SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
_______________________
FORM 10-K
ANNUAL REPORT PURSUANT TO SECTION 13 OR 15 (d) OF
THE SECURITIES EXCHANGE ACT OF 1934
_______________________
For the Fiscal Year Ended: Commission File Number: O-26440
December 31, 1996
QUANTUM FINANCIAL HOLDINGS, INC.
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(Exact name of registrant as specified in its charter)
Maryland 52-1919323
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(State or other jurisdiction of I.R.S. Employer
incorporation or organization) Identification No.)
4023 Annapolis Road, Baltimore, Maryland 21227
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(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code: (410) 789-1962
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Securities registered pursuant to Section 12(b) of the Act: None
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Securities registered pursuant to Section 12(g) of the Act:
Common Stock, par value $0.01 per share
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(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 _____.
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Indicate by check mark if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K is not contained herein and will not be contained, to the
best of the registrant's knowledge, in definitive proxy or information
statements incorporated by reference in Part III of this Form 10-K or any
amendment to this Form 10-K. [X]
As of March 1, 1996, 106,924 shares of the registrant's Common Stock, $0.01
par value, were issued and outstanding.
The registrant's voting stock is not regularly and actively traded in any
established market and there are no regularly quoted bid and asked prices for
the registrant's voting stock. As of March 1, 1996, the aggregate market value
of the voting stock held by non-affiliates of the registrant, computed by
reference to recent sales of the voting stock known to the registrant was
$908,854 (106,924 shares at $8.50 per share). For purposes of this calculation
it is assumed that none of the registrant's officers or directors are
affiliates.
DOCUMENTS INCORPORATED BY REFERENCE
1. Portions of Proxy Statement for the 1997 Annual Meeting of Stockholders.
(Parts I and III)
PART I
ITEM 1. BUSINESS
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General
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Quantum Financial Holdings, Inc. ("QFH") is a Maryland chartered holding
company formed on July 12, 1995 pursuant to a reorganization described in detail
in a proxy statement/prospectus dated April 7, 1995. As a result of that
reorganization, existing shares of Baltimore American Savings Bank, FSB
("Baltimore American" or "Savings Bank") were exchanged for shares of QFH, with
shares of certain dissenting shareholders being redeemed for cash. Baltimore
American is the sole subsidiary of QFH.
Baltimore American is a federally-chartered savings bank located in
Baltimore, Maryland. Baltimore American was originally chartered in 1956. In
May 1986, Lansdowne Building and Loan Association merged into Baltimore
American, with Baltimore American as the surviving institution. In July 1987,
Baltimore American converted to a federal mutual savings bank, and since then
the Savings Bank has been a member of the Federal Home Loan Bank (the "FHLB")
System and has had its deposits federally insured. Baltimore American's
deposits are presently insured by the Savings Association Insurance Fund (the
"SAIF"), which is administered by the Federal Deposit Insurance Corporation (the
"FDIC"). The Savings Bank converted from mutual to stock form on July 29, 1988
through the sale and issuance of 112,874 shares of common stock at $8.00 per
share.
It is Baltimore American's mission to provide people with a safe place to
deposit their money, to provide a means for transferring their money in an
efficient manner, and to prudently satisfy their financial needs. Baltimore
American attracts deposits from the general public and originates mortgage loans
on owner-occupied single family residences, non-owner occupied investment
properties, and to a lesser extent on commercial real estate. Baltimore
American also makes loans for the construction of residential and commercial
properties, consumer loans, commercial business loans and through its subsidiary
has engaged in limited real estate construction activities. The principal
sources of funds for Baltimore American's lending activities include deposits
received from the general public, principal amortization and prepayment of
loans, as well as borrowings from the FHLB of Atlanta and other sources.
Baltimore American's primary sources of income are interest on loans and
investments, fees generated by originating loans for the Savings Bank's
portfolio and loans presold to investors. Baltimore American invests in various
federal and government agency obligations and other investment securities
permitted by applicable laws and regulations. Baltimore American's principal
expenses are interest paid on deposit accounts and borrowings, and normal
operating expenses. See "Table 1. Distribution of Assets, Liabilities &
Stockholders' Equity; Interest Rates and Interest Differential."
Baltimore American's operations are conducted through its office located at
4023 Annapolis Road, Baltimore, Maryland. Baltimore American operates loan
origination offices located at 609 Bosley Avenue, Towson, Maryland; 14300
Gallant Fox Lane, Bowie, Maryland; and 2708 Dillon Street, Baltimore, Maryland.
For additional information, see "Item 2. Properties."
2
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TABLE 1
Average Balances, Interest and Effective Interest Rates
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1996
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Effective
Average Interest
ASSETS Balance* Interest Rate
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Earning Assets
Loans $22,176,605 $ 2,006,454 9.05%
Interest on investment
securities 1,202,900 106,921 8.88
Federal funds sold 1,383,577 79,512 5.75
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Total Earning Assets: 24,763,082 2,192,887 8.86
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Nonearning Assets
Cash and due from banks 505,214
Premises and Equipment 1,582,142
Real estate & repossessed
assets 1,720,973
Other Assets 346,048
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Total Nonearning Assets: 4,154,377
Less allowance for loan losses: (411,961)
TOTAL ASSETS: $28,505,498
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LIABILITIES & STOCKHOLDERS' EQUITY
Interest-bearing Liabilities:
Interest-bearing deposits $25,956,121 1,384,193 5.33%
Other borrowed money 138,833 14,772 10.64
----------- ----------- --------
Total interest-bearing
liabilities 26,094,954 1,398,965 5.36
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Noninterest-bearing Liabilities:
Demand deposits 370,903
Other liabilities (72,687)
Stockholders' Equity 2,112,328
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TOTAL LIABILITIES & STOCK-
HOLDERS' EQUITY $28,505,498
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Net Interest Earnings $ 793,922
===========
Interest Rate Spread 3.50%
========
Net Yield on Earning Assets 3.21%
======== (Continued)
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*Month end average
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TABLE 1 (Continued)
Distribution of Assets, Liabilities and Stockholders' Equity;
Interest Rates and Interest Differential
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1995 1994
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Effective Effective
Average Interest Average Interest
ASSETS Balance* Interest Rate Balance* Interest Rate
------------- ----------- -------- ----------- ----------- --------
Earning Assets
Loans $22,045,257 $ 2,036,975 9.24% $20,676,910 $ 1,979,118 9.58%
Interest on investment
securities 1,227,098 108,584 8.85 1,455,773 135,583 9.32
Federal funds sold 430,312 22,607 5.25 305,919 20,757 6.79
----------- ----------- -------- ----------- ----------- --------
Total Earning Assets: 23,702,667 2,168,166 9.15 22,438,602 2,135,458 9.52
----------- ----------- -------- ----------- ----------- --------
Nonearning Assets
Cash and due from banks 646,091 694,310
Premises and Equipment 1,435,616 218,450
Real estate & repossessed
assets 1,846,129 2,767,011
Other Assets 489,932 303,796
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Total Nonearning Assets: 4,417,768 3,983,567
Less allowance for loan losses: (235,055) (394,537)
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TOTAL ASSETS: $27,885,380 $26,027,632
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LIABILITIES & STOCKHOLDERS' EQUITY
Interest-bearing Liabilities:
Interest-bearing deposits $22,527,850 1,119,063 4.97 22,141,708 983,712 4.43
Other borrowed money 2,486,083 161,491 6.50 1,094,333 56,263 5.14
----------- ----------- -------- ----------- ----------- --------
Total interest-bearing
liabilities 25,013,933 1,280,554 5.12 23,236,041 1,039,975 4.48
----------- -------- ----------- --------
Noninterest-bearing Liabilities:
Demand deposits 270,410 167,682
Other liabilities 81,531 108,119
Stockholders' Equity 2,519,506 2,515,790
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TOTAL LIABILITIES & STOCK-
HOLDERS' EQUITY $27,885,380 $26,027,632
=========== ===========
Net Interest Earnings $ 887,612 $ 1,095,483
=========== ===========
Interest Rate Spread 4.03% 5.04%
======== ========
Net Yield on Earning Assets 3.74% 4.88%
======== ========
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*Month end average
Recent Legislative Developments
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During the quarter ended September 30, 1996, the Company incurred a before-
tax charge of $138,941 as the result of the imposition of a special assessment
by the FDIC to recapitalize the SAIF. The FDIC operates two deposit insurance
funds: the Bank Insurance Fund ("BIF") which generally insures the deposits of
commercial banks and the Savings Association Insurance Fund ("SAIF") which
generally insures the deposits of savings associations. Because the reserves of
the SAIF have been below statutorily required minimums, institutions with SAIF-
assessable deposits, like the Bank, have been required to pay substantially
higher deposit insurance premiums than institutions with deposits insured by the
BIF for the past several semi-annual periods. In order to recapitalize the SAIF
and address the premium disparity, the recently-enacted Deposit Insurance Funds
Act of 1996 authorized the FDIC to impose a one-time special assessment on
institutions with SAIF-assessable deposits based on the amount determined by the
FDIC to be necessary to increase the reserve levels of the SAIF to the
designated reserve ratio of 1.25% of insured deposits. Institutions were
assessed at the rate of 65.7 basis points based on the amount of their SAIF-
assessable deposits as of March 31, 1995.
The FDIC has proposed a new assessment schedule for SAIF deposit insurance
pursuant to which the assessment rate for well-capitalized institutions with the
best supervisory ratings would be reduced to zero and institutions in the worst
risk assessment classification will be assessed at the rate of 0.27% of insured
deposits. Until December 31, 1999, however, SAIF-insured institutions will be
required to pay assessments to the FDIC at the rate of 6.5 basis points to help
fund interest payments on certain bonds issued by the Financing Corporation
("FICO"), an agency of the federal government established to finance takeovers
of insolvent thrifts. During this period, BIF members will be assessed for FICO
obligations at the rate of 1.3 basis points. After December 31, 1999, both BIF
and SAIF members will be assessed at the same rate for FICO payments.
The Deposit Insurance Funds Act of 1996 provides that the BIF and the SAIF
will be merged into a single Deposit Insurance Fund effective January 1, 1999,
but only if there are no insured savings associations on that date. The
legislation directs the Department of the Treasury to make recommendations to
Congress for the establishment of a single charter for banks and thrifts. The
Company cannot predict what the effect of any such legislation will be on the
Bank.
The Savings Bank's Level of Nonperforming Assets
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At December 31, 1996, the Savings Bank's nonaccrual loans and loans 90 days
or more past due totalled $2,023,213 or 7.40% of total assets. In addition, the
Savings Bank had $2,910,493 or 10.62% of total assets in foreclosed properties,
which subjects the Savings Bank to significant risks. Additional losses
resulting from the costs of maintaining and disposing of foreclosed properties,
and from nonperforming assets could severely impact the Savings Bank's net
income, reduce regulatory capital and may subject the Savings Bank to future
regulatory action. Under OTS capital regulations, the Savings Bank may be
required to deduct the amount of its investment in foreclosed properties from
total capital if such properties have not been disposed of within five years of
their acquisition unless the OTS grants an extension of time for the disposition
of such properties. At December 31, 1996, the Savings Bank was required to
deduct $211,853 in investments in foreclosed real estate from total capital
because such properties had been held for more than five years. In addition,
the Savings Bank's $1,185,207 investment in Sheridan Station must be deducted
from total capital beginning in June 1998. If the Savings Bank were required to
deduct Sheridan Station from total capital, the Savings Bank would no longer be
in compliance with OTS risk-based capital requirements and would become subject
to significant restrictions on its operations. Depending on its capital levels
at the time, the Savings Bank could become subject to more severe sanctions
including
5
conservatorship or receivership which would generally result in a complete loss
of the Company's investment in the Savings Bank. Although management of the
Savings Bank is working to dispose of its foreclosed properties and to resolve
its nonperforming assets, stockholders should be aware that the future results
of operations of the Savings Bank, its compliance with regulatory capital
requirements and its ability to continue as a going concern are all subject to
the satisfactory disposition of these foreclosed properties and nonperforming
assets.
Lending Activities
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GENERAL. The principal lending activity of Baltimore American has
historically been the origination of conventional first mortgage loans secured
by residential property, primarily single family homes, and to a lesser extent
commercial real estate and construction loans, commercial business loans and
consumer loans. See "Table 2. Composition of Loan Portfolio." Various
legislative and regulatory changes in the early 1980's broadened the Savings
Bank's lending powers permitting Baltimore American to develop a variety of
mortgage instruments, including those providing for periodic interest rate
adjustments. The passage of the Financial Institutions Reform, Recovery and
Enforcement Act of 1989 (FIRREA), resulted in the Savings Bank emphasizing
secured residential property lending.
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TABLE 2
Composition of Loan Portfolio
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1996 1995 1994
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Residential mortgages $16,763,297 79.69% $17,332,606 76.41% $17,540,780 84.22%
Commercial real estate 1,089,498 5.18 1,087,446 4.79 1,133,015 5.44
Consumer 834,539 3.96 776,958 3.43 522,488 2.51
Residential construction 1,584,980 7.53 2,109,426 9.30 1,363,770 6.55
Commercial 763,033 3.64 1,376,886 6.07 266,307 1.28
----------- ------- ----------- ------ ----------- ------
$21,035,347 100.00% $22,683,322 100.00% $20,826,360 100.0%
=========== ======= =========== ====== =========== ======
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In order to improve the profitability of the Savings Bank and to reduce the
effects of interest rate movements on the Savings Bank's net interest income,
Baltimore American has formed an Asset/ Liability Management Policy, which
emphasizes matching the average maturities of the Savings Bank's assets and
liabilities. See "Table 3.a. Maturities and Sensitivities of Loans to Changes
in Interest Rates" and "Table 3.b. Fixed and Variable Rates on Loans." Interest
rate risk is further reduced by coordinating lending and investment policies to
obtain the maximum yield possible, while also providing for market rate
sensitivity. Baltimore American originates loans with adjustable interest
rates, or loans which include a three-year or five-year call provision. In
addition, Baltimore American originates short-term consumer loans, which have
terms limited to no more than seven years. The majority of the mortgage loans
originated by Baltimore American are secured by real estate located in the
Savings Bank's market area. The Savings Bank currently defines its market area
as portions of Baltimore City, Baltimore County, and Anne Arundel County in
Maryland.
6
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TABLE 3.a
Maturities and Sensitivities of Loans to Changes in Interest Rates /1/
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DUE IN: 1 year 1 - 5 More than
or less years 5 years Total
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Real Estate:
Residential $5,832,415 $ 366,466 $10,564,416 $16,763,297
Construction residential 1,584,980 -- -- 1,584,980
Commercial real estate 487,365 28,835 573,298 1,089,498
Commercial Business 227,299 535,734 -- 763,033
Consumer 490,820 110,805 232,914 834,539
---------- ---------- ----------- -----------
TOTAL $8,622,879 $1,041,840 $11,370,628 $21,035,347
========== ========== =========== ===========
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/1/ This table sets forth certain information at December 31, 1996 regarding
the dollar amount of loans maturing in the Savings Bank's portfolio based
on their contractual terms to maturity. Demand loans, loans having no
stated schedule of repayments and no stated maturity, and overdrafts are
reported as due in one year or less. Amounts of deferred loan origination
fees, loan loss allowances, and discounts on loans purchased have not been
deducted from the amounts of maturing loans.
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TABLE 3.b
Fixed and Variable Rates on Loans /2/
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Variable
Fixed Rate Rates Total
----------- ----------- -----------
Real Estate:
Residential $12,854,610 $3,908,687 $16,763,297
Construction residential 1,584,980 -- 1,584,980
Commercial real estate 1,089,498 -- 1,089,498
Commercial business 622,033 141,000 763,033
Consumer 514,435 320,104 834,539
----------- ---------- -----------
Total $16,665,556 $4,369,791 $21,035,347
=========== ========== ===========
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/2/ This table sets forth the dollar amount of all loans at December 31, 1996
due after one year which have predetermined interest rates and have
floating or adjustable interest rates.
7
RESIDENTIAL REAL ESTATE LOANS. The primary lending activity of the Savings
Bank has historically been the origination of conventional first mortgage loans
to enable borrowers to purchase existing homes or construct new homes. The
Savings Bank is qualified to originate, and originates mortgage loans insured by
the Federal Housing Authority ("FHA") or guaranteed by the Veterans
Administration ("VA"). The Savings Bank's underwriter is directly endorsed by
FHA to underwrite FHA loans and as such is automatically approved by the VA to
underwrite VA loans. A portion of the Savings Bank's mortgage loans are also
made on non-owner occupied, income producing properties. While such loans
usually provide for shorter terms, and allow the Savings Bank to charge a higher
rate of interest, they also carry a higher risk than loans on owner occupied
single family residences.
The debt-to-income ratios, the loan-to-value ratios, maturities and other
provisions of the loans made by the Savings Bank have generally reflected the
policy established by Baltimore American in response to regulations, market
conditions, and underwriting standards. The Savings Bank's lending policies,
however, limit the maximum loan-to-value ratio on one-to-four family real estate
mortgage loans to 95% of the lesser of the appraised value or the purchase
price, with private mortgage insurance required for the amount of the loan above
85% of the appraised value or the purchase price, as applicable.
Mortgage loans made by the Savings Bank have traditionally been long-term
loans, amortized on a monthly basis, with principal and interest due each month.
The term of fixed-rate real estate loans is typically 15 to 30 years. Since the
beginning of 1989, the Savings Bank has originated long-term, fixed-rate
mortgage loans, as well as adjustable rate mortgage loans in accordance with
standards that permit their sale to FHLMC or other secondary market purchasers,
as appropriate. However, loans originated for the Savings Bank's portfolio are
typically not sold in the secondary market.
Adjustable rate mortgage loans offered by the Savings Bank have interest
rates which adjust every one to three years, with such adjustments tied to the
U.S. Treasury Bill rate for the corresponding period, or the prime interest rate
as quoted in the Wall Street Journal. Typically, limits on interest rate
adjustments are 2% per adjustment and 6% over the life of the loan. Adjustable
rate mortgage loans are amortized over 30 years and are written pursuant to
FHLMC underwriting standards. The Savings Bank originates adjustable rate
mortgage loans for sale in the secondary mortgage market and such sales are
made, as market conditions allow. The majority of fixed-rate mortgages
originated by the Savings Bank for its portfolio contain an optional call
provision at the end of three or five years, at which time the Savings Bank may
elect to renegotiate the terms of the loan at then current interest rates. The
Savings Bank's experience indicates that real estate loans remain outstanding
for significantly shorter periods than their contractual terms. Borrowers may
refinance or prepay loans at their option with no prepayment penalty.
CONSTRUCTION LOANS. Baltimore American engages in construction lending for
the construction of single family residential real estate. In past years, the
Savings Bank has also originated construction loans on commercial properties.
Commercial construction loans are granted for the construction of small strip
shopping centers, restaurants, medical centers and office buildings. These
loans involve a preliminary construction period requiring monthly interest
payments, followed by a permanent loan requiring monthly principal and interest
payments. Construction loans usually have terms ranging from six months to
eighteen months.
The application process for construction loans is similar to the process
required for mortgage loans and also includes a submission to the Savings Bank
of recorded plats, plans, specifications, permits and costs of the property to
be constructed. These items are reviewed with an appraisal to determine the
value of the subject property. Residential construction loans entail a higher
degree of risk than residential real estate loans. Repayment of a construction
loan depends upon the successful completion of the construction project.
Unexpected delays or an inability to complete a construction project may result
in the inability of the borrower to repay the loan as contracted. If the
borrower is unable to repay the loan, the value of the underlying collateral may
be insufficient to assure full repayment. For more information on the risks
inherent in construction lending see "Item 1. Business -- Lending Activities --
Commercial Real Estate Loans."
8
The Savings Bank's risk of loss on a construction loan is dependent largely upon
the accuracy of the initial estimate of the property's value upon completion of
construction and the estimated cost (including interest) of construction, as
well as the borrower's financial condition and his ability to repay the debt.
If the estimate of construction costs or salability of the properties proves to
be inaccurate, the Savings Bank may be required to advance funds beyond the
amount originally committed to permit completion of the development, or the
borrower may have difficulty paying the loan upon maturity. If the estimate of
value proves to be inaccurate, the Savings Bank may be confronted, at or prior
to the maturity of the loan, with a project with a value which is insufficient
to assure full repayment.
COMMERCIAL REAL ESTATE LOANS. Commercial real estate loans are typically
made to a maximum of 80% of the appraised value of the commercial property.
Baltimore American originates commercial real estate loans, only in its market
area, including loans secured by small businesses, strip shopping centers,
restaurants and other retail developments.
Commercial real estate lending is generally considered to involve higher risk
than single-family residential lending. The risk of loss of principal is
increased due to the significant concentration in debt in a single loan and the
effects of general economic conditions on the salability of constructed
properties, as well as the success of the contractor or business enterprises.The
risk of loss on a commercial real estate loan is dependent on the cash flow of
the business or rental income from the commercial property.
COMMERCIAL BUSINESS LOANS. Unlike residential mortgage loans, which
generally are made on the basis of the borrower's ability to make repayment from
his or her employment and other income and which are secured by real property
whose value tends to be more easily ascertainable, commercial business loans are
higher risk and typically are made on the basis of the borrower's ability to
make repayment from the cash flow of the borrower's business. As a result, the
availability of funds for the repayment of commercial business loans may be
substantially dependent on the success of the business itself. Further, the
collateral securing the loans may depreciate over time, may be difficult to
appraise and may fluctuate in value based on the success of the business.
As of December 31, 1996, the Savings Bank's commercial business portfolio
consisted of approximately thirty-four (34) loans in the amount of $763,033.
Thirty-one of those loans represent leases that are collateralized by the
various leasing equipment for which they were granted. Approximately 100% of
these loans have recourse through either the borrowing corporation or the
leasing company or both. Commercial business loans declined by $613,853, or
44.58%, as the Savings Bank sought to reduce its exposure to equipment leases.
Although such leases were orginated for resale, the sales of the pre-sold leases
were not completed as a result of the recourse demanded by the purchaser.
Management has sold and refinanced out of the Savings Bank several leases and
wil continue in its efforts.
The Savings Bank recognizes the increased risks associated with commercial
business lending. The Savings Bank's commercial business lending policy
emphasizes complete credit file documentation and analysis of the borrower's
character, capacity to repay the loan, the adequacy of the borrower's capital
and collateral as well as an evaluation of the industry conditions affecting the
borrower. Analysis of the borrower's past, present and future cash flows is
also an important aspect of the Savings Bank's credit analysis. The Savings
Bank's commercial business loans have been to borrowers in its primary market
area, and the Savings Bank intends to continue its commercial business lending
in this geographic area.
In addition, the Savings Bank originates lines of credit to small businesses
and residential builders, which are primarily secured by real estate.
CONSUMER LOANS. Federal regulations permit federally chartered thrift
institutions to make secured and unsecured consumer loans including automobile
loans, home equity loans, property improvement loans and loans secured by
savings accounts. The Savings Bank grants home improvement loans, automobile
loans, recreational vehicle loans, unsecured personal loans and loans secured by
passbook savings accounts. Consumer loans may entail greater risk than do
residential mortgage loans, particularly in the
9
case of consumer loans which are unsecured or secured by rapidly depreciable
assets such as automobiles. In such cases, any repossessed collateral for a
defaulted consumer loan may not provide an adequate source of repayment of the
outstanding loan balance as a result of the greater likelihood of damage, loss
or depreciation. The Savings Bank vigorously pursues the borrower for any
shortfall that may occur.
The Savings Bank believes that the shorter terms and normally higher rates
available on various types of consumer loans have been helpful in maintaining a
profitable spread between the Savings Bank's average loan yield and its cost of
funds. Consumer loans do, however, pose additional risks of collectibility when
compared to residential mortgage loans. In many instances the Savings Bank is
required to rely on the borrower's ability to repay since the collateral may be
of reduced value at the time of collection.
LOAN ORIGINATIONS, PURCHASES AND SALES. The Savings Bank originates long-
term fixed rate mortgage loans, as well as adjustable rate mortgage loans in
accordance with standards which permit their sale to FHLMC and other secondary
market purchasers. Sales of loans originally placed in the Savings Bank's loan
portfolio are made as market conditions allow, are made without recourse to the
Savings Bank, and servicing is usually not retained on loans sold.
In addition, the Savings Bank originates loans on behalf of other financial
institutions, for which it receives an origination fee. In general, all loans
originated for the secondary market are sold prior to the closing of the loan.
Under these circumstances, the Savings Bank funds the loans at closing and is
reimbursed by the investor/purchaser generally within thirty (30) days. During
this time, the Savings Bank receives interest at the initial note rate stated in
the promissory note and mortgage deed of trust.
LOAN ORIGINATION AND OTHER FEES. In addition to interest earned on loans and
fees for making loan commitments, the Savings Bank receives loan origination
fees for originating loans. Loan origination fees are a percentage of the
principal amount of the mortgage loan which are charged to the borrower for
funding the loan. Such fees, net of direct and incremental origination costs,
are deferred and recognized as income on an effective interest rate method over
the expected life of the loan, when the loan is originated for the Savings
Bank's loan portfolio. For the years ended December 31, 1996, 1995 and 1994 net
loan origination fees, were $22,706, $34,945 and $72,065 respectively. When
loans are originated for the secondary market, fees are recognized in the period
in which the loan closes. For the years ended December 31, 1996, 1995 and 1994,
net fees on loans originated for the secondary market were $115,179, $91,317 and
$192,928 respectively.
NON-PERFORMING LOANS AND ASSET CLASSIFICATION. The Savings Bank's collection
procedures provide that when a loan is 15 days delinquent, the borrower will be
contacted by mail and payment requested. Generally, after a delinquency of 60
days, a loan is forwarded to an attorney for collection. If the delinquency
continues, subsequent efforts will be made by the Savings Bank or the attorney
to contact the delinquent borrower. In certain instances, the Savings Bank may
modify the loan or grant a limited moratorium on loan payments to enable the
borrower to reorganize his financial affairs. If the loan continues in a
delinquent status for 90 days or more, the Savings Bank generally will initiate
foreclosure proceedings.
Loans are reviewed on a regular basis and are placed on a non-accrual status
when, in the opinion of management, the collection of additional interest is
doubtful. Residential mortgage loans are generally placed on non-accrual status
when either principal or interest is 90 days or more past due and the likelihood
of recovery is doubtful. Consumer loans generally are charged off the earlier
of when management determines that the collection of principal and interest is
unlikely, or when the loan is more than 120 days past due. Commercial real
estate loans are generally placed on non-accrual status when the loan is 90 days
or more past due. Interest accrued and unpaid at the time a loan is placed on
non-accrual status is charged against interest income. Subsequent payments are
either applied to the outstanding principal balance or recorded as interest
income, depending on the assessment of the ultimate collectibility of the loan.
10
"Table 4a. Nonperforming Assets" on the following page sets forth
information with respect to the Savings Bank's nonperforming assets for the
periods indicated. "Table 4b. Allowance for Loan Loss" is a breakdown of the
allowance for loan losses for the periods indicated. During the periods shown,
the Savings Bank had no restructured loans within the meaning of Statement of
Financial Accounting Standards No. 15.
The Savings Bank had $643,057 and $307,794 in loans as of December 31, 1996
and 1995, respectively, for which accrual of interest had been discontinued. If
all loans were accruing interest, interest income would have been $43,362 and
$89,398 higher in the years ended December 31, 1996 and 1995, respectively.
Actual interest income recognized on those loans contractually past due 90 days
or more was $27,664 and $53,598, respectively. See the Residential Real Estate,
Commercial Real Estate, and Commercial Business Loans sections above for further
discussion of nonperforming assets.
Total non-accrual loans and loans 90 days or more past due increased to
$2,021,140 at December 31, 1996 from $959,751 at December 31, 1995. The
increase reflects a $335,262 or 108.92% increase in non-accrual loans and
$726,127 or 111.38% increase in accruing loans 90 days or more past due. The
increase in non-accrual loans was attributable to a 14-lot subdivision loan for
residential houses which was placed on non-accrual status during 1996.
Accruing loans which were contractually past due 90 days or more as of
December 31, 1996 totalled $1,378,084. These loans consisted of 13 residential
mortgages and 5 consumer loans. While the Savings Bank does receive payments,
these loans require special attention. The increase in accruing loans past due
90 days or more was attributable to a commercial land loan and several single
family resiential dwellings.
At December 31, 1996, the Savings Bank had no potential problem loans that
have not been disclosed in Table 4a based on Management's awareness of facts and
circumstances existing at the time.
Real estate acquired by the Savings Bank as a result of foreclosure or by
deed in lieu of foreclosure is classified as real estate owned until such time
as it is sold. When such property is acquired, it is recorded at fair value
less estimated disposition costs. Subsequently, the property is carried at the
lower of this value or current fair value. Other non-performing assets,
consisting principally of assets acquired through foreclosure or repossession,
increased by $148,812 or 5.34% to $2,936,687 reflecting the Savings Bank's
foreclosure on three residential properties and an increase in the carrying
value of certain properties already in portfolio as the result of renovations in
preparation for disposition.
Prior to June 18, 1992, the Savings Bank was a participant in a commercial
loan secured by certain commercial real estate known as Sheridan Station
Shopping Center (Sheridan Station). The Savings Bank owned a 61% interest in
the loan and United Savings Bank ("United"), the lead lender, owned the
remaining 39% interest.
On July 30, 1990, United was declared insolvent by the Office of Thrift
Supervision and its assets, including its 39% interest in Sheridan Station, were
turned over to the Resolution Trust Corporation (RTC) for disposition. On June
18, 1992, RTC and Baltimore American foreclosed on the property as a result of
the borrowers' failure to pay in accordance with the applicable loan agreement.
At that time, the Savings Bank took its proportional 61% interest in Sheridan
Station. On June 25, 1993, the Savings Bank acquired the RTC's 39% interest in
Sheridan Station for $174,890. As a result of this transaction, the Savings
Bank became the sole owner of the property. As of December 31, 1994, the
Savings Bank's total investment in the property was $1,086,647.
As of December 31, 1996, the center was seventy-two percent (72%) leased.
During 1996, the center generated operating income of $215,341 and operating
expenses of $101,130, for a pre-tax income of $114,211, which is included as
other operating income in the consolidated statement of operation for the year
ended December 31, 1996. As of December 31, 1996, the Savings Bank's total
investment in the property was $1,185,207.
11
- --------------------------------------------------------------------------------
TABLE 4 a.
Nonperforming Assets
- --------------------------------------------------------------------------------
At December 31,
---------------
1996 1995 1994 1993 1992
------------ ------------ ------------ ------------ ------------
Loans accounted for on a
non-accrual basis: /1/
Real estate
Residential $ 599,146 $ 305,969 $ 619,853 $ 983,857 $1,063,909
Commercial -- -- -- -- --
Commercial business 31,386 -- -- 34,000 385,909
Consumer 12,525 1,825 22,976 25,968 103,740
---------- ---------- ---------- ---------- ----------
Total $ 643,057 $ 307,794 $ 642,829 $1,043,825 $1,553,558
========== ========== ========== ========== ==========
Accruing loans which are
contractually past due
90 days or more:
Real estate
Residential $1,020,265 $ 650,884 $ 396,778 $ 232,804 $ 687,153
Commercial 319,640 -- -- 286,154 448,624
Commercial business 18,493 -- -- -- 34,000
Consumer 19,686 1,073 664 70,632 26,784
---------- ---------- ---------- ---------- ----------
Total $1,378,084 $ 651,957 $ 397,442 $ 589,590 $1,196,561
========== ========== ========== ========== ==========
Total of nonaccrual loans
and loans 90 days or
more past due: $2,021,140 $ 959,751 $1,040,271 $1,633,415 $2,750,119
========== ========== ========== ========== ==========
Percentage of total loans: 7.39% 4.23% 4.99% 8.73% 13.30%
Percentage of total assets: 9.61% 3.31% 3.85% 6.02% 10.73%
Other nonperforming
assets: /2/ $2,936,687 $2,787,875 $3,025,045 $2,559,698 $1,558,957
========== ========== ========== ========== ==========
- --------------------------------------------------------------------------------
/1/ Non-accrual status denotes loans which are 90 days or more past due or
loans which meet non-accrual criteria as established by regulatory
authorities.
/2/ Other nonperforming assets represent property acquired by the Savings Bank
through foreclosure or repossession or considered by management to be in-
substance foreclosed.
12
- --------------------------------------------------------------------------------
TABLE 4 b.
Allowance for Loan Loss
- --------------------------------------------------------------------------------
At December 31,
------------------------------------------------------------
1996 1995 1994
----------------- ----------------- ------------------
Amount Percent Amount Percent Amount Percent
-------- ------- -------- ------- -------- -------
Real Estate $246,719 65.50% $282,245 63.11% $150,802 85.8%
Commercial 107,068 28.43 150,000 33.54
Consumer 22,875 6.07 14,981 3.35 25,022 14.2
-------- ----- -------- ----- -------- -----
Total $376,662 100.0% $447,226 100.0% $175,824 100.0%
======== ===== ======== ===== ======== =====
- --------------------------------------------------------------------------------
Management is actively marketing this property and intends to sell the
property as soon as a viable buyer is identified. While management believes it
will be able to find a buyer in the near future, no assurance can be made that a
buyer will be found or that losses on the sale or from operations prior to the
sale will not be realized. Management, after reviewing recent appraisals of the
property, believes that an adequate allowance for any potential losses on the
property has been provided as of December 31, 1996.
Investment Activities
- ---------------------
Interest from cash deposits and investment securities generally provide the
second largest source of interest income for Baltimore American after interest
on loans. At December 31, 1996, Baltimore American's investment securities
portfolio totaled $920,187. Such funds consisted of $492,000 in interest-
bearing deposits in other banks, $100,565 in corporate debt obligations, and
$327,622 in U.S. Government obligations.
Baltimore American is required under federal regulations to maintain a
minimum amount of liquid assets which may be invested in specified short-term
securities and is also permitted to make certain other security investments.
See "Table 5. Maturity Distribution of Investment Portfolio" on the following
page.
There has been no active trading of the Savings Bank's investment portfolio,
and investment securities are generally held to maturity and carried at cost.
Liquidity levels may be increased or decreased depending upon the yields on
investment alternatives and upon management's judgment as to the attractiveness
of the yields then available in relation to other opportunities and its
expectation of the level of yield that will be available in the future.
Sources of Funds
- ----------------
Deposits are the major source of Baltimore American's funds for lending and
other investment purposes. In addition to deposits, the Savings Bank has in the
past derived funds from loan principal repayments. Loan repayments are a
relatively stable source of funds, while deposit inflows and outflows may be
significantly influenced by general interest rates, economic conditions and
money market conditions. Borrowings are used as warranted to compensate for
short-term reductions in the availability of funds from other sources. They may
also be used on a longer term basis for general business purposes.
13
- --------------------------------------------------------------------------------
TABLE 5
Maturity Distribution of Investment Portfolio
- --------------------------------------------------------------------------------
1996 1995 1994
---------------- ---------------- ----------------
Maturing Within Amount Yield Amount Yield Amount Yield
- ----------------- -------- ----- -------- ----- -------- -----
One year $724,622 6.0% $365,000 5.9% $255,045 5.8%
1 - 5 years 145,644 7.2 149,892 7.2 145,190 7.7
6 - 10 years 49,921 50,035 7.1 50,152 7.9
After 10 years -- -- -- -- -- --
-------- ---- -------- ---- -------- ----
$920,187 6.5% $564,927 6.7% $450,387 7.0%
======== ==== ======== ==== ======== ====
- --------------------------------------------------------------------------------
DEPOSITS. Local deposits are and traditionally have been the primary source
of Baltimore American's funds for use in lending and for other general business
purposes. Baltimore American offers a number of deposit accounts including
passbook, business, money market, certificates of deposit, individual retirement
accounts and checking accounts currently ranging in maturity from three months
to five years. Deposit accounts vary as to terms, with the principal
differences being the minimum balance required, the time period the funds must
remain on deposit and the interest rate. See "Table 6. Composition of
Deposits" and "Table 7. Deposit Maturities."
BORROWINGS. Savings deposits are the primary source of funds for Baltimore
American's lending and investment activities and for its general business
purposes. The Savings Bank does, however, have access to advances from the FHLB
of Atlanta to supplement its supply of lendable funds for granting residential
loans and to meet deposit withdrawal requirements. The Savings Bank has a
secured line of credit for $3,000,000 with the FHLB of Atlanta.
The FHLB of Atlanta functions as a central reserve bank providing credit for
savings and loan associations, savings banks and certain other member financial
institutions. As a member of the FHLB of Atlanta, Baltimore American is
required to own capital stock in the FHLB of Atlanta and is authorized to apply
for advances on the security of such stock and certain of its home mortgages and
other assets (principally, securities which are obligations of, or guaranteed
by, the United States) provided certain standards related to creditworthiness
have been met. Advances are made pursuant to several different programs. Each
credit program has its own interest rate and range of maturities. Depending on
the program, limitations on the amount of advances are based either on a fixed
percentage of a savings bank's net worth or on the FHLB's assessment of the
institution's credit-worthiness. (Refer to "Table 1. Distribution of Assets,
Liabilities and Stockholders' Equity; Interest Rates and Interest Differential
and see "Regulation -- Federal Home Loan Bank System"). There were advances of
$450,000 and $2,000,000 outstanding as of December 31, 1996 and 1995,
respectively.
Subsidiary Activities
- ---------------------
Baltimore American has one wholly owned subsidiary, Baltimore American
Financial Corporation, Inc. (BAFC). In July 1994, the Savings Bank took control
of Sheridan Station as described above. At that time, the Savings Bank
contributed its interest in the property to BAFS. BAFS has operated this
commercial retail center since that time. Prior to receiving the Savings Bank's
interest in Sheridan Station, this subsidiary was inactive.
14
- --------------------------------------------------------------------------------
TABLE 6
Composition and Maturities of Deposits
- --------------------------------------------------------------------------------
As of December 31, 1996 and 1995, deposits consisted of:
Weighted Average 1996 1995
-------------------- -------------------
Rate as of
December 31, 1996 Amount Percent Amount Percent
------------------ ----------- --------- ----------- ---------
Demand 0.00% $ 351,185 1.41% $ 152,604 0.62%
NOW 2.38 570,141 2.29 544,166 2.22
Money market 3.19 4,236,659 17.02 4,414,048 17.98
Passbook savings 2.85 1,483,107 5.96 1,416,368 5.77
Mortgage escrows 0.99 196,406 0.79 168,697 0.69
--------- ----------- --------- ----------- ---------
2.98 6,837,498 27.47 6,695,883 27.28
--------- ----------- --------- ----------- ---------
Time Deposits:
3% to 4% -- 0.00 414,591 1.69
4% to 5% 1,564,632 6.29 2,117,137 8.62
5% to 6% 9,545,257 38.35 7,024,588 28.62
6% to 7% 6,456,551 25.94 7,437,375 30.30
7% to 8% 485,692 1.95 857,134 3.49
8% to 9% -- -- -- --
----------- --------- ----------- ---------
18,052,132 72.53 17,850,825 72.72
----------- --------- ----------- ---------
$24,889,630 100.00% $24,546,708 100.00%
=========== ========= =========== =========
Time deposits include $2,352,674 and $1,740,562 of deposits of $100,000 or more
as of December 31, 1996 and 1995, respectively.
As of December 31, 1996, scheduled maturities of time deposits are as follows:
1997 1998 1999 2000 2001 Total
----------- ---------- ---------- ---------- ---------- -----------
3% to 4% $ -- $ -- $ -- $ -- $ -- $ --
4% to 5% 1,526,019 38,613 -- -- -- 1,564,632
5% to 6% 7,513,429 857,761 1,007,758 10,758 155,551 9,545,257
6% to 7% 2,148,470 167,417 1,221,756 1,332,376 1,586,532 6,456,551
7% to 8% -- -- 301,206 184,486 -- 485,692
----------- ---------- ---------- ---------- ---------- -----------
$11,187,918 $1,063,791 $2,530,720 $1,527,620 $1,742,083 $18,052,132
=========== ========== ========== ========== ========== ===========
- --------------------------------------------------------------------------------
15
-----------------------------------------------------
TABLE 7
Deposit Maturities
-----------------------------------------------------
1996 (in thousands)
--------------------------------
Time deposits of All other
Maturing Within $100,000 or more Time Deposits
--------------- ---------------- -------------
3 months or less $ 330,330 $ 3,724,273
4 - 6 months 304,082 2,657,303
7 - 12 months 623,262 3,548,668
Over 12 months 1,095,000 5,769,214
---------- -----------
$2,352,674 $15,699,458
========== ===========
-----------------------------------------------------
Competition
- -----------
Baltimore American faces strong competition in the attraction of savings
deposits (its primary source of lendable funds) and in the origination of home
mortgage loans. Its most direct competition for savings deposits has
historically come from other thrift institutions and commercial banks located in
Baltimore, Maryland. In times of high interest rates, the Savings Bank faces
additional significant competition for investor funds from short-term money
market securities and other corporate and government securities. The Savings
Bank's competition for real estate loans comes principally from other thrift
institutions, commercial banks, and mortgage banking companies.
The Savings Bank competes for loans principally through the interest rates
and loan fees it charges and the efficiency and quality of the services it
provides borrowers, real estate brokers, and home builders. It competes for
savings by offering depositors a variety of savings accounts, a convenient
office location, and other services. Competition is a significant factor in
determining the Savings Bank's interest income and its interest expense, which
causes changes in net interest income. See "Table 8. Analysis of Changes in
Net Interest Income."
The Savings Bank considers Baltimore City/County, Maryland and, to a lesser
extent, Anne Arundel County, to be its primary market area for savings. While
the majority of the Savings Bank's mortgage loans are originated in this market
area, the Savings Bank has also made loans, to a lesser degree, throughout
Maryland and in the Washington, D.C. metropolitan area.
REGULATION OF THE COMPANY
- -------------------------
GENERAL. The Company is registered as a savings and loan holding company
with the OTS and is subject to OTS regulations, examinations, supervision and
reporting requirements. As a subsidiary of a savings and loan holding company,
the Savings Bank is subject to certain restrictions in its dealings with the
Company and affiliates thereof.
16
- --------------------------------------------------------------------------------
TABLE 8
Analysis of Changes in Net Interest Income
- --------------------------------------------------------------------------------
1996 1995
------------------------------------ ------------------------------------
Rate & Total Rate & Total
Volume Rate Volume Change Volume Rate Volume Change
--------- --------- --------- --------- --------- ---------- --------- ----------
Interest Income:
Loans $ 12,137 $(42,405) $ (253) $ (30,521) $ 130,973 $ (68,578) $ (4,538) $ 57,857
Investments and other
Interest-earning assets 73,540 (11,725) (6,573) 55,242 (9,254) (16,895) 1,000 (25,149)
--------- -------- -------- --------- --------- --------- -------- ---------
Total Interest Income 85,677 (54,130) (6,826) 24,721 (121,719) (85,473) (3,538) 32,708
--------- -------- -------- --------- --------- --------- -------- ---------
Interest Expense:
Deposits 170,299 82,306 12,525 265,130 17,156 116,169 2,026 135,351
Other (141,003) (45,053) 39,337 (146,719) 71,554 14,823 18,851 105,228
--------- -------- -------- --------- --------- --------- -------- ---------
Total Interest Expense 29,296 37,253 51,862 118,411 88,710 130,992 20,877 240,579
--------- -------- -------- --------- --------- --------- -------- ---------
Net Interest Income $ 56,381 $(91,383) $(58,688) $ (93,690) $ 33,009 $(216,465) $(24,415) $(207,871)
========= ======== ======== ========= ========= ========= ======== =========
- --------------------------------------------------------------------------------
NOTE: Interest on nonaccrual loans has been excluded from these amounts
in accordance with the policies described herein.
17
ACTIVITIES RESTRICTIONS. The Board of Directors of the Company presently
operates the Company as a unitary savings and loan holding company. There are
generally no restrictions on the activities of a unitary savings and loan
holding company. However, if the Director of OTS determines that there is
reasonable cause to believe that the continuation by a savings and loan holding
company of an activity constitutes a serious risk to the financial safety,
soundness or stability of its subsidiary savings association, the Director of
the OTS may limit (i) payment of dividends by the savings association, (ii)
transactions between the savings association and its affiliates, and (iii) any
activities of the savings association that might create a serious risk that the
liabilities of the holding company and its affiliates may be imposed on the
savings association. Notwithstanding the above rules as to permissible business
activities of unitary savings and loan holding companies, if the savings
association subsidiary of such a holding company fails to meet the Qualified
Thrift Lender ("QTL") Test, then the unitary holding company also becomes
subject to the activities restrictions applicable to multiple holding companies
and unless the savings association requalifies as a QTL within one year
thereafter, register as, and become subject to, the restrictions applicable to a
bank holding company. See "Regulation of the Savings Bank -- Qualified Thrift
Lender Test."
If the Company were to acquire another savings association, the Company
would become a multiple savings and loan holding company subject to further
restrictions on its activities. Among other things, no multiple savings and loan
holding company or subsidiary thereof which is not a savings association may
commence or continue for a limited period of time after becoming a multiple
savings and loan holding company or subsidiary thereof, any business activity,
upon prior notice to, and no objection by the OTS, other than (i) furnishing or
performing management services for a subsidiary savings association, (ii)
conducting an insurance agency or escrow business, (iii) holding, managing, or
liquidating assets owned by or acquired from a subsidiary savings institution,
(iv) holding or managing properties used or occupied by a subsidiary savings
institution, (v) acting as trustee under deeds of trust, (vi) those activities
previously directly authorized by regulation as of March 5, 1987 to be engaged
in by multiple holding companies or (vii) those activities authorized by the
Board of Governors of the Federal Reserve System (the "Federal Reserve Board")
as permissible for bank holding companies, unless the Director of OTS by
regulation prohibits or limits such activities for savings and loan holding
companies.
RESTRICTIONS ON ACQUISITIONS. Savings and loan holding companies are
prohibited from acquiring, without prior approval of the Director of OTS, (i)
control of any other savings association or savings and loan holding company or
substantially all the assets thereof, or (ii) more than 5% of the voting shares
of a savings association or holding company thereof which is not a subsidiary.
Except with the prior approval of the Director of OTS, no director or officer of
a savings and loan holding company or person owning or controlling by proxy or
otherwise more than 25% of such company's stock, may also acquire control of any
savings association, other than a subsidiary savings association, or of any
other savings and loan holding company.
The Director of OTS may only approve acquisitions resulting in the
formation of a multiple savings and loan holding company which controls savings
associations in more than one state if: (i) the multiple savings and loan
holding company involved controls a savings institution which operated a home or
branch office in the state of the association to be acquired as of March 5,
1987; (ii) the acquiror is authorized to acquire control of the savings
association pursuant to the emergency acquisition provisions of the Federal
Deposit Insurance Act; or (iii) the statutes of the state in which the
association is located specifically permit institutions to be acquired by state-
chartered associations or savings and loan holding companies located in the
state where the acquiring entity is located (or by a holding company that
controls such state-chartered savings institutions).
Under the Maryland Financial Institution Code, Maryland savings and loan
associations and holding companies whose assets consist principally of a
Maryland savings and loan association may only be acquired by out-of-state
savings and loan holding companies that have their principal place of business
and more than 80% of the deposits of their savings and loan association
subsidiaries located in the states of Alabama, Arkansas, Delaware, Florida,
Georgia, Kentucky, Louisiana, Maryland, Mississippi, North Carolina,
18
Pennsylvania, South Carolina, Tennessee, Virginia, and West Virginia and the
District of Columbia. The Maryland Commissioner of Financial Institutions may
not approve the acquisition of a Maryland savings and loan association or
Maryland holding company by an out-of-state savings and loan holding company
unless the Maryland association or each of the Maryland subsidiaries of the
holding company, as the case may be, has been in existence for more than four
years and the Commissioner determines that the laws of the jurisdictions in
which the out-of-state holding company has its principal place of business and
its greatest concentration of savings association deposits each permit Maryland
savings and loan holding companies to acquire savings and loan associations and
their holding companies in those jurisdictions. In addition, following the
acquisition, all of the association subsidiaries of the out-of-state holding
company which will operate or have deposit-taking offices in Maryland must be
organized under the laws of the United States.
The Bank Holding Company Act of 1956 has been amended to specifically
authorize the Federal Reserve Board to approve an application by a bank holding
company to acquire control of any savings association. Pursuant to rules
promulgated by the Federal Reserve Board, owning, controlling or operating a
savings association is a permissible activity for bank holding companies, if the
savings association engages only in deposit-taking activities and lending and
other activities that are permissible for bank holding companies. In approving
such an application, the Federal Reserve Board may not impose any restriction on
transactions between the savings association and its holding company affiliates
except as required by Sections 23A and 23B of the Federal Reserve Act.
A bank holding company that controls a savings association may merge or
consolidate the assets and liabilities of the savings association with, or
transfer assets and liabilities to, any subsidiary bank which is a member of the
Bank Insurance Fund ("BIF") with the approval of the appropriate federal banking
agency and the Federal Reserve Board. The resulting bank will be required to
continue to pay assessments to the SAIF at the rates prescribed for SAIF members
on the deposits attributable to the merged savings association plus an annual
growth increment. In addition, the transaction must comply with the restrictions
on interstate acquisitions of commercial banks under the Bank Holding Company
Act.
REGULATION OF THE SAVINGS BANK
- ------------------------------
GENERAL. As a federally chartered, SAIF-insured savings bank, Baltimore
American is subject to extensive regulation by the OTS. Lending activities and
other investments must comply with various federal statutory and regulatory
requirements. Baltimore American is required to file reports with the OTS and
FDIC describing its activities and financial condition. This supervision and
regulation is intended primarily for the protection of depositors. The Savings
Bank is also subject to certain reserve requirements promulgated by the Board of
Governors of the Federal Reserve System (the "Federal Reserve Board").
FEDERAL HOME LOAN BANK SYSTEM. Baltimore American is a member of the
Federal Home Loan Bank System ("FHLBS"), which consists of 12 regional Federal
Home Loan Banks subject to supervision and regulation by the Federal Housing
Finance Board ("FHFB"). The Federal Home Loan Banks provide a central credit
facility primarily for member institutions. Baltimore American, as a member of
the FHLB of Atlanta, is required to acquire and hold shares of capital stock in
the FHLB of Atlanta in an amount at least equal to 1% of the aggregate principal
amount of its unpaid residential mortgage loans, home purchase contracts, and
similar obligations at the beginning of each year, or 1/20 of its advances
(borrowings) from the FHLB of Atlanta, whichever is greater. At December 31,
1996, Baltimore American was in compliance with this requirement with an
investment of $169,100 in FHLB of Atlanta stock.
The FHLB of Atlanta serves as a reserve or central bank for its member
thrift institutions within its assigned region. It is funded primarily from
proceeds derived from the sale of consolidated obligations of the FHLB system.
It makes advances to members in accordance with policies and procedures
established by the FHFB and the Board of Directors of the FHLB of Atlanta. As of
December 31, 1996, Baltimore American had $450,000 in advances from the FHLB of
Atlanta. See "Item 1. Business -- Sources of Funds -- Borrowings." Under FIRREA,
long-term advances may only be made for the purpose of providing funds for
residential housing finance.
19
LIQUIDITY REQUIREMENTS. Baltimore American is required to maintain an
average daily balance of liquid assets (cash, certain time deposits, bankers'
acceptances and specified United States government, state or federal agency
obligations) equal to a monthly average of not less than a specified percentage
of its net withdrawable savings deposits plus short-term borrowings. This
liquidity requirement, which is currently 5%, may be changed from time to time
by the OTS to any amount within the range of 4% to 10% depending upon economic
conditions and the savings flow of member institutions. OTS regulations also
require each institution to maintain an average daily balance of short-term
liquid assets at a specified percentage, which is currently 1%, of the total of
its net withdrawable savings accounts and borrowings payable in one year or
less. Monetary penalties may be imposed for failure to meet liquidity
requirements. Baltimore American's liquidity at December 31, 1996 was 7%, which
exceeded the 5% liquidity requirement. The Savings Bank's short-term liquidity
ratio at December 31, 1996 was 7%, which exceeds the 1% requirement.
QUALIFIED THRIFT LENDER TEST. A savings association that does not meet the
Qualified Thrift Lender test ("QTL Test") must either convert to a bank charter
or comply with the following restrictions on its operations: (i) the
institution may not engage in any new activity or make any new investment,
directly or indirectly, unless such activity or investment is permissible for a
national bank; (ii) the branching powers of the institution shall be restricted
to those of a national bank; (iii) the institution shall not be eligible to
obtain any advances from its FHLB; and (iv) payment of dividends by the
institution shall be subject to the rules regarding payment of dividends by a
national bank. Upon the expiration of three years from the date the institution
ceases to be a Qualified Thrift Lender, it must cease any activity, and not
retain any investment not permissible for a national bank and immediately repay
any outstanding FHLB advances (subject to safety and soundness considerations).
To meet its QTL test, an institution must either satisfy the tax code
definition of a "domestic building and loan association" or its "Qualified
Thrift Investments" must total at least 65% of "portfolio assets." Portfolio
assets are defined as total assets less intangibles, property used by a savings
association in its business and liquidity investments in an amount not exceeding
20% of assets. Qualified Thrift Investments consist of (i) loans, equity
positions or securities related to domestic, residential real estate or
manufactured housing, (ii) 50% of the dollar amount of residential mortgage
loans subject to sale under certain conditions, and (iii) stock in an FLHB or
FHLMC. In addition, subject to a 20% of portfolio assets limit, savings
associations are able to treat as Qualified Thrift Investments 200% of their
investments in loans to finance "starter homes" and loans for construction,
development or improvement of housing and community service facilities or for
financing small businesses in "credit-needy" areas. In order to maintain QTL
status, a savings association must maintain a weekly average percentage of
Qualified Thrift Investments to portfolio assets equal to 65% on a monthly
average basis in nine out of 12 months. A savings association that fails to
maintain QTL status is permitted to requalify once, and if it fails the QTL test
a second time, it will become immediately subject to all penalties as if all
time limits on such penalties had expired.
At December 31, 1996, the Savings Bank satisfied the tax code definition of
"domestic building and loan association"; approximately 84.23% of the Savings
Bank's assets were invested in Qualified Thrift Investments, which was in excess
of the percentage required to qualify the Savings Bank as a Qualified Thrift
Lender.
REGULATORY CAPITAL REQUIREMENTS. OTS regulations require savings
associations to satisfy three different capital requirements. Specifically,
savings associations must maintain "tangible" capital equal to 1.5% of adjusted
total assets, "core" capital equal to 3% of adjusted total assets and "total"
capital (a combination of core and "supplementary" capital) equal to 8.0% of
"risk-weighted" assets. In addition, the OTS has recently adopted regulations
which impose certain restrictions on savings institutions that have a total
risk-based capital ratio that is less than 8.0%, a ratio of Tier 1 capital to
risk-weighted assets of less than 4.0% or a ratio of Tier 1 capital to adjusted
total assets of less than 4.0% (or 3.0% if the institution is rated composite 1
under the OTS examination rating system). For purposes of these regulations,
Tier 1 capital has the same definitions as core capital. See "-- Prompt
Corrective Regulatory Action." Core capital
20
is defined as common stockholders' equity (including retained earnings),
noncumulative perpetual preferred stock and related surplus, minority interests
in the equity accounts of fully consolidated subsidiaries, certain
nonwithdrawable accounts and pledged deposits and "qualifying supervisory
goodwill," less tangible assets other than certain qualifying supervisory
goodwill and certain purchased mortgage servicing rights. Tangible capital is
given the same definition as core capital but does not include qualifying
supervisory goodwill and is reduced by the amount of all the savings
institution's intangible assets with only a limited exception for mortgage
servicing rights.
The OTS capital rules require that core and tangible capital be reduced by
an amount equal to a savings institution's debt and equity investments in
subsidiaries engaged in activities not permissible to national banks, other than
subsidiaries engaged in activities undertaken as agent for customers or in
mortgage banking activities and subsidiary depository institutions or their
holding companies ("nonincludable subsidiaries"). As of December 31, 1996, the
Saving Bank had no investments in or extensions of credit to nonincludable
subsidiaries.
Adjusted total assets are a savings institution's total assets as
determined under generally accepted accounting principles increased by certain
goodwill amounts and by a pro rated portion of the assets of unconsolidated
includable subsidiaries in which the savings institution holds a minority
interest. Adjusted total assets are reduced by the amount of assets that have
been deducted from capital, the savings institution's minority investments in
unconsolidated includable subsidiaries and, for purposes of the core capital
requirement, qualifying supervisory goodwill.
In determining compliance with the risk-based capital requirement, a savings
institution is allowed to include both core capital and supplementary capital in
its total capital, provided the amount of supplementary capital included does
not exceed the savings institution's core capital. Supplementary capital is
defined to include certain preferred stock issues, nonwithdrawable accounts and
pledged deposits that do not qualify as core capital, certain approved
subordinated debt, certain other capital instruments and a portion of the
savings institution's general loss allowances. Total core and supplementary
capital are reduced by the amount of capital instruments held by other
depository institutions pursuant to reciprocal arrangements and by the Savings
Bank's high loan-to-value ratio land loans and non-residential construction
loans and equity investments other than those deducted from core and tangible
capital.
The risk-based capital requirement is measured against risk-weighted
assets, which equals the sum of each on-balance-sheet asset and the credit-
equivalent amount of each off-balance-sheet item after being multiplied by an
assigned risk weight. Under the OTS risk-weighted system, cash and securities
backed by the full faith and credit of the U.S. government are given a 0% risk
weight. Mortgage-backed securities that qualify under the Secondary Mortgage
enhancement Act, including those issued, or fully guaranteed as to principal and
interest, by the FNMA or FHLMC, are assigned a 20% risk weight. Single-family
first mortgages not more than 90 days past due with loan-to-value ratios under
80%, multi-family mortgages (maximum 36 dwelling units) with loan-to-value
ratios under 80% and average annual occupancy rates over 80%, and certain
qualifying loans for the construction of one- to four-family residences pre-sold
to home purchasers are assigned a risk weight of 50%. Consumer loan, non-
qualifying residential construction loans and commercial real estate loans,
repossessed assets and assets more than 90 days past due, as well as all other
assets not specifically categorized, are assigned a risk weight of 100%. The
portion of equity investments not deducted from core or supplementary capital is
assigned a 100% risk-weight. OTS capital regulations require savings
institutions to maintain minimum total capital, consisting of core capital plus
supplemental capital, equal to 8.0% of risk-weighted assets.
"Table 9. Reconciliation of GAAP Capital to Regulatory Capital" on the
following page reconciles the Savings Bank's retained earnings as reported in
its consolidated statements of financial condition at December 31, 1996, to its
tangible, core and total regulatory capital at that date.
21
- --------------------------------------------------------------------------------
TABLE 9
Reconciliation of GAAP Capital to Regulatory Capital
- --------------------------------------------------------------------------------
Regulatory Capital (in thousands)
-----------------------------------
Tangible Core Risk-based
Capital Capital Capital
-------- ------- -----------
GAAP capital $1,765 $1,765 $1,765
Nonallowable capital -- -- (212)
Additional capital items:
General valuation allowances - limited* -- -- 227
------ ------ ------
Regulatory capital 1,765 1,765 1,780
Minimum capital requirement 411 822 1,445
------ ------ ------
Regulatory capital - excess $1,354 $ 943 $ 335
====== ====== ======
- --------------------------------------------------------------------------------
Institutions with more than a "normal" level of interest rate risk are
required to maintain additional total capital. A savings institution's interest
rate risk will be measured in terms of the sensitivity of its "net portfolio
value" to changes in interest rates. Net portfolio value is defined, generally,
as the present value of expected cash inflows from existing assets and off-
balance sheet contracts less the present value of expected cash outflows from
existing liabilities. A savings institution will be considered to have a
"normal" level of interest rate risk exposure if the decline in its net
portfolio value after an immediate 200 basis point increase or decrease in
market interest rates (whichever results in the greater decline) is less than
2.0% of the current estimated economic value of its assets. A savings
institution with a greater than normal interest rate risk will be required to
deduct from total capital, for purposes of calculating its risk-based capital
requirement, an amount (the "interest rate risk component") equal to one-half
the difference between the institution's measured interest rate risk and the
normal level of interest rate risk, multiplied by the economic value of its
total assets.
As the preceding table demonstrates, at December 31, 1996 Baltimore
American exceeded its tangible, core and risk-based regulatory capital
requirements. See Note 19 to Consolidated Financial Statements.
The OTS calculates the sensitivity of a savings institution's net portfolio
value based on data submitted by the institution in a schedule to it quarterly
Thrift Financial Report and using the interest rate risk measurement model
adopted by the OTS. The amount of the interest rate risk component, if any, to
be deducted from a savings institution's total capital will be based on the
institution's Thrift Financial Report filed two quarters earlier. Savings
institutions with less than $300 million in assets and a risk-based capital
ratio above 12% are generally exempt from filing the interest rate risk schedule
with their Thrift Financial Reports. However, the OTS will require any exempt
savings institution that it determines may have a high level of interest rate
risk exposure to file such schedule on a quarterly basis. The Savings Bank has
determined that, on the basis of current financial data, it would not be deemed
to have more than normal level of interest rate risk under the new rule and
believes that it will not be required to increase its total capital as a result
of the rule.
22
In addition to requiring generally applicable standards for savings
associations, FIRREA authorizes the Director of OTS to establish the minimum
level of capital for a savings institution at such amount or at such ratio of
capital-to-assets as the Director determines to be necessary or appropriate for
such institution in light of the particular circumstances of the institution.
The Director of OTS may treat the failure of any savings institution to maintain
capital at or above such level as an unsafe or unsound practice and may issue a
directive requiring any savings institution which fails to maintain capital at
or above the minimum level required by the Director to submit and adhere to a
plan for increasing capital. Such an order may be enforced in the same manner as
an order issued by the FDIC.
OTS staff policies specify that savings institutions failing any one of
their minimum regulatory capital requirements may not increase their total
assets during any quarter in excess of an amount equal to net interest credited
during the quarter. Under these policies, institutions that have submitted
capital plans that are rejected by the District Director or that have had
capital plans approved but do not meet the targets or requirements of the
capital plan may not make any new loans or investments except with the prior
written approval of the District Director. Such approval will only be granted
when the proposed loan or investment is reasonable in the context of the
institution's operations and does not significantly increase the risk profile of
the savings institution.
The Director of OTS must restrict the asset growth of savings institutions
not in regulatory capital compliance, subject to a limited exception for growth
not exceeding interest credited. In addition, savings institutions not in full
compliance with capital standards then applicable would be subject to a capital
directive which may include such restrictions, including restrictions on the
payment of dividends and on compensation, as deemed appropriate by the Director
of OTS. The Director of OTS is directed to treat as an unsafe and unsound
practice any material failure by a savings institution to comply with a capital
plan or capital directive. The sanctions and penalties that could be imposed
range from restrictions on branching or on the activities of the institution, to
restrictions on the ability to obtain FHLB advances, to termination of insurance
of accounts following appropriate proceedings, to the appointment of a
conservator or receiver. A savings institution not in full compliance with the
capital standards could apply for a further limited exemption from sanctions. If
the exemption is granted, the savings institution would still remain subject to
restrictions on growth.
In addition to the limitations on asset growth, an institution not in
capital compliance is subject to the following restrictions: (i) new directors
and senior executive officers and employment contracts for senior executive
officers must be approved by the OTS in advance; (ii) the institution may no
longer accept or renew any brokered deposits without FDIC permission; (iii) the
institution will be subject to higher OTS assessments as a capital-deficient
institution; and (iv) the institution may not make any capital distributions
without prior written approval.
ENFORCEMENT
- -----------
Under the Federal Deposit Insurance Act (the "FDI Act"), the OTS has
primary enforcement responsibility over savings institutions and has the
authority to bring enforcement action against all "institution-related parties,"
including stockholders, and any attorneys, appraisers and accountants who
knowingly or recklessly participate in wrongful action likely to have an adverse
effect on a savings institution. Civil penalties cover a wide range of
violations and actions and range up to $25,000 per day unless a finding of
reckless disregard is made, in which case penalties may be as high as $1.0
million per day. Criminal penalties for most financial institution crimes
include fines of up to $1.0 million and imprisonment for up to 30 years. In
addition, regulators have substantial discretion to take enforcement action
against an institution that fails to comply with its regulatory requirements,
particularly with respect to the capital requirements. Possible enforcement
actions range from the imposition of a capital plan and capital directive to
receivership, conservatorship or the termination of deposit insurance. Under the
FDI Act, the FDIC has the authority to recommend to the Director of OTS
enforcement action to be taken with respect to a particular savings institution.
If action is not taken by the Director, the FDIC has authority to take such
action under certain circumstances.
23
DEPOSIT INSURANCE
- -----------------
The FDIC may establish an assessment rate for deposit insurance premiums
which protects the insurance fund and considers the fund's operating expenses,
case resolution expenditures, income and effect of the assessment rate on the
earnings and capital of SAIF members. Under the Federal Deposit Insurance Act,
the FDIC is required to set semi-annual assessments for SAIF-insured
institutions at a rate determined by the FDIC to be necessary to maintain the
designated reserve ratio of the SAIF at 1.25% of estimated insured deposits, or
at such a higher percentage of insured deposits that the FDIC determines to be
justified for that year by circumstances raising a significant risk of
substantial future losses to the SAIF.
The assessment rate for an insured depository institution depends on the
assessment risk classification assigned to the institution by the FDIC which is
determined by the institution's capital level and supervisory evaluations.
Using the same percentage criteria as under the prompt corrective regulatory
action regulations, institutions are assigned to one of three capital groups --
well capitalized, adequately capitalized or undercapitalized -- based on the
data reported to regulators for the date closest to the last day of the seventh
month preceding the semi-annual assessment period. Within each capital group,
institutions will be assigned to one of three subgroups on the basis of
supervisory evaluations by the institution's primary supervisory authority and
such other information as the FDIC determines to be relevant to the
institution's financial condition and the risk posed to the deposit insurance
fund.
For the past several semi-annual periods, institutions with SAIF-assessable
deposits, like the Savings Bank, have been required to pay higher deposit
insurance premiums than institutions with deposits insured by the BIF. In order
to recapitalize the SAIF and address the premium disparity, the recently-enacted
Deposit Insurance Funds Act of 1996 authorized the FDIC to impose a one-time
special assessment on institutions with SAIF-assessable deposits based on the
amount determined by the FDIC to be necessary to increase the reserve levels of
the SAIF to the designated reserve ratio of 1.25% of insured deposits.
Institutions were assessed at the rate of 65.7 basis points based on the amount
of their SAIF-assessable deposits as of March 31, 1995. As a result of the
special assessment the Savings Bank incurred an after-tax expense of $138,941
during the quarter ended September 30, 1996.
The FDIC has adopted a new assessment schedule for SAIF deposit insurance
pursuant to which the assessment rate for the well-capitalized institutions with
the highest supervisory ratings would be reduced to zero and institutions in the
lowest risk assessment classification will be assessed at the rate of 0.27% of
insured deposits. Until December 31, 1999, however, SAIF member institutions
will be required to pay assessments to the FDIC at the rate of 6.5 basis points
to help fund interest payments on certain bonds issued by FICO, an agency of the
federal government established to finance takeovers of insolvent thrifts.
During this period, BIF members will be assessed for these obligations at the
rate of 1.3 basis points. After December 31, 1999, both BIF and SAIF members
will be assessed at the same rate for FICO payments.
SAIF members are generally prohibited from converting to BIF members or
merging with or transferring assets to a BIF member before the SAIF achieves the
designated reserve ratio. The FDIC, however, may approve such a transaction in
the case of a SAIF member in default or if the transaction involves an
insubstantial portion of the deposits of each participant. In addition,
mergers, transfers of assets and assumptions of liabilities may be approved by
the appropriate bank regulator so long as deposit insurance premiums continue to
be paid to the SAIF for deposits attributable to the SAIF members plus an
adjustment for the annual rate of growth of deposits in the surviving bank
without regard to subsequent acquisitions. Each depository institution
participating in a SAIF to BIF conversion transaction is required to pay an exit
fee to the SAIF and an entrance fee to the BIF. A savings institution may adopt
a commercial bank or savings bank charter if the resulting bank remains a SAIF
member.
FDIC regulations provide that any insured depository institution with a
ratio of Tier 1 capital to total assets of less than 2.0% will be deemed to be
operating in an unsafe or unsound condition, which would constitute grounds for
the initiation of termination of deposit insurance proceedings. the FDIC,
however,
24
will not initiate termination of insurance proceedings if the depository
institution has entered into and is in compliance with a written agreement with
its primary regulator, and the FDIC is a party to the agreement, to increase its
Tier 1 capital to such level as the FDIC deems appropriate. Tier 1 capital is
defined as the sum of common stockholders' equity, noncumulative perpetual
preferred stock (including any related surplus) and minority interests in
consolidated subsidiaries, minus all intangible assets other than mortgage
servicing rights and qualifying supervisory goodwill eligible for inclusion in
core capital under OTS regulations and minus identified losses and investments
in certain securities subsidiaries. Insured depository institutions with Tier 1
capital equal to or greater than 2.0% of total assets may also be deemed to be
operating in an unsafe or unsound condition notwithstanding such capital level.
The regulation further provides that in considering applications that must be
submitted to it by savings institutions, the FDIC will take into account whether
the savings institution is meeting the Tier 1 capital requirement for state non-
member banks of 4.0% of total assets for all but the most highly rated state
non-member banks.
LIMITS ON LOANS TO ONE BORROWER. The Home Owners' Loan Act ("HOLA"), as amended
by FIRREA, provides that the loans-to-one-borrower limits applicable to national
banks apply to savings associations in the same manner and to the same extent.
Previously, the Savings Bank was generally authorized to make loans to one
borrower, including related entities, in an amount equal to the lesser of 10.0%
of deposits or 100% of regulatory capital. Under the new limits, with certain
limited exceptions, loans and extensions of credit to a person outstanding at
one time generally shall not exceed 15.0% of the unimpaired capital and surplus
of the savings association. Loans and extensions of credit fully secured by
readily marketable collateral may comprise an additional 10.0% of unimpaired
capital and surplus. HOLA additionally authorizes savings associations to make
loans to one borrower, for any purpose, in an amount not to exceed $500,000 or,
by order of the Director of OTS, in an amount not to exceed the lesser of
$30,000,000 or 30% of unimpaired capital and surplus to develop residential
housing, provided: (i) the purchase price of each single-family dwelling in the
development does not exceed $500,000; (ii) the savings association is in
compliance with its fully phased-in capital requirements; (iii) the loans comply
with applicable loan-to-value requirements; and (iv) the aggregate amount of
loans made under this authority does not exceed 150% of unimpaired capital and
surplus.
The OTS has taken the position that the new loans-to-one-borrower limits do
not apply to loans and legally binding commitments outstanding as of the date of
enactment of FIRREA. However, the aggregate principal balance of loans which
exceeded the permissible limits on the effective date cannot be increased and
the institution must use its best efforts to reduce its interest therein in
order to bring such loans into compliance with the new standard. The loans-to-
one-borrower limits generally do not apply to purchase money mortgage notes
taken from the purchaser of real property acquired by the association in
satisfaction of debts previously contracted if no new funds are advanced to the
borrower and the savings institution is not placed in a more detrimental
position as a result of the sale. Management believes that the loans-to-one-
borrower limits imposed by FIRREA will not have a significant impact on the
operations of the Savings Bank.
TRANSACTIONS WITH AFFILIATES. Transactions between savings associations
and any affiliate are governed by Sections 23A and 23B of the Federal Reserve
Act. An affiliate of a savings association is any company or entity which
controls, is controlled by or is under common control with the savings
association. Generally, Sections 23A and 23B (i) limit the extent to which the
savings institution or its subsidiaries may engage in "covered transactions"
with any one affiliate to an amount equal to 10.0% of such institution's capital
stock and surplus, and contain an aggregate limit on all such transactions with
all affiliates to an amount equal to 20% of such capital stock and surplus and
(ii) require that all such transactions be on terms substantially the same, or
at least as favorable, to the institution or subsidiary as those provided to a
non-affiliate. The term "covered transaction" includes the making of loans,
purchase of assets, issuance of a guarantee and similar other types of
transactions. In addition to the restrictions imposed by Sections 23A and 23B,
no savings association may (i) loan or otherwise extend credit to an affiliate,
except for any affiliate which engages only in activities which are permissible
for bank holding companies, or (ii) purchase or invest in any stocks, bonds,
debentures, notes or similar obligations of any affiliate, except for affiliates
which are subsidiaries of the savings association.
25
Savings associations are also subject to the restrictions contained in
Section 22(h) of the Federal Reserve Act and the Federal Reserve Board's
Regulation O thereunder on loans to executive officers, directors and principal
stockholders. Under Section 22(h), loans to a director, executive officer or
greater than 10.0% stockholder of a savings association and certain affiliated
interests of the foregoing, may not exceed, together with all other outstanding
loans to such person and affiliated interests, the association's loans-to-one-
borrower limit (generally equal to 15% of the institution's unimpaired capital
and surplus) and all loans to such persons may not exceed the institution's
unimpaired capital and unimpaired surplus, unless the institution has less than
$100 million in deposits and meets or exceeds all regulatory capital
requirements in which case the aggregate limit may be increased by resolution of
the Board of Directors to no more than two times unimpaired capital and surplus.
Section 22(h) also prohibits loans, above amounts prescribed by the appropriate
federal banking agency, to directors, executive officers and greater than 10%
stockholders of a savings association, and their respective affiliates, unless
such loan is approved in advance by a majority of the board of directors of the
association with any "interested" director not participating in the voting.
Regulation O prescribes the loan amount (which includes all other outstanding
loans to such person), as to which such prior board of director approval is
required, as being the greater of $25,000 or 5.0% of capital and surplus (up to
$500,000). Further, the Federal Reserve Board pursuant to Section 22(h) requires
that loans to directors, executive officers and principal stockholders be made
on terms substantially the same as offered in comparable transactions to other
persons. Section 22(h) also prohibits a depository institution from paying the
overdrafts of any of its executive officers or directors.
Savings associations are further subject to the requirements and
restrictions of Section 22(g) of the Federal Reserve Act and Regulation O on
loans to executive officers and the restrictions of 12 U.S.C. Section 1972 on
certain tying arrangements and extensions of credit by correspondent banks.
Section 22(g) of the Federal Reserve Act requires that loans to executive
officers of depository institutions not be made on terms more favorable than
those afforded to other borrowers, requires approval for such extensions of
credit by the board of directors of the institution, and imposes reporting
requirements for and additional restrictions on the type, amount and terms of
credits to such officers. Section 1972(i) prohibits a depository institution
from extending credit to or offering any other services, or fixing or varying
the consideration for such extension of credit or service, on the condition that
the customer obtain some additional service from the institution or certain of
its affiliates or not obtain services of a competitor of the institution,
subject to certain exceptions, and (ii) prohibits extensions of credit to
executive officers, directors, and greater than 10% stockholders of a depository
institution by any other institution which has a correspondent banking
relationship with the institution, unless such extension of credit is on
substantially the same terms as those prevailing at the time for comparable
transactions with other persons and does not involve more than the normal risk
of repayment or present other unfavorable features.
REAL ESTATE LENDING POLICIES. Under OTS regulations which became effective
March 19, 1994, savings associations must adopt and maintain written policies
that establish appropriate limits and standards of extensions of credit that are
secured by liens or interests in real estate or are made for the purpose of
financing permanent improvements to real estate. These policies must establish
loan portfolio diversification standards, prudent underwriting standards,
including loan-to-value limits, that are clear and measurable, loan
administration procedures and documentation, approval and reporting
requirements. The real estate lending policies must reflect consideration of the
Interagency Guidelines for Real Estate Lending Policies (the "Interagency
Guidelines") that have been adopted by the federal bank regulators.
The Interagency Guidelines, among other things, call upon depository
institutions to establish internal loan-to-value limits for real estate loans
that are not in excess of the following supervisory limits: (i) for loans
secured by raw land, the supervisory loan-to-value limit is 65% of the value of
the collateral; (ii) for land development loans (i.e., loans for the purpose of
improving unimproved property prior to the erection of structures), the
supervisory limit is 75%; (iii) for loans for the construction of commercial,
multi-family or other nonresidential property, the supervisory limit is 80%;
(iv) for loans for the construction of one- to four-family properties, the
supervisory limit is 85%; and (v) for loans secured by other improved property
(e.g., farmland, completed commercial property and other income-producing
property including non-owner-
26
occupied, one- to four-family property), the limit is 85%. Although no
supervisory loan-to-value limit has been established for owner-occupied, one-to
four-family and home equity loans, the Interagency Guidelines state that for any
such loan with a loan-to-value ratio that equals or exceeds 90% at origination,
an institution should require appropriate credit enhancement in the form of
either mortgage insurance or readily marketable collateral.
STANDARDS FOR SAFETY AND SOUNDNESS. Under FDICIA, each federal banking
agency is required to prescribe, by regulation, non-capital safety and soundness
standards for institutions under its authority. The federal banking agencies,
including the OTS, have recently adopted standards covering internal controls,
information systems and internal audit systems, loan documentation, credit
underwriting, interest rate exposure, asset growth, compensation, fees, and
benefits, and standards for asset quality and earnings sufficiency. An
institution which fails to meet any of these standards would be required to
develop a plan acceptable to the agency, specifying the steps that the
institution will take to meet the standards. Failure to submit or implement
such a plan may subject the institution to regulatory sanctions. The Savings
Bank has not been advised that it does not meet the standards which have been
adopted.
PROMPT CORRECTIVE REGULATORY ACTION. FDICIA requires the federal banking
regulators to take prompt corrective action if an institution failed to satisfy
certain minimum capital requirements. Under FDICIA, capital requirements
include a leverage limit, a risk-based capital requirement, and any other
measure deemed appropriate by the federal banking regulators for measuring the
capital adequacy of an insured depository institution. All institutions,
regardless of their capital levels, are restricted from making any capital
distribution or paying any management fees that would cause the institution to
become undercapitalized. An institution that fails to meet the minimum level for
any relevant capital measure (an "undercapitalized institution") generally is:
(i) subject to increased monitoring by the appropriate federal banking
regulator; (ii) required to submit an acceptable capital restoration plan within
45 days; (iii) subject to asset growth limits; and (iv) required to obtain prior
regulatory approval for acquisitions, branching and new lines of businesses.
The capital restoration plan must include a guarantee by the institution's
holding company that the institution will comply with the plan until it has been
adequately capitalized on average for four consecutive quarters, under which the
holding company would be liable up to the lesser of 5.0% of the institution's
total assets or the amount necessary to bring the institution into capital
compliance as of the date it failed to comply with its capital restoration plan.
A significantly undercapitalized institution, as well as any undercapitalized
institution that does not submit an acceptable capital restoration plan, may be
subject to regulatory demands for recapitalization, broader application of
restrictions on transactions with affiliates, limitations on interest rates paid
on deposits, asset growth and other activities and possible replacement of
directors and officers. The senior executive officers of a significantly
undercapitalized institution may not receive bonuses or increases in
compensation without prior approval and the institution is prohibited from
making payments of principal or interest on its subordinated debt, with certain
exceptions. If an institution's ratio of tangible capital to total assets falls
below a level established by the appropriate federal banking regulator, which
may not be less than 2.0% of total assets nor more than 65% of the minimum
tangible capital level otherwise required (the "critical capital level"), the
institution will be subject to conservatorship or receivership within 90 days
unless periodic determinations are made that forbearance from such action would
better protect the deposit insurance fund. Unless appropriate findings and
certifications are made by the appropriate federal bank regulatory agencies, a
critically undercapitalized institution must be placed in receivership if it
remains critically undercapitalized on average during the calendar quarter
beginning 270 days after the date it became critically undercapitalized. If a
savings association is in compliance with an approved capital plan on the date
of enactment of FDICIA, however, it is not required to submit a capital
restoration plan if it is undercapitalized, and it will not be subject to the
restrictions applicable to significantly and critically undercapitalized
institutions prior to July 1, 1994.
The OTS has adopted regulations implementing the prompt corrective action
provisions of FDICIA. Under the regulations, the OTS will measure a savings
institution's capital adequacy on the basis of its total risk-based capital
ratio (the ratio of its total capital to risk-weighted assets), Tier 1 risk-
based capital ratio (the ratio of its core capital to risk-weighted assets) and
leverage ratio (the ratio of its core capital to adjusted total assets). A
savings institution that is not subject to an order or written directive to meet
or maintain a specific capital level will be deemed "well capitalized" if it
also has: (i) a total risk-based capital
27
ratio of 10% or greater; (ii) a Tier 1 risk-based capital ratio of 6.0% or
greater; and (iii) a leverage ratio of 5.0% or greater. An "adequately
capitalized" savings institution is a savings institution that does not meet the
definition of well capitalized and has: (i) a total risk-based capital ratio of
8.0% or greater; (ii) a Tier 1 capital risk-based ratio of 4.0% or greater; and
(iii) a leverage ratio of 4.0% or greater (or 3.0% or greater if the savings
institution has a composite 1 CAMEL rating). An "Undercapitalized institution"
is a savings institution that has (i) a total risk-based capital ratio less than
8.0%; or (ii) a Tier 1 risk-based capital ratio of less than 4.0%; or (iii) a
leverage ratio of less than 4.0% (or 3.0% if the institution has a composite 1
CAMEL rating). A "significantly undercapitalized" institution is defined as a
savings institution that has: (i) a total risk-based capital ratio of less than
6.0%; or (ii) a Tier 1 risk-based capital ratio of less than 3.0%; or (iii) a
leverage ratio of less than 3.0%. A "critically undercapitalized" savings
institution is defined as a savings institution that has a ratio of "tangible
equity" to total assets of less than 2.0%. Tangible equity is defined as core
capital minus cumulative perpetual preferred stock (and related surplus) less
all intangibles other than qualifying supervisory goodwill and certain purchased
mortgage servicing rights. The OTS may reclassify a well capitalized savings
institution as adequately capitalized and may require an adequately capitalized
or undercapitalized institution to comply with the supervisory actions
applicable to institutions in the next lower capital category if the OTS
determines, after notice and an opportunity for a hearing, that the savings
institution is in an unsafe or unsound condition or that the institution has
received and not corrected a less-than-satisfactory rating for any CAMEL rating
category. The Savings Bank is classified as "adequately capitalized" under the
new regulations.
FEDERAL RESERVE SYSTEM. Pursuant to regulations of the Federal Reserve
Board, a thrift institution must maintain average daily reserves equal to 3% on
the first $49.3 million of net transaction accounts, plus 10% on the remainder.
These percentages are subject to adjustment by the Federal Reserve Board.
Because required reserves must be maintained in the form of vault cash or in a
non-interest bearing account at a Federal Reserve Bank, the effect of the
reserve requirement is to reduce the amount of the institution's interest-
earning assets. As of December 31, 1996, the Savings Bank met its reserve
requirements.
CAPITAL DISTRIBUTION REGULATIONS. Federal regulations impose certain
limitations on the payment of dividends and other capital distributions
(including stock repurchases and cash mergers) by the Savings Bank. Under these
regulations, a savings institution that, immediately prior to, and on a pro
forma basis after giving effect to, a proposed capital distribution, has total
capital (as defined by OTS regulation) that is equal to or greater than the
amount of its fully phased-in capital requirements (a "Tier 1 Association") is
generally permitted, after notice but without OTS approval, to make capital
distributions during a calendar year in the amount equal to the higher of 75% of
its net income over the most recent four-quarter period, or up to 100% of is net
income to date during the calendar year plus an amount that would reduce by one-
half the amount by which its total capital exceeded its fully phased-in capital
to assets ratio at the beginning of the calendar year. A savings institution
with total capital in excess of current minimum capital requirements but not in
excess of the fully phased-in requirements (a "Tier 2 Association") is permitted
to make capital distributions without OTS approval of up to 75% of its net
income for the previous four quarters, less dividends already paid for such
period depending on the savings institution's level of risk-based capital. A
savings institution that fails to meet current minimum capital requirements (a
"Tier 3 Association") is prohibited from making any capital distributions
without the prior approval of the OTS. Tier 1 Associations that have been
notified by the OTS that they are in need of more than normal supervision will
be treated as either a Tier 2 or Tier 3 Association. At December 31, 1996, the
Savings Bank exceeded its fully phased-in capital requirements.
FEDERAL AND STATE TAXATION
- --------------------------
FEDERAL TAXATION. Bank holding companies and thrift institutions are subject
to the provisions of the Internal Revenue Code of 1986, as amended (the "Code")
in the same general manner as other corporations. However, institutions such as
Baltimore American which met certain definitional tests and other conditions
prescribed by the Code formerly benefited from certain favorable provisions
regarding their deductions from taxable income for annual additions to their bad
debt reserve. For purposes of the bad debt reserve deduction, loans were
separated into "qualifying real property loans," which generally are loans
28
secured by certain interests in real property, and "nonqualifying loans," which
are all other loans. The bad debt reserve deduction with respect to
nonqualifying loans was based on actual loss experience. The amount of the bad
debt reserve deduction with respect to qualifying real property loans was
required to be based upon either (a) actual loss experience or (b) a percentage
of taxable income before such deduction.
QFH files its consolidated federal income tax returns on a calendar year
basis. The Savings Bank has historically elected to use the method which has
resulted in the greatest tax deduction.
Earnings appropriated to Baltimore American's bad debt reserve and claimed as
a tax deduction are not available for the payment of cash dividends or for
distribution to stockholders (including distributions made on dissolution or
liquidation), unless the Savings Bank includes the amount in taxable income,
along with the amount deemed necessary to pay the resulting federal income tax.
Legislation recently signed by the President repealed the percentage of
taxable income method of calculating the bad debt reserve. Savings associations,
like the Savings Bank, which have previously used that method are required to
recapture into taxable income post-1987 reserves in excess of the reserves
calculated under the experience method over a six-year period beginning with the
first taxable year beginning after December 31, 1995. The start of such
recapture may be delayed until the third taxable year beginning after December
31, 1995 if the dollar amount of the institution's residential loan originations
in each year is not less than the average dollar amount of residential loans
originated in each of the six most recent years disregarding the years with the
highest and lowest originations during such period. For purposes of this test,
residential loan originations would not include refinancings and home equity
loans. The Savings Bank has provided deferred taxes for the amount of the
recapture.
Beginning with the first taxable year beginning after December 31, 1995,
savings institutions, such as the Savings Bank, will be treated the same as
commercial banks. Institutions with $500 million or more in assets will only be
able to take a tax deduction when a loan is actually charged off. Institutions
with less than $500 million in assets will still be permitted to make deductible
bad debt additions to reserves, but only using the experience method.
STATE TAXATION. QFH is subject to the provisions of the Maryland Income Tax
Code in the same general manner as other corporations. The Maryland code does
not permit consolidated returns. The State of Maryland imposes a franchise tax
upon thrift institutions computed at a rate of 7% of the net earnings of the
thrift institution. For the purpose of the 7% franchise tax, net earnings are
defined as the net income of the thrift institution as determined for federal
corporate income tax purposes, plus (i) interest income from obligations of the
United States, of any state, including Maryland and of any county, municipal or
public corporation authority, special district or political subdivision of any
state, including Maryland, and (ii) any profit realized from the sale or
exchange of bonds issued by the State of Maryland or any of its political
subdivisions.
EMPLOYEES
- ---------
As of December 31, 1996, Baltimore American had 14 full-time and no part-time
employees. The employees are not represented by a collective bargaining unit.
The Savings Bank believes its relationship with its employees to be good.
EXECUTIVE OFFICERS OF QFH
- -------------------------
RICHARD W. KRAUS, age 41, has been with the Savings Bank since November 1988
and became President and Chief Executive Officer (CEO) of the Savings Bank in
December 1990. From November 1988 to December, 1990 he had served as Executive
Vice President of Operations. He has served as a Director since December 16,
1988. In 1995, Mr. Kraus was presented the President's Citation in recognition
of his commitment to building strong communities and the City of Baltimore
Mayor's Citation for his contributions to the civic welfare of Baltimore's
municipality and his continuing public service.
29
Elisa S. Conn has been with the Bank since December 1988, and served as
Administrator of Lending and Chief Underwriter. In November 1993, Ms. Conn was
promoted to Vice President of the Bank. Ms. Conn has an FHA direct endorsement
and is VA automatic underwriter for the Bank. Ms. Conn has a diverse background
in all aspects of banking, as well as in mortgage banking.
ITEM 2. PROPERTIES
- -------------------
Baltimore American's office, located at 4023 Annapolis Road in Baltimore,
Maryland, was opened in 1956 and has 3,725 square feet. This facility is owned
by the Savings Bank.
Baltimore American's origination offices, located at 609 Bosley Avenue in
Towson, Maryland, and 14300 Gallant Fox Lane, Bowie, Maryland, were opened in
February and November, 1993, and have 900 square feet and 1100 square feet,
respectively. These facilities are leased by the Savings Bank. During the first
quarter 1995, Baltimore American opened an additional loan origination office
located at 2708 Dillon Street, Baltimore, Maryland.
The Savings Bank owns various computer equipment pertaining to mortgage
banking and servicing divisions, and bookkeeping and accounting equipment and
utilizes the services of the NCR Corporation, Columbia, Maryland for its data
processing needs.
ITEM 3. LEGAL PROCEEDINGS
- --------------------------
Baltimore American is not engaged in any legal proceedings of a material
nature at the present time. From time to time it is a party to legal proceedings
in the ordinary course of business.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
- ------------------------------------------------------------
No matters were submitted to a vote of security holders during the fourth
quarter of the fiscal year ended December 31, 1996.
PART II
ITEM 5. MARKET FOR THE REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER
- --------------------------------------------------------------------------
MATTERS
- -------
At the present time, there is not an established market in which shares of
QFH's capital stock are regularly traded, nor are there any uniformly quoted
prices for the trading of such shares. However, during 1996, trades known to the
Savings Bank's management have occurred at prices at and between $8.50-$9.50 per
share. As of December 31, 1996, the Savings Bank had 108 stockholders.
During 1995 and 1994, prior to the formation of QFH, the Savings Bank paid
dividends totalling $0.13 per share and $0.26 per share respectively. No
dividends were paid subsequent to the reorganization. While no assurance can be
given that QFH will experience results of operations sufficient to enable the
payment of dividends to stockholders, it is the intention of the Board of
Directors to pay small dividends in any year in which earnings exceed the on-
going regulatory and economic needs for increased capital.
30
ITEM 6. SELECTED FINANCIAL DATA
- --------------------------------
At December 31,
-------------------------------------------------------------------------------
1996 1995 1994 1993 1992
--------------- --------------- -------------- -------------- -------------
Total interest income $ 2,192,887 $ 2,168,166 $ 2,135,458 $ 2,168,003 $ 2,119,364
Total interest expense 1,398,965 1,280,554 1,039,975 1,123,010 1,313,698
Net income (loss) (366,248) (298,205) 127,636 251,153 202,187
Loans receivable, net 20,473,502 22,006,556 20,390,223 18,064,426 19,866,153
Investment Securities 920,187 564,927 450,387 565,621 545,519
Total assets 27,341,505 28,983,726 27,017,858 27,129,235 25,637,737
Deposits 24,889,630 24,546,708 21,786,784 22,581,433 23,036,228
Federal Home Loan Bank
advances 450,000 2,000,000 2,500,000 1,800,000 --
Other borrowings 18,000 27,000 36,000 45,000 54,000
/1/Regulatory capital 1,764,775 2,102,334 2,555,486 2,752,725 2,246,119
Total number of branches 1 1 1 1 1
Total number of loan
origination offices 4 4 3 2 1
___________________________
/1/ Regulatory capital represents core capital as defined under the OTS risk-
based capital guidelines for the years ended December 31, 1992 through
1996. The risk-based capital guidelines required savings banks to maintain
total capital equal to 6.4% of risk-weighted assets until December 30,
1990; then 7.2% until December 31, 1993 and will now remain at 8.0% of
risk-weighted assets.
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
- --------------------------------------------------------------------------------
OF OPERATIONS
- -------------
INTRODUCTION
Baltimore American was chartered by the State of Maryland in October 1956,
and on July 31, 1987 received a federal charter for conversion to a federal
mutual savings bank. On July 29, 1988, the Savings Bank was converted to a
federal stock savings bank, known as Baltimore American Savings Bank, F.S.B. On
July 12, 1995, the Savings Bank was party to a reorganization which resulted in
the formation of QFH and the Savings Bank became the sole subsidiary of QFH.
Baltimore American's mission is to provide people with a safe place to deposit
their money, to provide a means for transferring their money in an efficient
manner and to prudently satisfy their financial needs. This mission helps to
assure that the collective wealth of the Savings Bank's community is put to
efficient use in a safe way. QFH and the Savings Bank are located at 4023
Annapolis Road, Baltimore, Maryland.
31
Baltimore American performs its basic functions by attracting deposits from
the general public and originating mortgage loans on owner-occupied single
family residences, non-owner occupied investment properties, and to a lesser
extent on commercial real estate. Baltimore American also makes loans for the
construction of residential and commercial properties, consumer loans, and
commercial business loans. The principal sources of funds for Baltimore
American's lending activities include deposits received from the general public,
principal amortization and prepayment of loans and borrowings from the FHLB of
Atlanta and other sources. Baltimore American's primary sources of income are
interest on loans and investments, and revenues on loans originated for
investors in the secondary market. Baltimore American invests in various federal
and government agency obligations and other investment securities permitted by
applicable laws and regulations. Baltimore American's principal expenses are
interest paid on deposit accounts and borrowings, and normal operating expenses.
Baltimore American's operations are conducted through its headquarters and
main branch located at 4023 Annapolis Road, Baltimore, Maryland and loan
origination offices located at 609 Bosley Avenue, Towson, Maryland, 14300
Gallant Fox Lane, Bowie, Maryland and 2708 Dillon Street, Baltimore, Maryland.
This discussion should be read in conjunction with the consolidated financial
statements and the selected financial data presented elsewhere in this annual
report. Management's discussion concerns the general business dynamics of
banking as well as the Savings Bank's financial condition and results of
operations.
ANNUAL OVERVIEW
As of December 31, 1996, QFH posted a $366,248 loss as compared to a loss of
$298,205 and net income of $127,636 in 1995 and 1994, respectively.
The decline in earnings in 1994 was primarily the result of the drastic
decline in mortgage originations by the Savings Bank. In 1995, the Savings Bank
made a significant provision for loan losses in relation to its high level of
nonperforming assets which, in conjunction with the decline in mortgage
originations, impacted earnings. In 1996, the Company incurred a before-tax
charge of $138,941 as the result of the imposition of a special assessment by
the FDIC to recapitalize the Savings Association Insurance Fund (SAIF), which
significantly impacted earnings. The Savings Bank made a significant provision
for loan losses as well, which further impacted earnings. Although management
and the Board have made and will continue to make extraordinary efforts in the
disposition of the real estate owned, the results are obscured and will continue
to be obscured until the real estate owned is sold.
While no assurances as to future success can be made, Management and the
Board of Directors believe that the current problems facing the Savings Bank can
only be resolved over time and they will continue their strategic plan to bring
success to the Savings Bank in the future.
FINANCIAL CONDITION
Total assets decreased by $1,642,221 or 5.6% during 1996 primarily due to the
decrease in loans receivable, net, which was the result of a decrease in the
number of loans originated in the Savings Bank's portfolio and early loan
payoffs. "Table 10. Utilization of Assets" exhibits for the periods indicated
certain consolidated balance sheet items related to the financial structure of
Baltimore American.
The decrease in cash and due from banks is primarily due to the
reclassification of $298,000 in CD's from cash and cash equivalents to nonliquid
investments and a $201,962 or 82.8% decrease in the Bank's account at the
Federal Reserve. This account is used for cash deposits and withdrawals for most
of the Bank's deposit and lending activities. Therefore, the balance in this
account is sensitive to the level and timing of transactions in the last few
days of the year.
32
- --------------------------------------------------------------------------------
TABLE 10
Utilization of Assets
- --------------------------------------------------------------------------------
1996 1995 Difference
----------- ----------- --------------------
Cash and due from banks $ 450,230 $ 1,063,563 $ (613,633) (57.7)%
Federal funds sold 465,530 509,018 (43,488) ( 8.5)
Investment securities 920,187 564,927 355,260 62.9
Loans receivable, net 20,473,502 22,006,556 (1,533,054) (6.9)
Secondary market funding receivable 522,763 525,732 (2,969) (0.5)
Foreclosed real estate 2,910,493 2,787,875 122,618 4.4
Other assets 1,598,800 1,526,055 72,745 4.7
----------- ----------- ----------- ------
$27,341,505 $28,983,726 $(1,642,221) (5.6)%
=========== =========== =========== ======
- --------------------------------------------------------------------------------
The slight decrease in secondary market funding receivable is primarily the
result of the level and timing of transactions with the investor.
In 1996, loan originations increased by approximately 26% from 1995. This
increase was the result of concentrating originations in the areas of
nonconforming paper, which is typcially more risky than conforming paper but
which risk is mitigated by little or no recourse to the originator.
Nonconforming paper in the mortgage industry are loans that do not conform to
Fannie Mae, Freddie Mac, FHA and VA guidelines. The Savings Bank will continue
this trend of originating nonconforming paper during 1997 and expects an
increased in the level of activity over 1996. The secondary market receivable
consists of residential mortgage loans originated for the secondary market,
under previously arranged purchase agreements, and are typically collected
within 30 days of closing. In 1995, the loan origination volume decreased by 50%
from 1994 from the impact of the devastating decline in the real estate
residential mortgage market. The decreased activity was primarily the result of
two factors. First was the significant lack of demand for residential mortgage
refinancing after the 1993 boom. Second was the lack of demand for new home
purchases generated by the fear associated with high levels of unemployment in
our primary lending markets.
As of December 31, 1996, foreclosed real estate consists of $1,307,098,
representing a strip shopping center and commercial land; and $1,603,395 in
foreclosed residential properties, compared to $1,524,583 and $1,425,217
respectively as of December 31, 1995 and 1994. The slight increase of $122,618
or 4.4% in foreclosed real estate is the result of foreclosing on three
additional residential properties within the Baltimore City/County market and
the renovation of previously acquired real estate owned properties in
preparation for disposition.
Prior to June 18, 1993, the Bank was a participant in a commercial loan
secured by certain commercial real estate known as Sheridan Station Shopping
Center (Sheridan Station). The Bank owned a 61% interest in the loan and United
Savings Bank (United), the lead lender, owned the remaining 39% interest.
33
On June 18, 1993, United and Baltimore American foreclosed on the property as
a result of the borrowers' failure to pay in accordance with the applicable loan
agreement. At that time, the Bank took its proportional 61% interest in Sheridan
Station. On July 30, 1990, United was declared insolvent by the Office of Thrift
Supervision and its assets, including its 39% interest in Sheridan Station, were
turned over to the Resolution Trust Corporation (RTC) for disposition. On June
25, 1993, the Bank acquired the RTC's 39% interest in Sheridan Station for
$174,890. As a result of this transaction, the Bank became the sole owner of the
property.
As of December 31, 1996, the center was seventy-two percent (72%) leased.
During 1996, the center generated operating income of $215,342 and operating
expenses of $101,130, for a pre-tax income of $114,211, which is included as
other operating income in the consolidated statement of operation for the year
ended December 31, 1996. During 1995, the center generated operating income of
$147,669 and operating expenses of $69,479, for a pre-tax income of $78,190,
which is included as other operating income in the accompanying consolidated
statement of operation for the year ended December 31, 1995. During 1994, the
center generated operating income of $170,820 and operating expenses of $105,596
for a pre-tax income of $65,224.
Management is actively marketing this property. Management intends to sell
the property as soon as a viable buyer is identified. However, no assurance can
be made that a sale will be consummated or that losses on the sale or from
operations prior to the sale will not be realized. Management, after reviewing
appraisals of the property, believes that an adequate allowance for any
potential losses on the ultimate sale of the property has been provided as of
December 31, 1996.
In addition, the Savings Bank's $1,185,207 investment in Sheridan Station
must be deducted from total capital beginning in June 1998. If the Savings Bank
were required to deduct Sheridan Station from total capital, the Savings Bank
would no longer be in compliance with OTS risk-based capital requirements and
would become subject to significant restrictions on its operations. Depending on
its capital levels at the time, the Savings Bank could become subject to more
severe sanctions including conservatorship or receivership which would generally
result in a complete loss of the Company's investment in the Savings Bank.
Although management of the Savings Bank is working to dispose of its foreclosed
properties and to resolve its nonperforming assets, stockholders should be aware
that the future results of operations of the Savings Bank, its compliance with
regulatory capital requirements and its ability to continue as a going concern
are all subject to the satisfactory disposition of these foreclosed properties
and nonperforming assets.
The increase in foreclosed properties is a result of an increase in
foreclosures resulting from the continuing economic difficulties in the Savings
Bank's primary service area. Management and the Board of Directors believe that
these local economic difficulties will continue in the immediate future. As a
result, it is likely that the Bank will continue to experience high levels of
nonperforming assets. As of December 31, 1996, Management and the Board of
Directors believe that the allowance for loan losses is adequate to absorb
future losses resulting from current economic conditions. However, no assurance
can be given that future losses on loans outstanding at December 31, 1996, will
not exceed the allowance provided at that date.
Total liabilities decreased by $1,284,973 or 4.80% during 1996 primarily due
to the repayment of advances in the amount of $1,550,000 to Federal Home Loan
Bank (see "Table 11. Source of Funds").
Deposits remained relatively stable as a result of Management attempting to
maintain the yields paid on deposits as other institutions raised their yields.
34
- --------------------------------------------------------------------------------
TABLE 11
Source of Funds
- --------------------------------------------------------------------------------
1996 1995 Difference
----------- ----------- ---------------------
Deposits $24,889,630 $24,546,708 $ 342,922 1.39%
Accrued expenses 89,887 203,431 (113,544) (55.81)
Other liabilities 63,149 18,500 44,649 241.35
Advances from FHLB 450,000 2,000,000 (1,550,000) (77.50)
Other borrowed money 18,000 27,000 (9,000) (33.33)
----------- ----------- ----------- ------
$25,510,666 $26,795,639 $(1,284,973) (4.80)%
=========== =========== =========== ======
- --------------------------------------------------------------------------------
Advances from the Federal Home Loan Bank represents a $3,000,000 line of
credit which is secured by a portion of the Bank's residential mortgage
portfolio. Management uses this line of credit from time to time to fund short-
term liquidity needs arising from the secondary market origination activities as
well as a back-up liquidity source to meet depositor needs. As of December 31,
1996 and 1995, there were advances of $450,000 and $2,000,000, respectively. The
effective interest rate was 6.95% and 6.10%, the maximum outstanding balance was
$759,178 and $2,500,000, and the average outstanding balance was $160,574 and
$2,458,333 for the years ended December 31, 1996 and 1995, respectively.
Liquidity
Adequate liquidity must be maintained to fund deposit withdrawals, to meet
customers' borrowing needs, to take advantage of investment opportunities, to
fund closings of mortgages originated for the secondary market, and to maintain
the required levels of reserves. On the asset side, the primary sources of
liquidity are interest bearing deposits with other banks, federal funds sold,
and scheduled repayments on outstanding loans. On the liability side, the
primary sources of liquidity are deposit growth and the line of credit with the
Federal Home Loan Bank.
Management evaluates the Savings Bank's liquidity position on a daily basis
to maintain a level conducive to efficient operations and to satisfy regulatory
requirements. Attention is directed primarily to assets and liabilities that
mature or can be repriced within a period of 30 to 365 days. The Savings Bank
matches the maturities, to the extent possible, of its assets and liabilities to
minimize variability in net interest income; this practice helps to minimize
interest rate risk. Prudent risks are taken, however, by leaving certain assets
and liabilities unmatched in an effort to benefit from the interest rate
sensitivity inherent in the U.S. monetary system.
The minimum regulatory required level of long-term liquidity is currently 5%
of total deposits and borrowed money; the minimum required level of short-term
liquidity is 1%. The liquidity level of Baltimore American, as measured for
regulatory purposes, was 7% at December 31, 1996, for both the long-term and
short-term regulatory requirements. Management believes the Savings Bank can
meet its obligations of outstanding loan commitments and at the same time
maintain liquidity in excess of the minimum regulatory requirement without
having to borrow funds.
35
Asset/Liability Management
The concept of asset/liability management originated when rising interest
rates in the 1970's produced drastically lower margins and reduced earnings of
banks throughout the country, which continued into the 1980's. It is important
to stress that this concept is not just a "tool of management" but is the
essence of successfully operating a financial institution. Interest rate
sensitivity is a primary and vital component of asset/liability management, but
is not the sole determinant in operating a profitable savings bank.
Management has attempted to develop and implement effective Asset/Liability
Management policies. Predicting changes in interest rate margins caused by
changes in general interest rates is a very imprecise art, primarily due to the
perception of the customer. Whether interest rates move up or down, the customer
will make changes in deposit and loan accounts for his own economic benefit. Due
to this uncontrollable variable, Management attempts to operate the Savings Bank
within self-imposed interest rate risk limits.
When outside these limits, Management tries to bring the asset/liability mix
back into line by increasing or restricting the number of fixed-rate loans, by
initiating 3-5 year calls on fixed loans, using adjustable mortgages, adjusting
maturities on investments or changing the liability (deposit) mix.
Capital Resources
In 1996, QHF's capital position was $1,764,775 as compared to a capital
position of $2,102,334 in 1995. This decrease in capital was the direct result
of a $366,248 loss in net income primarily attributable to the after tax charge
of $138,941 resulting from the imposition of a special assessment by the FDIC to
recapitalize the Savings Association Insurance Fund (SAIF) and the significant
provision for loan losses. "Table 12. Return on Equity and Assets" summarizes
the 1996 and 1995 results of operation.
- --------------------------------------------------------------------------------
TABLE 12
Return on Equity and Assets
- --------------------------------------------------------------------------------
1996 1995 1994
-------- ------- -----
Return (Loss) on assets (1.34)% (1.03)% 0.5 %
Return (Loss) on Stockholders'
Equity (17.42) (13.63) 5.0
Stockholders' equity as a percentage
of assets 6.7 7.6 9.5
Dividend payout ratio -- -- 23.3
- --------------------------------------------------------------------------------
Under OTS capital regulations, the Savings Bank may be required to deduct the
amount of its investment in foreclosed property from total capital if such
property has not been disposed of within five years of their acquisition unless
the OTS grants an extension of time for the dispostion of such properties. At
December 31, 1996, the Savings Bank was required to deduct $211,853 in
investment in forecosed real estate from total capital because such property has
been held for more than five years.
36
As of December 31, 1996, the most recent notification from the OTS categorized
the Savings Bank as adequately capitalized under the regulatory framework for
prompt corrective action. There are no conditions or events since that
notification that Management believes have changed the institution category.
Baltimore American exceeds all the regulatory requirements for capital.
Management continually reviews and identifies areas of growth opportunity. The
various methods for generating equity from internal and external sources are
constantly under review to ascertain the most effective approach for the Savings
Bank.
RESULTS OF OPERATIONS
In 1996, Baltimore American reported a net loss of $366,248, compared to a net
loss of $298,205 and net income of $127,636 for 1996 and 1995 respectively. The
higher net loss for QFH is primarily attributable to the before-tax charge of
$138,941 (as the result of the imposition of a special assessment by the FDIC to
recapitalize the SAIF). an increase in interest paid on deposits and short-term
borrowings, an increase in the provision for loan loss, and a significant
increase in other operating expenses. Stockholders lost $3.43 per share of
common stock for the year ended December 31, 1996, as compared to a loss of
$2.69 and earnings of $1.12 per share of common stock in 1995 and 1994
respectively.
"Table 13. Operations Items" on the following page exhibits for the periods
indicated certain consolidated statement of operations items which contributed
to the decrease in stockholders' equity.
Net Interest Income
Net interest income is the foundation of Baltimore American's earnings,
representing the difference between total interest and fees earned on all loans,
investments and other interest earning assets, and the total interest paid on
deposits and borrowings.
Net interest income for 1996 decreased by $93,690 or 10.55%, as compared with
a decrease of $207,871 or 18.98% for 1995. The decrease in net interest income
is the direct result of the increase in yields paid on deposits and short-term
borrowings and the impact on interest income resulting from nonperforming loans.
Interest income for 1996 increased moderately as a direct result of the
increase in interest on federal funds sold. As of December 31, 1996, $643,057
of the Savings Bank's loan portfolio was accounted for on a nonaccrual basis, in
comparison to $307,794 in 1995. Loans accounted for on the accrual basis but
which were contractually 90 days or more past due were $1,378,084. The primary
reason for the increase in nonperforming loans was the general economic
condition of the Savings Bank's market area. According to the Regional Economic
Studies Institute of Towson State University, the Baltimore area's economy grew
significantly slower than the national economy over the past six years. The
Baltimore area had a negative growth of -1.82% as compared with a 7.12% positive
growth factor for the nation. If these nonperforming loans had performed in
accordance with their contractual terms, additional interest income of $43,362
for 1996, $89,398 for 1995, and $111,733 for 1994 would have been recognized.
Interest expense increased $118,411 or 9.25% during 1996 compared to an
increase of $240,579 or 23.13% during 1995. The increase in interest expense is
directly attributable to the increase in the yields paid on deposits and short-
term borrowings.
37
- --------------------------------------------------------------------------------
TABLE 13
Summary of Operations Items
- --------------------------------------------------------------------------------
1996 1995 Difference 1995 1994 Difference
----------- ----------- ------------------- ---------- ---------- -------------------
INTEREST INCOME:
Interest and fees on loans $2,006,454 $2,036,975 $ (30,521) (1.50)% $2,036,975 $1,979,118 $ 57,857 2.92%
Other interest income 186,433 131,191 55,242 42.11 131,191 156,340 (25,149) (16.09)
---------- ---------- --------- ------ ---------- ---------- --------- ------
2,192,887 2,168,166 24,721 1.14 2,168,166 2,135,458 32,708 1.53
---------- ---------- --------- ------ ---------- ---------- --------- ------
INTEREST EXPENSE:
Interest on deposits 1,384,193 1,119,063 265,130 23.69 1,119,063 983,712 135,351 13.76
Other interest expense 14,772 161,491 (146,719) (90.85) 161,491 56,263 105,228 187.03
---------- ---------- --------- ------ ---------- ---------- --------- ------
1,398,965 1,280,554 118,411 9.25 1,280,554 1,039,975 240,579 23.13
---------- ---------- --------- ------ ---------- ---------- --------- ------
PROVISION FOR LOAN LOSSES 143,674 585,918 (442,244) (75.47) 585,918 132,431 453,487 342.43
---------- ---------- --------- ------ ---------- ---------- --------- ------
OTHER INCOME:
Fees on loans originated for others 115,179 91,317 23,862 26.13 91,317 192,928 (101,611) 52.67
Other operating income 272,559 177,774 94,785 53.32 177,774 135,558 42,216 31.14
---------- ---------- --------- ------ ---------- ---------- --------- ------
387,738 269,091 118,647 44.09 269,091 328,486 (59,395) (18.08)
---------- ---------- --------- ------ ---------- ---------- --------- ------
OTHER EXPENSES:
Salaries, benefits and payroll taxes 533,014 531,669 1,345 0.25 531,669 542,872 (11,203) (2.06)
Other operating expenses 936,692 595,321 341,371 57.34 595,321 552,474 42,847 7.76
---------- ---------- --------- ------ ---------- ---------- --------- ------
$1,469,706 $1,126,990 $ 342,716 30.41% $1,126,990 $1,095,346 $ 31,644 2.89%
---------- ---------- --------- ------ ---------- ---------- --------- ------
- --------------------------------------------------------------------------------
Provision for Loan Losses
In recognition of the nonperforming loans, and the inherent risk in lending,
Management has established an allowance for loan losses. The allowance for loan
losses is a reserve of funds established to absorb potential loan losses after
evaluating the asset portfolio (current economic conditions, changes in the
nature and volume of lending, and past loan loss experience, as well as other
factors). The provision for loan losses is further elaborated in Note 1. Loans
and Allowances for Loan Losses. The provision for loan losses for the year
ended December 31, 1996 was $143,674, compared to $585,918 and $132,431 for the
years ended December 31, 1995 and 1994, respectively. "Table 14. Summary of
Loan Loss Experience" illustrates Baltimore American's loan loss experience for
the years ended December 31, 1996 and 1995.
- --------------------------------------------------------------------------------
TABLE 14
Summary of Loan Loss Experience
- --------------------------------------------------------------------------------
1996 1995
--------- ---------
Balance, January 1 $ 447,226 $ 175,824
Charge-offs (251,734) (321,458)
Recoveries 27,496 6,942
--------- ---------
Net charge-offs (224,238) (314,516)
Provision charged to expense 143,674 585,918
--------- ---------
Balance, December 31 $ 366,662 $ 447,226
========= =========
Net charge-offs to average loans outstanding 1.06% 1.43%
========= =========
- --------------------------------------------------------------------------------
The allowance for loan losses was 1.79% and 2.03% of total loans outstanding
as of December 31, 1996 and 1995, respectively. The increase in the provision
for loan losses in 1996 is primarily due to Management and the Board of
Directors' continuing efforts to establish prudent reserves as a result of the
soft real estate market, poor local economic conditions and the current
regulatory environment, in which the regulators have applied conservative
criteria in assessing the adequacy of the provisions for possible loan losses.
This reserve also provides for a contingency against the number of nonaccrual
loans. Management and the Board of Directors believe the current level of loan
loss reserves are adequate in comparison to the risk of the asset portfolio.
Other Income
Other income increased by $118,647 or 44.09% in 1996 compared to a decrease
of $59,395 or 18.08% in 1995. Fees on loans originated for others increased by
$23,862 or 26.13% compared to a decrease of $101,611 or 52.67%. The primary
reason for the increase in revenues is the result of concentrating originations
in the areas of nonconforming paper, which is typically more risky than
conforming paper but which risk is mitigated by little or no recourse to the
originator.
39
Other operating income increased $94,785 or 53.32% as compared to an increase
of $42,216 or 31.14% in 1995. Other income increased as a result of net
operating income in the amount of $114,211 generated by the operation of
Sheridan Station as discussed above, an increase in customer service fees, and
the gain on the sale of real estate owned.
Other Expense
Other expense increased significantly by $342,716 or 30.41% in 1996 as
compared to an increase of $31,644 or 2.89% in 1995. This significant increase
is the result of imposed regulatory costs and the required services of attorneys
and accountants in operating the Savings Bank.
Employee compensation slightly increased by $1,345 or 0.25%.
Professional fees significantly increased $74.963 or 56.18% in 1996 as
compared with a decrease of $28,986 or 17.85% in 1995. This significant
increase is the result of the Savings Bank defending itself against litigation
and the resolution of certain supervisory issues including the termination of
the Memorandum of Understanding to which the Savings Bank was formerly subject.
Insurance costs increased $150,567 or 186.80% as compared to a decrease of
$12,249 or 13.19% in 1995. The increase was primarily due to the before-tax
charge of $138,941 [as the result of the imposition of a special assessment by
the FDIC to recapitalize the Savings Association Insurance Fund (SAIF)].
Supplies, postage and office expenses increased $21,496 or 22.73% in 1996 as
compared with a decrease of $13,281 or 12.31% in 1995. The increase was
primarily due to the increase in business on the secondary market and costs
associated with litigation. Occupancy expense increased $16,433 or 24.09% as a
result of re-activating operations at the Bowie office and opening the Dillon
Street location. Other expenses increased by $59,802 or 33.78% primarily as a
result of increased costs in (1) marketing and advertising in order to generate
increased business; operating the ATM; additional REO; and increased travel
costs resulting from litigation (see Note 16 to the Consolidated Financial
Statements).
Provision For Taxes
The Savings Bank's effective tax rate varies with changes in corporate tax
rates and certain local tax credits (see Note 17 to the Consolidated Financial
Statements). Provision for income taxes was a benefit of $65,472 in 1996, as
compared to a tax benefit of $258,000 in 1995. The tax benefit is the direct
result of the net loss posted by QFH. However, the decrease in the benefit
received was the result of tax rules governing the carrying back of losses.
In February 1992, the Financial Accounting Standards Board issued "Statement
of Financial Accounting Standards 109 (SFAS 109), which provides new guidelines
for accounting for income taxes. Under these guidelines, deferred income tax
amounts will be adjusted annually to reflect current statutory tax rates with
the difference being charged against or credited to income in the current
period. SFAS 109 became effective for the Savings Bank on January 1, 1993; the
adoption did not have a material impact on the financial position of the Savings
Bank.
IMPACT OF INFLATION AND CHANGING PRICES
The impact of inflation on the Savings Bank is reflected primarily in the
increased cost of operations. A portion of these increased costs are generally
passed on to customers in the form of increased service fees. Because the
Savings Bank's assets and liabilities are virtually all monetary in nature,
reinvestment and prepayment rate fluctuations more significantly impact the
Savings Bank's performance than the effects of inflation. Volatile interest
rate environments require management to maintain acceptable levels of liquidity
and to maintain proper maturity structure of the Savings Bank's assets and
liabilities.
40
In structuring fees, negotiating loan margins, and developing customer
relationships, Management concentrates its efforts on maximizing earnings, while
attempting to contain increases in operating expenses. Management and the Board
of Directors continually review the feasibility of new and additional fee-
generating services to offset the effects of inflation and changing prices.
Management and the Board of Directors perform this function with the objective
of increased earnings.
41
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
- ----------------------------------------------------
QUANTUM FINANCIAL HOLDINGS, INC. AND SUBSIDIARY
BALTIMORE, MARYLAND
INDEPENDENT AUDITOR'S REPORT
AND
FINANCIAL STATEMENTS
DECEMBER 31, 1996
42
QUANTUM FINANCIAL HOLDINGS, INC. AND SUBSIDIARY
BALTIMORE, MARYLAND
DECEMBER 31, 1996
TABLE OF CONTENTS
Independent Auditor's Report
Financial Statements
- --------------------
Consolidated Balance Sheets
Consolidated Statements of Operations
Consolidated Statements of Changes in Stockholders' Equity
Consolidated Statements of Cash Flows
Notes to Consolidated Financial Statements
43
INDEPENDENT AUDITOR'S REPORT
To the Stockholders of
Quantum Financial Holdings, Inc.
We have audited the accompanying consolidated balance sheet of Quantum
Financial Holdings, Inc. and subsidiary as of December 31, 1996, and the
related consolidated statements of operations, changes in stockholders' equity
and cash flows for the year then ended. These financial statements are the
responsibility of the Company's management. Our responsibility is to express
an opinion on these financial statements based on our audit. The consolidated
financial statements of Quantum Financial Holdings, Inc. and subsidiary as of
December 31, 1995 and for the years ended December 31, 1995 and 1994, were
audited by other auditors whose report dated March 8, 1996, expressed an
unqualified opinion on those statements.
We conducted our audit in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to
obtain reasonable assurance about whether the financial statements are free of
material misstatement. An audit includes examining, on a test basis, evidence
supporting the amounts and disclosures in the financial statements. An audit
also includes assessing the accounting principles used and significant
estimates made by management, as well as evaluating the overall financial
statement presentation. We believe that our audit provides a reasonable basis
for our opinion.
In our opinion, the consolidated financial statements referred to above
present fairly, in all material respects, the financial position of Quantum
Financial Holdings, Inc. and subsidiary as of December 31, 1996, and the
results of their operations and their cash flows for the year then ended, in
conformity with generally accepted accounting principles.
/s/ Wooden & Benson, Chartered
March 31, 1997
Baltimore, Maryland
44
ARTHUR ANDERSEN LLP
REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS
To the Stockholders of
Quantum Financial Holdings, Inc.
We have audited the accompanying consolidated balance sheet of Quantum Financial
Holdings, Inc. (a Maryland corporation) and subsidiary as of December 31, 1995
and the related consolidated statements of operations, changes in stockholders'
equity and cash flows for the years ended December 31, 1995 and 1994. These
financial statements are the responsibility of the Company's management. Our
responsibility is to express an opinion on these financial statements based on
our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimated made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present
fairly, in all material respects, the financial position of Quantum Financial
Holdings, Inc. and subsidiary as of December 31, 1995, and the results of their
operations and their cash flows for the years ended December 31, 1995 and 1994,
in conformity with generally accepted accounting principles.
/s/ Arthur Andersen LLP
Baltimore, Maryland,
March 8, 1996
QUANTUM FINANCIAL HOLDINGS, INC. AND SUBSIDIARY
BALTIMORE, MARYLAND
CONSOLIDATED BALANCE SHEETS
DECEMBER 31, 1996 AND 1995
ASSETS 1996 1995
------------ ------------
Cash and due from banks $ 450,230 $ 1,063,563
Federal funds sold 465,530 509,018
----------- -----------
Total cash and cash equivalents (Notes 1 and 9) 915,760 1,572,581
Investment securities held to maturity (Notes 1, 2 and 9) 920,187 564,927
Accrued interest receivable (Notes 3 and 9) 278,140 249,527
Secondary market funding receivable (Notes 1 and 9) 522,763 525,732
Loans receivable, net (Notes 1, 4, 8, 9 and 10) 20,473,502 22,006,556
Residential real estate owned (Note 1) 1,603,395 1,524,583
Commercial real estate owned (Notes 1 and 5) 1,307,098 1,263,292
Federal Home Loan Bank stock (Note 9) 169,100 165,000
Premises and equipment, net (Notes 1 and 6) 426,125 381,971
Other assets (Notes 1 and 17) 725,435 729,557
----------- -----------
Total assets $27,341,505 $28,983,726
=========== ===========
LIABILITIES AND STOCKHOLDERS' EQUITY
Liabilities
- -----------
Savings and NOW deposits $ 6,837,498 $ 6,695,883
Other time deposits 18,052,132 17,850,825
----------- -----------
Total deposits (Notes 7 and 9) 24,889,630 24,546,708
Federal Home Loan Bank advances (Notes 8 and 9) 450,000 2,000,000
Accrued expenses 89,887 203,431
Other liabilities 63,149 18,500
Other borrowed money (Notes 8 and 9) 18,000 27,000
----------- -----------
Total liabilities 25,510,666 26,795,639
Commitments and contingencies (Note 18)
Stockholders' equity (Notes 1, 11, 12, 13 and 19)
- --------------------
Common stock, par value $.01 per share; 5,000,000
shares authorized, 106,924 shares
issued and outstanding 1,069 1,069
Additional paid-in capital 700,205 700,205
Retained earnings (Note 13) 1,147,565 1,513,813
----------- -----------
1,848,839 2,215,087
Deferred compensation (Note 11) (18,000) (27,000)
----------- -----------
Total stockholders' equity 1,830,839 2,188,087
----------- -----------
Total liabilities and stockholders' equity $27,341,505 $28,983,726
=========== ===========
The accompanying notes to financial statements are an integral part of these
statements.
45
QUANTUM FINANCIAL HOLDINGS, INC. AND SUBSIDIARY
BALTIMORE, MARYLAND
CONSOLIDATED STATEMENTS OF OPERATIONS
FOR THE YEARS ENDED DECEMBER 31, 1996, 1995 AND 1994
1996 1995 1994
----------- ----------- ----------
Interest Income
- ---------------
Interest and fees on loans (Notes 1 and 4) $2,006,454 $2,036,975 $1,979,118
Interest on investment securities 106,921 108,584 135,583
Interest on federal funds sold 79,512 22,607 20,757
---------- ---------- ----------
Total interest income 2,192,887 2,168,166 2,135,458
Interest Expense
- ----------------
Interest on deposits 1,384,193 1,119,063 983,712
Other interest expense 14,772 161,491 56,263
---------- ---------- ----------
Total interest expense 1,398,965 1,280,554 1,039,975
Net interest income 793,922 887,612 1,095,483
Provision for loan losses 143,674 585,918 132,431
---------- ---------- ----------
Net interest income after provision
for loan losses 650,248 301,694 963,052
Other Income
- ------------
Fees on loans originated for others, net of
related commissions and payroll taxes
(Notes 1 and 14) 115,179 91,317 192,928
Other operating income (Notes 5 and 15) 272,559 177,774 135,558
---------- ---------- ----------
Total other income 387,738 269,091 328,486
General and Administrative Expenses
- -----------------------------------
Salaries, benefits and payroll taxes 533,014 531,669 542,872
Other operating expenses (Note 16) 936,692 595,321 552,474
---------- ---------- ----------
Total general and administrative expenses 1,469,706 1,126,990 1,095,346
---------- ---------- ----------
Income (loss) before income taxes (431,720) (556,205) 196,192
Income tax expense (benefit) (Notes 1 and 17) (65,472) (258,000) 68,556
---------- ---------- ----------
Net income (loss) $ (366,248) $ (298,205) $ 127,636
========== ========== ==========
Earnings (loss) per share (Note 1) $(3.43) $(2.69) $1.12
========== ========== ==========
Weighted avg. number of shares outstanding 106,924 110,959 114,374
========== ========== ==========
The accompanying notes to financial statements are an integral part of these
statements.
46
QUANTUM FINANCIAL HOLDINGS, INC. AND SUBSIDIARY
BALTIMORE, MARYLAND
CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY
FOR THE YEARS ENDED DECEMBER 31, 1996, 1995 AND 1994
Common Stock Additional
--------------------
Paid-in Retained Deferred
Shares Par Value Capital Earnings Compensation
-------- ---------- ----------- ----------- -------------
Balance, December 31, 1993 114,374 $1,144 $763,455 $1,728,988 $(45,000)
Amortization of deferred compensation (Note 11) - - - - 9,000
Net income - - - 127,636 -
Dividends paid, $.26 per share - - - (29,737) -
------- ------ -------- ---------- --------
Balance, December 31, 1994 114,374 1,144 763,455 1,826,887 (36,000)
Amortization of deferred compensation (Note 11) - - - - 9,000
Redemption of shares held by dissident
stockholders not re-issued (Note 1) (7,450) (75) (63,250) - -
Net loss - - - (298,205) -
Dividends paid, $.13 per share - - - (14,869) -
------- ------ -------- ---------- --------
Balance, December 31, 1995 106,924 1,069 700,205 1,513,813 (27,000)
Amortization of deferred compensation (Note 11) - - - - 9,000
Net loss - - - (366,248) -
------- ------ -------- ---------- --------
Balance, December 31, 1996 106,924 $1,069 $700,205 $1,147,565 $(18,000)
======= ====== ======== ========== ========
The accompanying notes to financial statements are an integral part of these
statements.
QUANTUM FINANCIAL HOLDINGS, INC. AND SUBSIDIARY
BALTIMORE, MARYLAND
CONSOLIDATED STATEMENTS OF CASH FLOWS
FOR THE YEARS ENDED DECEMBER 31, 1996, 1995 AND 1994
1996 1995 1994
------------ ------------ ------------
Cash Flows From Operating Activities
- ------------------------------------
Net income (loss) $ (366,248) $ (298,205) $ 127,636
Adjustments to reconcile net income (loss) to net
cash provided by (used in) operating activities:
- ----------------------------------------------------
Provision for loan losses 143,674 585,918 132,431
Loan fees deferred, net of costs 22,706 34,945 72,065
Amortization of deferred loan fees (60,994) (61,514) (79,176)
Depreciation 58,535 47,035 28,508
Decrease (increase) in accrued interest (28,613) 19,586 (53,927)
Origination of loans sold on secondary market (4,379,883) (4,268,757) (9,571,100)
Proceeds from sale of loans on the secondary 4,382,851 4,117,652 12,543,036
Gain on sale of real estate owned (31,095) - -
Decrease (increase) in deferred income tax 21,308 (71,120) 113,366
(Increase) in other assets (17,186) (190,682) (213,122)
Increase (decrease) in accrued expenses
and other liabilities (68,895) 82,342 (114,627)
Amortization of deferred compensation 9,000 9,000 9,000
Loss on employee advances 24,081 - -
Stock dividends received on Federal Home
Loan Bank stock - - (11,472)
----------- ----------- -----------
Net cash provided by (used in) operating activities (290,759) 6,200 2,982,618
Cash Flows From Investing Activities
- ------------------------------------
Proceeds from maturing investment securities 266,000 - 308,280
Purchases of investment securities (618,262) (114,540) (193,046)
Purchases of FHLB stock (4,100) (16,100) -
Proceeds from sale of FHLB stock - - 94,900
Decrease (increase) in loans, net 1,296,963 (2,175,681) (2,451,119)
Purchase of premises and equipment (81,688) (196,314) (44,327)
Proceeds from sale of real estate owned 64,419 - -
Investment in foreclosed real estate (73,316) (129,951) (98,226)
----------- ----------- -----------
Net cash provided by (used in) investing activities 850,016 (2,632,586) (2,383,538)
Cash Flows From Financing Activities
- ------------------------------------
Increase (decrease) in deposits, net 342,922 2,759,924 (794,649)
Repayment of FHLB advances (1,550,000) (500,000) (2,300,000)
Increase in short-term borrowings, net - - 3,000,000
Dividends paid - (14,869) (29,737)
Debt repayment (9,000) (9,000) (9,000)
Redemption of stock - (63,325) -
----------- ----------- -----------
Net cash provided by (used in) financing activities (1,216,078) 2,172,730 (133,386)
----------- ----------- -----------
Increase (decrease) in cash and cash equivalents (656,821) (453,656) 465,694
Cash and cash equivalents, beginning of year 1,572,581 2,026,237 1,560,543
----------- ----------- -----------
Cash and cash equivalents, end of year $ 915,760 $ 1,572,581 $ 2,026,237
=========== =========== ===========
Supplemental Disclosures
- ------------------------
Cash paid during the year for:
Interest $ 1,407,484 $ 1,280,554 $ 1,039,975
Income taxes, net of refund 30 (112,478) 86,709
In-substance foreclosure on real estate - 77,977 386,277
Foreclosure on real estate 99,278 420,119 1,020,346
The accompanying notes to financial statements are an integral part of these
statements.
48
QUANTUM FINANCIAL HOLDINGS, INC. AND SUBSIDIARY
BALTIMORE, MARYLAND
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1996
Note 1 - Summary of Significant Accounting Policies
------------------------------------------
The accompanying consolidated financial statements include the
accounts of Quantum Financial Holdings, Inc., and its wholly-owned
subsidiary (together "the Company"), Baltimore American Savings Bank,
FSB ("the Bank"). On July 12, 1995, the Company completed the
acquisition of the Bank pursuant to an Agreement and Plan of
Reorganization in which the Bank became a wholly-owned subsidiary of
the Company, a newly formed holding company. Under the terms of the
Agreement and Plan of Reorganization, each outstanding share, other
than shares as to which dissenters' rights were properly exercised, of
the common stock, $1.00 par value per share, of the Bank ("the Bank's
common stock") was converted into one share of the common stock $0.01
par value per share, of the Company and the former holders of the
Bank's common stock became the holders of all the outstanding common
stock of the Company. This transaction was accounted for as a pooling
of interests. All material intercompany amounts have been eliminated.
Quantum Financial Holdings, Inc. and subsidiary follow generally
accepted accounting principles and reporting practices applicable to
the savings and loan industry. The preparation of financial statements
in conformity with generally accepted accounting principles requires
management to make estimates and assumptions that affect the reported
amounts of assets and liabilities and disclosure of contingent assets
and liabilities as of the date of the financial statements and the
reported amounts of revenues and expenses during the reporting period.
Actual results could differ from those estimates.
Current Operating Environment
-----------------------------
The Bank obtains deposits from the surrounding community and makes
loans, primarily secured by real estate. The Bank has been adversely
affected by the decline in the Baltimore/Washington regional economy.
As a result, nonperforming assets were 17.78% and 10.70% as of
December 31, 1996 and 1995, respectively. Such economic conditions
will continue to place pressure on the Bank's earnings ability,
traditional funding sources, capital adequacy, liquidity, levels of
nonperforming assets and overall adequacy of the allowance for loan
losses.
In the opinion of management, the allowance for loan losses as of
December 31, 1996 and 1995 is adequate. However, substantial risk and
loss potential continues to exist in the loan portfolio, primarily
because of continued poor economic conditions and a concentration of
residential mortgage loans secured by properly located in declining
neighborhoods in Baltimore City. Consequently, high levels of
nonperforming assets may continue in the foreseeable future. These
conditions in the loan portfolio have caused the Bank to foreclose on
a number of properties and have created significant nonperforming
assets. As a result of this, management has spent significant effort
to minimize its losses on these assets. Present management has
expertise in the construction business, and can perform improvements
and get the properties in rental condition inexpensively. Present
management has also been successful in obtaining tenants to rent some
of these properties, with the rental income reducing the principal
balance on the debt until the Bank can find a buyer for the property.
There is no assurance that management will be able to continue this
course of action with its foreclosed properties, that management's
philosophy of handling these assets will not change, or that if there
is a turnover
49
of management, the new management will have the skills necessary to
continue this course of action. If any of the above events should
occur, additional loan loss reserves, or write-down of real estate
owned may be required, and the additional amounts may be significant.
As long as the level of nonperforming loans remains high, the results
of operations of the Bank will continue to be adversely affected.
Interest Rate Risk
------------------
Net income is the foundation of the Bank's earnings, representing
the difference between total interest and fees earned on all loans,
investments and other interest earning assets, and the total interest
paid on deposits and borrowings. As of December 31, 1996, the Bank had
40.70% of its outstanding loans which matured in one year or were
variable rate loans which would reprice within one year. Also, as of
December 31, 1996, 27.58% of its deposits had fixed rates which mature
in greater than one year. As part of the Bank's management of interest
rate risk, it balances its variable rate deposits and loans with its
fixed rate loans and deposits.
Cash and Cash Equivalents
-------------------------
Cash and cash equivalents included interest bearing deposits in
other banks with original maturities of less than three months in the
amount of $298,000 as of December 31, 1995. Cash and cash equivalents
also includes federal funds sold.
Investment Securities
---------------------
The Bank carries investment securities in accordance with Statement
of Financial Accounting Standards No. 115, "Accounting for Certain
Investments in Debt and Equity Securities" ("SFAS No. 115"). SFAS No.
115 requires institutions to classify and account for debt and equity
securities in one of three categories, as follows: 1) debt securities
that an institution has the positive intent and ability to hold to
maturity are classified as held-to-maturity and reported at amortized
cost; 2) debt and equity securities that are purchased and held
principally for the purpose of selling them in the near term are
classified as trading securities and reported at fair value, with
unrealized gains and losses included in earnings; and 3) debt and
equity securities not classified as either held-to-maturity or trading
securities are classified as available-for-sale and reported at fair
value, with unrealized gains and losses excluded from earnings and
reported as a net amount in a separate component of stockholders'
equity, net of the related income tax effect. As of December 31, 1996
and 1995, all investment securities held by the Bank were classified
as held-to-maturity and recorded at amortized cost. Gains or losses on
disposition are based on the net proceeds and the adjusted carrying
amount of the securities sold, using the specific identification
method.
Loans and Allowance for Loan Losses
-----------------------------------
Loans are stated at the amount of unpaid principal, reduced by an
allowance for loan losses and deferred loan fees. Interest on loans is
calculated by using the simple interest method on daily balances of
the principal amount outstanding. The allowance for loan losses is
established through a provision for loan losses charged to expense.
Loans are charged against the allowance for loan losses when
management believes that the principal is uncollectible. The allowance
is an amount that management believes will be adequate to absorb
possible losses on existing loans that may become uncollectible, based
on evaluations of the collectibility of loans and prior loan loss
experience. The evaluations take into consideration such factors as
changes in the nature and volume of the loan portfolio, portfolio
quality, review of specific problem loans and current economic
conditions that may affect the borrower's ability to pay. The
allowance for loan losses is based on estimates, and ultimate losses
may vary from the current estimates. These estimates are reviewed
periodically, and as adjustments become necessary, they are reported
in the periods in which they become known. Accrual of interest is
discontinued on a
50
loan when management believes, after considering economic and business
conditions and collection efforts, that the borrower's financial
condition is such that the interest is uncollectible.
The Bank has adopted Statement of Financial Accounting Standards
(SFAS) No. 114, "Accounting by Creditors for Impairment of a Loan,"
and SFAS No. 118, "Accounting by Creditors for Impairment of a Loan --
Income Recognition and Disclosure," as of January 1, 1995 (see Note
4). The Bank evaluates loans to determine if impaired. SFAS No. 114
requires that certain impaired loans be measured based on the present
value of expected future cash flows discounted at the loan's original
effective interest rate. As a practical expedient, impairment may be
measured based on the loan's observable market price or the fair value
of the collateral if the loan is collateral dependent. When the
measure of the impaired loan is less than the recorded investment in
the loan, the impairment is recorded through a valuation allowance.
In the ordinary course of business, the Bank has entered into off-
balance sheet financial instruments consisting of commitments to
extend credit, commitments under lines of credit and stand-by letters
of credit. Such financial instruments are recorded in the financial
statements when they are funded or related fees are incurred or
received.
Secondary Market Funding Receivable
-----------------------------------
Secondary Market Funding Receivable consists of residential mortgage
loans originated for the secondary market, under previously arranged
purchase agreements. As of December 31, 1996 and 1995, secondary
market receivables are carried at the lower of cost or market value.
The pre-established purchase prices are at least equal to cost.
Secondary market funding receivables are typically collected within
thirty (30) days of closing.
Real Estate Owned
-----------------
Real estate owned includes real estate on which the Bank has
completed foreclosure proceedings. All foreclosed assets are held for
sale. The Bank actively tries to dispose of the real estate held for
sale, and expects to dispose of the property as soon as possible.
Foreclosed assets held for sale are carried at the lower of cost or
fair value less estimated selling costs. Cost is defined as the fair
value of the assets foreclosed at the time of foreclosure, plus costs
incurred subsequent to foreclosure, which are required to bring the
property to its most marketable condition. During the holding period,
management generally operates foreclosed property as rental
properties. Valuations are periodically performed by management with
the adjustment to the carrying value being charged to earnings in the
period of the adjustment. Foreclosed assets are usually not
depreciated.
Federal Home Loan Bank Stock
----------------------------
Federal Home Loan Bank (FHLB) stock consists of the Bank's required
investment in FHLB common stock under the terms of its charter. The
stock is carried at cost, which approximates market.
Loan and Fee Income
-------------------
Interest on loans is accrued and credited to income based upon the
principal outstanding. Loan fees, net of direct and incremental
origination costs, are deferred over the life of the related loans and
amortized using the effective interest rate method.
51
Depreciation
------------
Bank premises and equipment are stated at cost less accumulated
depreciation computed using the straight-line method over the estimated
useful lives of the assets. Building and improvements are depreciated
over 19-40 years. Furniture and equipment are depreciated over 3-7
years.
Income Taxes
------------
Deferred income taxes are provided for income and expense items
recognized in different periods for financial reporting purposes than
for purposes of computing current income taxes payable. These
temporary differences relate primarily to the provision for loan
losses, deferred loan fees, and depreciation.
Deferred income tax assets and liabilities are adjusted annually to
reflect the effect, at current statutory tax rates, of the differences
in income and expense recognition for book and tax purposes.
Earnings (Loss) Per Share
-------------------------
Earnings (loss) per share are based upon the weighted average number
of common shares outstanding during the periods.
Note 2 - Investment Securities Held to Maturity
--------------------------------------
As of December 31, 1996 and 1995, investment securities held to
maturity consisted of:
1996
-------------------------------------------
Gross Gross
Amortized Unrealized Unrealized Fair
Cost Gains Losses Value
--------- ---------- ---------- --------
Interest bearing deposits in other $492,000 $ - $ - $492,000
banks
Corporate debt obligations 100,565 99 1,143 99,521
U.S. Government obligations 327,622 2,495 822 329,295
-------- ------ ------- --------
$920,187 $2,594 $1,965 $920,816
======== ====== ======= ========
1995
-------------------------------------------
Gross Gross
Amortized Unrealized Unrealized Fair
Cost Gains Losses Value
--------- ---------- ---------- --------
Interest bearing deposits in other $293,000 $ - $ - $293,000
banks
Corporate debt obligations 100,035 2,110 - 102,145
U.S. Government obligations 171,892 1,142 - 173,034
-------- ------ ------ --------
$564,927 $3,252 $ - $568,179
======== ====== ====== ========
52
As of December 31, 1996, investment securities mature in the
following periods:
Amortized
Cost Fair Value
--------- ----------
Due in one year or less $724,622 $726,295
Due in one-to-five years 145,644 145,248
Due in six-to-ten years 49,921 49,273
-------- --------
$920,187 $920,816
======== ========
Note 3 - Accrued Interest Receivable
---------------------------
As of December 31, 1996 and 1995, accrued interest receivable
consisted of:
1996 1995
-------- --------
Loans $264,579 $237,747
Investment securities 12,650 10,490
Interest-bearing deposits in
other banks 911 1,290
-------- --------
$278,140 $249,527
======== ========
Note 4 - Loans Receivable
----------------
Commercial, commercial real estate, and construction loans are
collateralized by real estate, equipment and receivables, and the loan-
to-value ratios generally do not exceed 80% at origination.
Residential real estate mortgage loans are collateralized by the
related property, and the loan-to-value ratios generally do not exceed
80% at origination. Any residential real estate mortgage loan
exceeding a loan-to-value ratio of 80% requires private mortgage
insurance. The Bank also grants unsecured loans to qualified borrowers
meeting the underwriting standards established by the Board of
Directors.
As of December 31, 1996 and 1995, loans receivable consisted of:
1996 1995
------------ ------------
Mortgage loans secured by one-to-four family residences $16,554,277 $16,876,206
Mortgage loans secured by second mortgages on 209,020 456,400
residences
Commercial real estate 1,089,498 1,087,446
Consumer 834,539 776,958
Residential construction 1,584,980 2,109,426
Commercial 763,033 1,376,886
----------- -----------
21,035,347 22,683,322
Less: Allowance for loan losses (366,662) (447,226)
Deferred loan fees (195,183) (229,540)
----------- -----------
$20,473,502 $22,006,556
=========== ===========
The Bank's real estate loans are primarily secured by real estate in
the Baltimore/ Washington metropolitan area.
As of December 31, 1996 and 1995, the Bank's recorded investment in
impaired loans was $793,938 and $307,794, respectively. At December
31, 1995, a valuation allowance of $42,000 was established for
approximately $232,000 of these loans. This valuation allowance is
included in the allowance for loan losses on the balance sheet. There
was no valuation allowance for the impaired loans at December 31, 1996
because the value of the collateral was greater than the carrying value
of the loans. The average recorded investment in impaired loans during
the years ended December 31, 1996 and 1995 was $800,731 and $76,950,
respectively.
53
Interest payments received on impaired loans are recorded as interest
income unless collection of the remaining recorded investment is
doubtful at which time payments received are recorded as reductions of
principal.
There were loans in process of $426,164 and $372,954 as of December
31, 1996 and 1995, respectively.
Activity in the allowance for loan losses was summarized as follows:
1996 1995 1994
---------- ---------- --------
Balance, beginning of year $ 447,226 $ 175,824 $ 354,159
Provision charged to operations 143,674 585,918 132,431
Loans charged off and write-down of REO (251,734) (321,458) (316,895)
Recoveries 27,496 6,942 6,129
--------- --------- ---------
Balance, end of year $ 366,662 $ 447,226 $ 175,824
========= ========= =========
The Bank had $643,057 and $307,794 of loans as of December 31, 1996
and 1995, respectively, for which accrual of interest had been
discontinued. If all loans were accruing interest, interest income
would have been $43,362, $89,398 and $111,733 higher in the years ended
December 31, 1996, 1995 and 1994, respectively. Actual interest income
recognized on these loans was $27,664, $53,598 and $44,000,
respectively.
The continuing softness of the economy and the real estate market
will continue to affect some borrower's ability to comply with the
terms of their loan agreements. Under these circumstances, increases
in nonperforming assets, credit losses and/or provisions for loan
losses may occur.
Note 5 - Commercial Real Estate Owned
----------------------------
Prior to June 18, 1992, the Bank was a participant in a commercial
loan secured by certain commercial real estate known as the Sheridan
Station Shopping Center (Sheridan Station). The Bank owned a 61%
interest in the loan and United Savings Bank (United), the lead lender,
owned the remaining 39% interest.
On July 30, 1990, United was declared insolvent by the Office of
Thrift Supervision and its assets, including its 39% interest in
Sheridan Station, were turned over to the Resolution Trust Corporation
(RTC) for disposition. On June 18, 1992, the RTC and the Bank
foreclosed on the property as a result of the borrowers' failure to pay
in accordance with the applicable loan agreement. At that time, the
Bank took its proportional 61% interest in Sheridan Station. On June
25, 1993, the Bank acquired the RTC's 39% interest in Sheridan Station
for $174,890. As a result of this transaction, the Bank became the
sole owner of the property.
As of December 31, 1996, the center was seventy-two percent (72%)
leased. During 1996, the center generated operating income of
$215,341 and operating expenses $101,130 for pretax income of $114,211,
which is included as other operating income in the accompanying
consolidated statement of operations for the year ended December 31,
1996. During 1995, the center generated operating income of $147,669
and operating expenses of $69,479 for pretax income of $78,190. During
1994, the center generated operating income of $170,820 and operating
expenses of $105,596 for a pretax profit of $65,224.
It is management's intention to actively market this property.
Management intends to sell the property as soon as a viable buyer is
identified. While management believes it will be able to find a buyer
in the near future, no assurance can be made that a buyer will be found
or that losses
54
on the sale or from operations prior to the sale will not be realized.
Management, after reviewing recent appraisals of the property, believes
that the carrying value as of December 31, 1996 will be realized.
Note 6 - Premises and Equipment
----------------------
As of December 31, 1996 and 1995, premises and equipment consisted
of:
1996 1995
-------- --------
Land $ 58,878 $ 58,878
Buildings and improvements 393,472 384,237
Furniture and equipment 351,438 257,986
-------- --------
803,788 701,101
Less: accumulated depreciation 377,663 319,130
-------- --------
$426,125 $381,971
======== ========
Depreciation expense was $58,535, $47,035 and $28,508 for the years
ended December 31, 1996, 1995 and 1994, respectively.
Note 7 - Deposits
--------
The aggregate amount of short-term jumbo CDs, each with a minimum
denomination of $100,000, was approximately $2,352,674 and $1,740,562
in 1996 and 1995, respectively.
At December 31, 1996, the scheduled maturities of CDs are as follows:
1997 $11,187,918
1998 1,063,791
1999 2,530,720
2000 1,527,620
2001 and thereafter 1,742,083
-----------
$18,052,132
===========
Note 8 - Borrowed Money
--------------
The Bank maintains an available line of credit with the Federal Home
Loan Bank of Atlanta (FHLB) of $3,000,000. Under the terms of this
line, the Bank has granted the FHLB a blanket lien on all residential
mortgages. As of December 31, 1996 and 1995, advances under this
agreement were $450,000 and $2,000,000, respectively. The advances
outstanding as of December 31, 1996 mature on December 2, 1997. The
loan had an effective interest rate of 6.95%, 6.10% and 4.86%,
respectively, during the years ended December 31, 1996, 1995 and 1994.
Other borrowed money consisted of a note payable to a bank in
connection with the employee stock ownership plan which bore interest
at 90% of the Bank's prime rate and is payable in annual installments
of $9,000 per year through July 29, 1998. The balance as of December
31, 1996 and 1995 was $18,000 and $27,000, respectively.
Note 9 - Financial Instruments
---------------------
The Company is a party to financial instruments with off-balance
sheet risk in the normal course of business to meet the financing needs
of its customers.
55
The estimated fair values of the Company's financial instruments were
as follows as of December 31, 1996 and 1995:
1996 1995
------------------------ ------------------------
Carrying Carrying
Amount Fair Value Amount Fair Value
----------- ----------- ----------- -----------
Financial assets:
Cash and cash equivalents $ 915,760 $ 915,760 $ 1,572,581 $ 1,572,581
Investment securities held to maturity 920,187 920,816 564,927 568,179
Secondary market funding receivable 522,763 522,763 525,732 525,732
Loans receivable 21,035,347 21,926,737 22,683,322 22,379,051
Federal Home Loan Bank stock 169,100 169,100 165,000 165,000
Accrued interest receivable 278,140 278,140 249,527 249,527
Financial liabilities:
Deposits 24,889,630 25,012,567 24,546,708 24,369,169
Federal Home Loan Bank Advances 450,000 450,000 2,000,000 2,000,000
Other borrowed money 18,000 18,000 27,000 27,000
The following methods and assumptions were used by the Company in
estimated fair values of financial instruments as disclosed:
Cash and cash equivalents - The carrying amounts of cash and cash
-------------------------
equivalents approximate their fair value.
Investment securities held-to-maturity securities - Fair values for
-------------------------------------------------
investment securities are based on quoted market prices.
Loans receivable - For variable-rate loans that reprice frequently
----------------
and have no significant change in credit risk, fair values are based
on carrying values. Fair values for real estate and commercial
loans are estimated using discounted cash flow analyses, using
interest rates currently being offered for loans with similar terms
to borrowers of similar credit quality. Fair values for impaired
loans are estimated using discounted cash flow analyses or
underlying collateral values, where applicable.
Secondary Market Funding Receivable - Carrying amount of secondary
-----------------------------------
market funding receivables approximates their fair value, due to
their pre-sell arrangements.
Deposits - The fair values disclosed for demand deposits are, by
--------
definition, equal to the amount payable on demand at the reporting
date (that is, their carrying amounts). The carrying amounts of
variable-rate, fixed-term money market accounts and variable-rate
certificates of deposit (CDs) approximate their fair values at the
reporting date. The fair values of fixed rate certificates of
deposit are estimated using cash flow analyses, using interest rates
currently being offered.
Borrowed Money - The carrying amounts of advances from the Federal
--------------
Home Loan Bank and other borrowed money approximate their fair
values.
Other - The carrying amounts of accrued interest receivable
-----
approximates fair value.
Note 10 - Related Party Transactions
--------------------------
In the normal course of business, loans are made to officers,
directors and shareholders of the Company and their related interests.
These loans are consistent with sound banking practices, are within
regulatory lending limitations and do not involve more than normal
risk of collectibility.
56
The following table summarizes the transactions in these loans for
the years ended December 31, 1996, 1995 and 1994, respectively.
1996 1995 1994
--------- ---------- ---------
Balance, beginning of year $649,993 $ 518,596 $534,802
New loans - 239,749 -
Repayments (85,588) (108,352) (16,206)
-------- --------- --------
Balance, end of year $564,405 $ 649,993 $518,596
======== ========= ========
Note 11 - Employee Stock Ownership Plan
-----------------------------
The Company has established an employee stock ownership plan. Under
the plan, the Company makes annual contributions to a trust for the
benefit of eligible employees, in the form of either cash or common
shares of the Company the amount of the annual contribution is
discretionary, except that it must be sufficient to enable the trust
to meet its current obligations. The Bank's cash contribution for the
years ended December 31, 1996, 1995 and 1994 was $12,489, $9,000 and
$5,907, respectively.
In 1988, the trust borrowed $90,000 to purchase 11,250 shares of the
Company's common stock at a price of $8.00 per share. The outstanding
balance of the loan has been recorded in the accompanying consolidated
balance sheets as a liability of the Company with a like amount of
deferred compensation being recorded as a reduction in stockholders'
equity.
Note 12 - Stock Option Plan
-----------------
Pursuant to a fixed stock option plan established in 1989, 11,287
shares of common stock are reserved for issuance upon the exercise of
options granted to officers, employees and directors of the Company.
Under the plan, options are granted on a discretionary basis by a
committee of the Board of Directors. The option price, established at
the time of grant by the committee, cannot be less than the market
price of the shares at the date of the grant. Options expire ten
years from the date of the grant.
The following table summarizes the activity of the stock option
plan:
1996 1995 1994
----- ----- -----
Options outstanding, beginning of year 4,500 4,500 -
Options granted exercise price of $8.50
a share (1996) and $9.50 a share (1994) 3,500 - 4,500
Options exercised - - -
----- ----- -----
Options outstanding and exercisable, end of year 8,000 4,500 4,500
===== ===== =====
The weighted average remaining contractual life and weighted average
exercise price of outstanding and exercisable options at December 31,
1996 is 8.05 years and $9.06, respectively.
Beginning in 1996, the fair value of each option grant is estimated
on the date of grant using the Black-Scholes option pricing model with
the following assumptions:
Annual rate of quarterly dividends 0.00%
Expected volatility 0.00%
Risk-free interest rate 4.81%
57
The Company applies Accounting Principles Board Opinion No. 25 and
related interpretations in accounting for its plan. Had compensation
cost for the Company's stock option plan been determined based on the
fair value at the grant date for the award under that plan in 1996
consistent with the method under Statement of Financial Accounting
Standards No. 123, the Company's net loss and loss per share would
have increased to the proforma amounts indicated below:
Loss per
Net Loss Share
---------- ---------
As reported $(366,248) $(3.43)
========= ======
Proforma $(378,568) $(3.54)
========= ======
Note 13 - Retained Earnings
-----------------
Upon its conversion to a stock institution, the Bank set aside its
retained earnings totaling $829,965, for future payments to savings
account holders in the event of future liquidation. In the event of
future liquidation, a person who held an account as of December 31,
1987, and remains an account holder through the liquidation date, will
receive a distribution from this reserve. The amount of the reserve
is reduced proportionately as eligible accounts are closed. As of
December 31, 1996, approximately $62,979 remained set aside.
Note 14 - Fees on Loans Originated for Others
-----------------------------------
Fees on loans originated for others consisted of:
1996 1995 1994
--------- -------- --------
Fee income $154,728 $144,378 $ 307,539
Less: Commissions paid to Bank employees (36,574) (49,293) (106,058)
Related payroll taxes (2,975) (3,948) (8,553)
-------- -------- ---------
$115,179 $ 91,137 $ 192,928
======== ======== =========
Note 15 - Other Operating Income
----------------------
Other operating income consisted of:
1996 1995 1994
-------- -------- ---------
Customer service fees $127,253 $ 99,584 $ 70,334
Net earnings from operation of
commercial real estate owned 114,211 78,190 65,224
Gain on sale of real estate owned 31,095 - -
-------- -------- ---------
$272,559 $177,774 $ 135,558
======== ======== =========
Note 16 - Other Operating Expenses
------------------------
Other operating expenses consisted of:
1996 1995 1994
-------- -------- ---------
Professional fees $208,408 $133,445 $ 162,431
Insurance expense 231,171 80,604 92,853
Data processing 59,551 41,441 44,897
Supplies, postage and office
expense 116,069 94,573 107,854
Occupancy expense 84,638 68,205 75,988
Other 236,855 177,053 68,451
-------- -------- ---------
$936,692 $595,321 $ 552,474
======== ======== =========
58
Note 17 - Income Taxes
------------
The income tax expense (benefit) in the accompanying consolidated
statements of operations consists of:
1996 1995 1994
---------- ---------- ---------
Current:
Federal $(85,519) $(157,480) $(37,590)
State (1,261) (29,400) (7,220)
Deferred:
Federal 16,591 (60,520) 95,100
State 4,717 (10,600) 18,266
-------- --------- --------
$(65,472) $(258,000) $ 68,556
======== ========= ========
The reconciliation of the statutory tax to the effective tax is as
follows:
1996 1995 1994
---------- ---------- --------
Statutory tax $(146,785) $(189,110) $66,705
State tax, net of federal benefit 2,281 (25,697) 9,604
Carryback limitations 94,038 - -
Other (15,006) (43,193) (7,753)
--------- --------- -------
$ (65,472) $(258,000) $68,556
========= ========= =======
Deferred income taxes reflect the net tax effects of temporary
differences between the financial statement and tax basis of assets
and liabilities. The significant components of the Company's deferred
tax assets and liabilities as of December 31, 1996 and 1995 were as
follows:
1996 1995
--------- ---------
Deferred tax assets:
Reserve for loan losses $ 46,210 $109,253
Deferred loan fees and costs 179,551 142,030
Other 9,802 -
--------- --------
Total deferred tax assets 235,563 251,283
-------- --------
Deferred tax liabilities:
Depreciation (38,563) (24,382)
Other - (43,593)
-------- --------
Total deferred tax liabilities (38,563) (67,975)
-------- --------
Net deferred tax asset 197,000 183,308
Valuation allowance 35,000 -
-------- --------
$162,000 $183,308
======== ========
As of December 31, 1996, the Company's deferred tax asset has been
reduced by a valuation allowance. The Company has not recorded the
effect of tax benefits from loss carryforwards which approximate
$244,000 at December 31, 1996. These carryforwards will expire in
2011.
Before 1996, the Bank was able to use the most beneficial of either
the percentage of income method or an experience method, similar to
that used by commercial banks, to determine its tax deduction for bad
debts under Section 593 of the Internal Revenue Code. Under
provisions of the Small Business Protection Act of 1996, Section 593
was repealed. The
59
new law also provided that cumulative bad debt deductions taken after
1987 (the base year) were to be recaptured as taxable income over a
six year period beginning in 1996. It further provided that the first
installment of the recapture could be deferred for up to two years if
a residential lending test is met. There was no material adverse
effect on the Bank's financial position or results of operations as a
result of the new law. The Bank qualifies as a small bank eligible to
use the bank experience method for bad debt deductions. However, the
deductions under this method are not expected to be as beneficial for
determining the current tax provision as the method previously
allowed.
Retained earnings at December 31, 1996 and 1995, include
approximately $293,000 for which no deferred income tax liability has
been recognized. This amount represents an allocation of income to
bad-debt deductions for tax purposes only. Reduction of amounts so
allocated for purposes other than tax bad-debt losses or adjustments
arising from carryback of net operating losses would create income for
tax purposes only, which would be subject to the then current
corporate income tax rate. The unrecorded deferred income tax
liability on the above amount is approximately $113,000.
Note 18 - Commitments and Contingencies
-----------------------------
Lending Activity
----------------
In the normal course of business, the Bank makes various commitments
and incurs certain contingent liabilities that are not presented in
the accompanying consolidated financial statements. The commitments
and contingent liabilities include various guarantees, commitments to
extend credit and standby letters of credit. As of December 31, 1996,
the Bank had no outstanding guarantees or undisbursed loan commitments
other than construction loans in process; however, stand-by letters of
credit and commitments under lines of credit were as follows:
Stand-by letters of credit $ 24,760
Commitments under lines of credit 458,632
--------
$483,392
========
Employment Contracts
--------------------
Effective February 13, 1996, the Company entered into an employment
agreement with its President. The agreement, which expires February
12, 1999, provides for a base salary and annual discretionary bonuses
to be determined by the Board of Directors. This agreement also
provides for a payment of approximately three times the President's
base pay in the event his employment is terminated within twenty-four
months of a change in control of the Company's ownership.
Litigation
----------
The Company is involved in litigation arising from the normal course
of operations. Management, after consultation with legal counsel,
believes that the ultimate liability, if any, arising from these
claims will not be material to the consolidated results of operations
or financial position of the Company.
Note 19 - Regulatory Matters
------------------
The Bank is subject to various regulatory capital requirements
administered by the federal banking agencies. Failure to meet minimum
capital requirements can initiate certain mandatory, and possibly
additional discretionary, actions by regulators that, if undertaken,
could have a direct material effect on the Bank's financial
statements. Under capital adequacy guidelines and the regulatory
framework for prompt corrective action, the Bank must meet
60
specific capital guidelines that involve quantitative measures of the
Bank's assets, liabilities, and certain off-balance-sheet items as
calculated under regulatory accounting practices. The Bank's capital
amounts and classification are also subject to qualitative judgments
by the regulators about components, risk weightings, and other
factors.
Quantitative measures established by regulation to ensure capital
adequacy require the Bank to maintain minimum amounts and ratios (set
forth in the table below) of total and Tier I capital (as defined in
the regulations) to risk-weighted assets (as defined). Management
believes, as of December 31, 1996, that the Bank meets all capital
adequacy requirements to which it is subject.
As of December 31, 1996, the most recent notification from the
Office of Thrift Supervision (OTS) categorized the Bank as adequately
capitalized under the regulatory framework for prompt corrective
action . To be categorized as adequately capitalized the Bank must
maintain minimum total risk-based, Tier I risk-based, and Tier I
leverage ratios as set forth in the table. There are no conditions or
events since that notification that management believes have changed
the institution's category.
The Bank's actual capital amounts and ratios are also presented in
the table.
To be Well
Capitalized Under
For Capital Prompt Corrective
Actual Adequacy Purposes Action Provisions
-------------------------------------------------------------------
Amount Ratio Amount Ratio Amount Ratio
--------------- ------------------ ---------------- ------
As of December 31, 1996:
Total Capital
(to Risk Weighted $1,779,509 9.85% $1,444,880 8% $1,806,100 10%
Assets)
Tier I Capital
(to Risk Weighted 1,552,921 8.60% 722,440 4% 1,083,660 6%
Assets)
Tier I Capital
(to Average Assets) 1,552,921 5.45% 1,138,816 4% 1,423,520 5%
As of December 31, 1995
Total Capital
(to Risk Weighted 2,222,334 11.40% 1,559,520 8% 1,949,400 10%
Assets)
Tier I Capital
(to Risk Weighted 2,102,334 10.78% 779,760 4% 1,169,640 6%
Assets)
Tier I Capital
(to Total Assets) 2,102,334 7.35% 1,144,120 4% 1,430,150 5%
The Economic Growth and Regulatory Paperwork Reduction Act of 1996
was signed into law on September 30, 1996. One major provision of the
act was that institutions such as the Bank, with deposits insured by
the Federal Deposit Insurance Corporation's Savings Association
Insurance Fund (SAIF), were assessed a one time charge to recapitalize
the SAIF. Subsequent regulations established the amount of this
assessment at .657% of the institution's insured deposits as of March
31, 1995. The law also provided that the assessment would be
deductible for tax purposes in the year it was paid. The Bank paid
its one-time assessment in the amount of $138,941 in November 1996.
It is anticipated that future deposit insurance premiums will be less
than those paid in the past because of the one-time assessment making
the SAIF solvent.
61
The act also allows for a merger of the SAIF with the Bank Insurance
Fund as of January 1, 1999 if no savings institutions exist at that
time. Consequently, the Bank may be required to change its charter to
a national bank or state chartered bank before that date.
Note 20 - Accounting Pronouncements With Future Effective Dates
-----------------------------------------------------
Statement of Financial Accounting Standards No. 125 "Accounting for
Transfers and Servicing of Financial Assets and Extinguishments of
Liabilities" was issued in June 1996. This statement provides that
transfers of financial assets be recognized as sales only when certain
specified criteria related to the transferor surrendering control of
the assets are met. These criteria are more restrictive than under
previous generally accepted accounting principles. The provisions of
this statement will affect the accounting for certain transactions
commonly entered into by community financial institutions such as
repurchase agreements, bankers acceptances and participation loans.
The statement is effective for transactions occurring after December
31, 1996 and is to be applied prospectively.
Statement of Financial Accounting Standards No. 127 " Deferral of
the Effective Date of Certain Provisions of FASB Statement No. 125"
was issued in December 1996. This statement defers, for one year, the
effective date of Statement No. 125 for repurchase agreements, dollar-
roll, securities lending and similar transactions.
The effect, on the Company's financial position or results of
operations, of implementing Statement No. 125 has not been determined
by management. However, such effect is not expected to be material.
62
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
- ------------------------------------------------------------------------
FINANCIAL DISCLOSURE
--------------------
Arthur Anderson LLP, served as the Company's independent auditors for the
1995 fiscal year. On November 7, 1996, Arthur Anderson LLP advised the Company
that they were resigning from their engagement. In connection with their audit
of the fiscal year ended December 31, 1995, there were no disagreements with
Arthur Andersen LLP on any matter of accounting principles or practices,
financial statement disclosure, or auditing scope or procedure which, if not
resolved to the satisfaction of Arthur Anderson LLP, would have caused them to
make reference to the subject of such disagreement in connection with their
reports. In addition, during this period there was no adverse opinion or
disclaimer of opinion or any opinion qualified or modified as to uncertainty,
audit scope or accounting principles.
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
------------------------------------------------------------
For information concerning the Board of Directors of QFH, the information
contained under the section captioned "Proposal I -- Election of Directors" in
the definitive proxy statement for the 1995 Annual Meeting of Stockholders
(the "Proxy Statement") is incorporated herein by reference.
For information concerning the Executive Officers, see "Item 1 - Business
-Executive Officers of QFH," which is incorporated herein by reference.
Pursuant to the Rules and Regulations of the Securities Exchange Act of
1934, the Company's officers, directors and persons who own more than ten
percent of the Common Stock are required to file reports detailing their
ownership and changes of ownership in the Common Stock. Officers, directors
and persons who own more than ten percent of the Common Stock are also
required to furnish the Company with copies of all such ownership reports that
are filed. Based solely on the Company's review of the copies of such
ownership reports, which it has received in the past fiscal year, and written
representations from officers, directors and persons who own more than ten
percent of the Common Stock that no annual report of change in beneficial
ownership is required for that person, the Company believes that during the
fiscal year ended December 31, 1996, all filing requirements applicable to its
officers, directors and stockholders owning in excess of ten percent of the
Common Stock have been complied with.
ITEM 11. EXECUTIVE COMPENSATION
--------------------------------
The information required by this item is contained under the section
captioned "Proposal I - Election of Directors - Executive Compensation" in the
Proxy Statement which is incorporated herein by reference.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
------------------------------------------------------------------------
a) Security Ownership of Certain Beneficial Owners
Information required by this item is incorporated herein by reference
to the Section captioned "Voting Securities and Principal Holders
Thereof" in the Proxy Statement.
b) Security Ownership of Management
Information required by this item is incorporated herein by reference
to the section captioned "Proposal I -- Election of Directors" and
"Voting Securities Principal Holders Thereof" in the Proxy Statement.
c) Change in Control
Management of the Company knows of no arrangements, including any
pledge by any person of securities of the Company, the operation of
which may at a subsequent date result in a change in control of the
registrant.
63
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
--------------------------------------------------------
The information required by this item is incorporated herein by reference
to the section captioned "Transactions with Management" in the Proxy
Statement.
PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K
-------------------------------------------------------------------------
(a) Documents Filed as Part of the Form 10-K
1. Consolidated Financial Statements
Report of Independent Public Accountants
Consolidated Balance Sheets at December 31, 1996 and 1995
Consolidated Statements of Operations for the Years ended December 31,
1996, 1995 and 1994
Consolidated Statements of Changes in Stockholders' Equity for the
Years ended December 31, 1996, 1995 and 1994
Consolidated Statements of Cash Flows for the Years ended December 31,
1996, 1995 and 1994
Notes to Consolidated Financial Statements
2. All financial statement schedules have been omitted, as the required
information is either not applicable or included in the financial
statements or related notes.
3. Exhibits
(a) A report on Form 8-K was filed on November 11, 1996.
(b) All required exhibits listed above are filed with this Form 10-K.
64
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the registrant has duly caused this report to be signed on
its behalf by the undersigned, thereunto duly authorized.
QUANTUM FINANCIAL HOLDINGS INC.
Date: March 31, 1997 By: /s/ Richard W. Kraus
---------------------------------------
Richard W. Kraus
President and Chief Executive Officer
(Duly Authorized Representative)
Pursuant to the requirements of the Securities Exchange Act of 1934, this
report has been signed below by the following persons on behalf of the
registrant and in the capacities and on the dates indicated.
Signatures
----------
/s/ Pearl J. Rogers Date: March 31, 1997
- ---------------------------------------------------
Pearl J. Rogers
(Chairman of the Board)
/s/ Richard Kraus Date: March 31, 1997
- --------------------------------------------------
Richard Kraus
(President and Chief Executive Officer)
/s/ Richard Kraus Date: March 31, 1997
- --------------------------------------------------
Richard Kraus
(Chief Financial & Accounting Officer; Director)
/s/ Jack A. Copeland Date: March 31, 1997
- --------------------------------------------------
Jack A. Copeland, (Director)
/s/ Vernon F. Plack Date: March 31, 1997
- --------------------------------------------------
Vernon F. Plack, (Director)
/s/ Jay Middleton Date: March 31, 1997
- --------------------------------------------------
Jay Middleton, (Director)
/s/ Peter J. Ensenat Date: March 31, 1997
- --------------------------------------------------
Peter J. Ensenat, (Director)
/s/ Nancy H. Burger Date: March 31, 1997
- ---------------------------------------------------
Nancy H. Burger, (Director)
65
EXHIBIT INDEX
Exhibit
No. Description
- ------- ---------------
8.1 Articles of Incorporation of Quantum Financial Holdings, Inc.
((incorporated by reference to Registration Statement on Form
S-4 (File No. 33-90350)).
3.2 Bylaws of Quantum Financial Holdings, Inc.
(incorporated by reference to Registration Statement on Form
S-4 (File No. 33-90350)).
10.1 Employment Agreement between the Registrant and Richard Kraus,
President & CEO (incorporated by reference to Annual Report
on Form 10-K for the fiscal year ended December 31, 1995)
10.2 Quantum Financial Holdings, Inc. 1988 Stock Option and Incentive
Plan (incorporated by reference to Post-Effective Amendment No. 1
on Form S-8 to Registration Statement on Form S-4 (File No.
33-90350))
21 Subsidiaries of Registrant (incorporated by reference to Annual
Report on Form 10-K for the fiscal year ended December 31, 1995)
23.1 Consent of Wooden & Benson, Chartered
23.2 Consent of Arthur Andersen LLP
27 Financial Data Schedule
66