average common and common equivalent shares outstanding as follows: SIX MONTHS ENDED THREE MONTHS ENDED JUNE 30, JUNE 30, ----------------- ------------------- 1996 1995 1996 1995 Primary 771,558 736,503 774,021 749,842 Fully diluted 774,560 749,842 774,829 749,842 3. NEW ACCOUNTING PRONOUNCEMENTS Effective January 1, 1996, the Company adopted SFAS No. 122, "Accounting for Mortgage Servicing Rights," which amended certain provisions of SFAS No. 65 to eliminate the accounting distinction between rights to service mortgage loans for others that are acquired through loan origination activities and those acquired through purchase transactions. When the Company purchases or originates mortgage loans, the cost of acquiring those loans includes the cost of the related mortgage servicing rights (MSRs). If the Company sells or securitizes the loans and retains the MSRs, the Company allocates the total cost of the mortgage loans between the MSRs and the loans (without MSRs) based on their relative fair values, if practicable. Any cost allocated to the MSRs is recognized as a separate asset. MSRs are amortized in proportion to and over the period of estimated net servicing income and are evaluated for impairment based on their fair value. During 1996 and 1995, the Company did not sell or securitize a material number or amount of loans and retain the MSRs. 6 Effective January 1, 1996, the Company adopted SFAS 123, "Accounting for Stock-Based Compensation." This Statement gives the Company the option of either (1) continuing to account for stock options and other forms of stock compensation under the accounting rules defined in APB No. 25, "Accounting for Stock Issued to Employees," while providing the disclosures required under SFAS 123 or (2) adopting SFAS 123 accounting for all stock compensation arrangements. The Company continues to account for stock options under the accounting rules stated in APB No. 25, and will provide the additional disclosures required under SFAS 123. Regulatory Issues--The Federal Deposit Insurance Corporation administers two separate deposit insurance funds, the BIF and SAIF. Congress is considering legislation that would recapitalize the SAIF fund through a special assessment on FDIC-insured institutions with SAIF deposits. While the specifics of the legislation have not been finalized, the impact of this deposit assessment could result in a future after-tax expense to the Company in an amount in excess of $700,000. This amount would be recorded as an expense if and when the legislation is enacted. * * * * * * 7 MANAGEMENT DISCUSSION AND ANALYSIS GENERAL Tri-County Financial Corporation owns 100% of the issued and outstanding common stock of Tri-County Federal Savings Bank of Waldorf (the Bank), which is the principal asset of the Company. Tri-County Financial Corporation does not presently own or operate any subsidiaries other than the Bank and its subsidiary, and the entities are collectively referred to as "the Company". The Company is primarily engaged in the business of obtaining funds in the form of savings deposits and investing such funds in mortgage loans on residential and commercial real estate and various types of consumer and other loans, mortgage-backed securities, and investment and money market securities. The Company's earnings, therefore, are primarily dependent upon its net interest income, which is determined by the Company's interest rate spread (the difference between the yields earned on its interest-earning assets and the rates paid on its interest-bearing liabilities) and the relative holdings of interest earning assets and interest-bearing liabilities. Also of significance to the Company's net income is its noninterest expenses, income taxes, provision for estimated loan losses, and other noninterest income. The Company's deposit flows and cost of funds are determined by interest rates on competing investments and general market rates of interest. Lending activities are affected by consumer demand, the interest rates in the market and the level of funds available. The Company grants loans throughout the Southern Maryland area. Its borrowers' ability to repay is, therefore, dependent upon the economy of Southern Maryland. FINANCIAL CONDITION Total assets as of June 30, 1996 grew $1.9 million from the December 31, 1995 level. This reflects a growth rate of 1.2% as compared to 7.3% asset growth during the previous year. Rates on long-term real estate loans have increased significantly, 87.5 basis points during the six months ended June 30, 1996. This has discouraged many consumers from initiating the purchase of their first or a larger home, as well as refinancing existing loans for a lower rate. Military base expansion in the Bank's market area has kept the real estate market strong despite the rate increase, but has drawn the attention of competing loan providers who are increasing their presence in the Southern Maryland market. Loan portfolio growth was slightly less than $1 million for the six-month period. This resulted from the retention of adjustable rate loans originated, as compared to the sale of fixed rate loans. Loan origination volume during the first six months of 1996 was $1.3 million or 4.8% less than during the corresponding period in 1995. The Bank is making more consumer and commercial loan products available. As a result, management considered it prudent to build somewhat higher loan loss reserves to compensate for the increased risk associated with these products. The balance in the reserve at June 30, 1996 was $835,000, an increase of $101,000 over the December 31, 1995 balance of $734,000. The Company's holdings of investment securities declined $2.6 million since December 31, 1995. Several securities experienced early payoff since the issuer was able to obtain better rates by calling the investment and reissuing it at the more attractive long-term rates currently available in the market. Approximately $3.4 million of investments were called during the six months ended June 30, 1996. The funds provided by these called investments were used to increase the mortgage-backed securities portfolio. Property and equipment increases of $250,000 since December 31, 1995 resulted as work continued on the new branch being built in Bryans Road, Maryland, and slated to open in the fall of 1996. In addition, to 8 protect our investment in a real estate loan, it was necessary to acquire one piece of property through foreclosure, resulting in an increase in real estate owned of $208,000. Liability growth was controlled to stay in line with the change in asset levels. Deposit growth has continued to be strong, with a $4 million or 3.1% increase in the six months ended June 30, 1996. The deposit base provides a source of funds at a lower average cost than can be realized by borrowing. Since the loan demand was low, and the Bank's liquidity is at an adequate level and in compliance with regulatory requirements, the funds were used to reduce the level of borrowed funds. Advance payments by borrowers for taxes and insurance increased to $1.4 million from $685,000 due to the steady accumulation of funds to meet tax payment requirements in September. Stockholders' equity increased $540,000 or 3.4% to $16.5 million at June 30, 1996 compared to $15.9 million at December 31, 1995. This reflects the net income of $935,000 for the six month period, a $424,000 decline in unrealized holding gains/losses on investment and mortgage-backed securities available for sale, and a cash distribution to shareholders in the form of a $0.10 per share cash dividend. A shift in the components of stockholders' equity occurred as a result of the declaration of a 5% stock dividend to shareholders; this resulted in a transfer of $525,000 from retained earnings to common stock and capital in excess of par. Members of senior management exercised options to purchase shares of stock, bringing an additional $103,000 into capital in excess of par. RESULTS OF OPERATIONS The Company reported net income of $935,000 and $1.1 million during the six months ended June 30, 1996 and 1995, respectively. Net income decreased $159,000 for the six months ended June 30,1996 compared to the comparable period in 1995. The decrease in net income resulted from a $79,000 decrease in net interest income, a $40,000 increase in the level of loan loss provisions, a $169,000 increase in net noninterest expenses, and a $129,000 reduction of income tax expense. Net interest income decreased by $119,000, or 3.5%, for the six months ended June 30, 1996 as compared to the same period in 1995. This is a direct result of the prolonged flat yield curve wherein the cost of funds remained high while the yield on longer term loan products declined. The effect of the curve reduced the marginal spread available to cover the cost of operations. Earnings per share for the first six months of 1996 were $1.21 per share, $.28 or 18.8% lower than for the corresponding period in 1995. As previously discussed, the increased offerings of consumer and commercial loan products led management to make larger provisions for loan losses. The provision for the six months ended June 30, 1996, was $120,000, $40,000, or 50%, higher than for the six months ended June 30, 1995. Operating expenses for the period increased 14.0% over the comparable period in 1995. The most significant component of operating expenses is employee compensation and benefits, which increased 15.9%. While individual compensation level merit and cost of living increases have been held to 4 or 5%, insurance benefit costs have increased by approximately 11% and new personnel have been hired to provide the level of expertise required to service the increasingly complex array of services offered by the Bank. Facility renovations and repairs were considered prudent to improve security at various branches. Data processing costs have increased as our customer base has grown and as a result of the upgrading of systems to provide better customer service. Advertising costs have increased in response to the higher level of competition in our market. 9 REGULATORY MATTERS The Bank is subject to capital requirements defined by the FDIC Improvement Act of 1991. At June 30, 1996 the Bank's tangible, core, and risk-based capital was 9.59%, 9.59%, and 16.7%, respectively. These levels are well in excess of the required 1.5%, 3.0%, and 8.0% ratios. 10 TRI-COUNTY FINANCIAL CORPORATION -------------------------------- PART II--OTHER INFORMATION -------------------------- Item 1 - Legal Proceedings ----------------- Not Applicable. Item 2 - Changes in Securities --------------------- Not Applicable. Item 3 - Defaults Upon Senior Securities ------------------------------- Not Applicable. Item 4 - Submission of Matters to a Vote of Security Holders --------------------------------------------------- Not Applicable. Item 5 - Other Information ----------------- None. Item 6 - Exhibits and Reports on Form 8-K -------------------------------- None. 11 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: By: /S/ Michael L. Middleton ------------------ --------------------------------- Michael L. Middleton, President and Chairman of the Board Date: By: /S/ Henry A. Shorter, Jr. ------------------ --------------------------------- Henry A. Shorter, Jr. Secretary 12