UNITED STATES SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 ----------------------- FORM 10-Q (Mark One) (X) QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the Quarterly Period Ended March 31, 1998 OR (_) TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the transition period from __________________ to _____________________ Commission File Number 0-18279 ---------------------------------- Tri-County Financial Corporation ---------------------------------------------------- (Exact name of registrant as specified in its charter) Maryland 52-1652138 - ---------------------------------- ------------------- (State of other jurisdiction of (I.R.S. Employer incorporation or organization) Identification No.) 3035 Leonardtown Road, Waldorf, Maryland 20601 - ------------------------------------------- ------------ (Address of principal executive offices) (Zip Code) (301) 645-5601 ------------------------------------------- (Registrant's telephone number, including area code) ----------------------------------------------------------- (Former name, former address and former fiscal year, if changed since last report) Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes x No ---- ---- Indicate the number of shares outstanding of each of the issuer's classes of common stock, as of the latest practical date. As of May 5, 1998 registrant had outstanding 813,967 shares of Common Stock. TRI-COUNTY FINANCIAL CORPORATION FORM 10-Q INDEX ------------------------------------------------------------- PART I - FINANCIAL INFORMATION Page Item 1 - Financial Statements (Unaudited) Consolidated Balance Sheets - March 31, 1998 and December 31, 1997 2 Consolidated Statements of Income and Comprehensive Income - Three Months Ended March 31, 1998 and 1997 3 Consolidated Statements of Cash Flows - Three Months Ended March 31, 1998 and 1997 4-5 Notes to Consolidated Financial Statements 6-7 Management's Discussion and Analysis of Financial Condition and Results of Operations 8-11 PART II - OTHER INFORMATION 12-13 Item 6 - Exhibits SIGNATURES 14 PART I. FINANCIAL INFORMATION ITEM I. FINANCIAL STATEMENTS (UNAUDITED) TRI-COUNTY FINANCIAL CORPORATION CONSOLIDATED BALANCE SHEETS MARCH 31, 1998 AND DECEMBER 31, 1997 - -------------------------------------------------------------------------------- March 31, December 31, 1998 1997 ASSETS Cash and due from banks $ 1,033,371 $ 650,923 Interest-bearing deposits with banks 4,943,964 5,169,830 Investment securities available for sale - at fair value 51,081,965 52,878,583 Investment securities held to maturity - at amortized cost 2,982,945 1,149,137 Stock in Federal Home Loan Bank and Federal Reserve Bank - at cost 1,724,000 1,724,000 Loans held for sale 3,752,301 1,698,872 Loans receivable - net of allowance for loan losses of $1,370,466 and $1,310,365, respectively 123,993,836 121,866,762 Premises and equipment, net 4,278,838 4,189,222 Accrued interest receivable 1,322,944 1,276,376 Other assets 615,527 584,655 ------------ ------------ TOTAL ASSETS $195,729,691 $191,188,360 ============ ============ LIABILITIES AND STOCKHOLDERS' EQUITY LIABILITIES: Noninterest-bearing deposits $ 7,853,226 $ 7,196,053 Interest-bearing deposits 137,316,433 135,080,024 ------------ ------------ Total deposits 145,169,659 142,276,077 Other borrowed funds 13,230,165 12,523,210 Long-term debt 16,606,995 16,678,610 Accrued expenses and other liabilities 994,692 624,384 ------------ ------------ Total liabilities 176,001,511 172,102,281 ------------ ------------ STOCKHOLDERS' EQUITY: Common stock - par value $.01; authorized - 15,000,000 shares; issued 782,866 and 782,699 shares, respectively 7,829 7,827 Surplus 6,575,945 6,574,162 Stock dividend distributable 711,259 - Retained earnings 12,127,461 12,256,443 Accumulated other comprehensive income 512,671 442,032 Unearned ESOP shares (206,985) (194,385) ------------ ------------ Total stockholders' equity 19,728,180 19,086,079 ------------ ------------ TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $195,729,691 $191,188,360 ============ ============ See notes to consolidated financial statements. 2 TRI-COUNTY FINANCIAL CORPORATION CONSOLIDATED STATEMENTS OF INCOME AND COMPREHENSIVE INCOME THREE MONTHS ENDED MARCH 31, 1998 AND 1997 - --------------------------------------------------------------------- Three Months Ended March 31, ---------------------- 1998 1997 INTEREST INCOME: Interest and fees on loans $2,847,616 $2,612,717 Taxable interest and dividends on investment securities 894,408 940,102 Interest on deposits with banks 34,236 23,610 ---------- ---------- Total interest income 3,776,260 3,576,429 ---------- ---------- INTEREST EXPENSE: Interest on deposits 1,422,932 1,409,647 Interest on other borrowed funds 188,428 219,536 Interest on long-term debt 230,682 104,448 ---------- ---------- Total interest expense 1,842,042 1,733,631 ---------- ---------- NET INTEREST INCOME 1,934,218 1,842,798 PROVISION FOR LOAN LOSSES 60,000 60,000 ---------- ---------- NET INTEREST INCOME AFTER PROVISION FOR LOAN LOSSES 1,874,218 1,782,798 ---------- ---------- NONINTEREST INCOME: Loan appraisal, credit and miscellaneous charges 112,512 85,548 Net gains on sale of loans held for sale 96,845 43,742 Service charges 148,620 115,010 Other 27,816 26,673 ---------- ---------- Total noninterest income 385,793 270,973 ---------- ---------- NONINTEREST EXPENSES: Salaries and employee benefits 621,096 561,727 Occupancy expense 109,854 94,199 Deposit insurance and surety bond premium 38,294 35,118 Data processing expense 62,251 56,651 Advertising 31,848 38,855 Depreciation of furniture, fixtures, and equipment 38,530 36,375 Other 294,095 306,837 ---------- ---------- Total noninterest expenses 1,195,968 1,129,762 ---------- ---------- INCOME BEFORE INCOME TAXES 1,064,043 924,009 INCOME TAXES 377,000 347,700 ---------- ---------- NET INCOME 687,043 576,309 OTHER COMPREHENSIVE INCOME, NET OF TAX - Net unrealized holding gains arising during the period 70,639 106,340 ---------- ---------- COMPREHENSIVE INCOME $ 757,682 $ 682,649 ========== ========== EARNINGS PER SHARE/(1)/ (Note 2): Basic .86 .67 Diluted .81 .67 /(1)/ Restated to reflect 1998 4% stock dividend See notes to consolidated financial statements. 3 TRI-COUNTY FINANCIAL CORPORATION CONSOLIDATED STATEMENTS OF CASH FLOWS THREE MONTHS ENDED MARCH 31, 1998 AND 1997 - --------------------------------------------------------------------- Three Months Ended March 31, --------------------- 1998 1997 CASH FLOWS FROM OPERATING ACTIVITIES: Net income $ 687,043 $ 576,309 Adjustments to reconcile net income to net cash provided by operating activities: Provision for loan losses 60,000 60,000 Depreciation and amortization 66,319 74,143 Net amortization of premium/discount on investment securities (8,819) (24,987) Deferred income tax benefit (95,000) (6,300) Increase in interest receivable (46,568) (102,467) Increase (decrease) in deferred loan fees 10,744 (213) Increase (decrease) in accounts payable, accrued expenses, and other liabilities 402,924 (123,947) Increase in other assets (117,698) (117,899) Gain on sale of premises and equipment (7,051) - Origination of loans held for sale (7,279,429) (1,449,280) Gain on sales of loans held for sale (96,845) (43,742) Proceeds from sale of loans held for sale 5,322,845 2,091,702 Gain on sale of foreclosed real estate - (7,000) ------------ ------------ Net cash (used) provided by operating activities (1,101,535) 926,319 ------------ ------------ CASH FLOWS FROM INVESTING ACTIVITIES: Net decrease (increase) in interest-bearing deposits with banks 225,866 (1,447,050) Purchase of investment securities available for sale (12,242,206) (5,437,676) Proceeds from sale, redemption or principal payments of investment securities available for sale 14,160,374 5,117,045 Purchase of investment securities held to maturity (2,000,260) - Proceeds from maturities or principal payments of investment securities held to maturity 168,805 157,543 Loans originated or acquired (12,341,919) (10,896,339) Principal collected on loans 10,144,101 7,633,593 Purchase of premises and equipment (148,037) (147,281) Proceeds from sales of premises and equipment 7,051 - Proceeds from disposition of foreclosed real estate - 162,135 ------------ ------------ Net cash used in investing activities (2,026,225) (4,858,030) ------------ ------------ 4 TRI-COUNTY FINANCIAL CORPORATION CONSOLIDATED STATEMENTS OF CASH FLOWS THREE MONTHS ENDED MARCH 31, 1998 AND 1997 - --------------------------------------------------------------------- Three Months Ended March 31, --------------------- 1998 1997 CASH FLOWS FROM FINANCING ACTIVITIES: Net increase in deposits $2,893,582 $ 2,814,366 Proceeds from long-term borrowings - 8,000,000 Payments of long-term (79,514) (8,044,352) Net increase in other borrowed funds 706,955 599,619 Exercise of stock options 1,785 44,354 Net change in unearned ESOP shares (12,600) 49,876 ---------- ----------- Net cash provided by financing activities 3,510,208 3,463,863 ---------- ----------- INCREASE IN CASH AND CASH EQUIVALENTS 382,448 (467,848) CASH AND CASH EQUIVALENTS - JANUARY 1 650,923 1,111,894 ---------- ----------- CASH AND CASH EQUIVALENTS - MARCH 31 $1,033,371 $ 644,046 ========== =========== SUPPLEMENTAL DISCLOSURES OF CASH FLOWS INFORMATION: Cash paid during the three months for: Interest $1,828,076 $ 1,726,042 ========== =========== Income taxes $ - $ 200,000 ========== =========== Tri-County Financial Corporation declared a 4% and 5% stock dividend payable April 13, 1998 and April 15, 1997, to shareholders of record on March 13, 1998 and March 7, 1997, respectively. Retained earnings in the amount of $711,259 in 1998 and $834,635 in 1997 was transferred to capital in excess of par and common stock to reflect these dividends. See notes to consolidated financial statements. 5 TRI-COUNTY FINANCIAL CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - -------------------------------------------------------------------------------- 1. BASIS OF PRESENTATION General - The consolidated financial statements of Tri-County Financial Corporation (the Company) and its wholly owned subsidiary, Community Bank of Tri-County (the Bank) included herein are unaudited; however, they reflect all adjustments consisting only of normal recurring accruals that, in the opinion of Management, are necessary to present fairly the results for the periods presented. Certain information and note disclosures normally included in financial statements prepared in accordance with Generally Accepted Accounting Principles have been condensed or omitted pursuant to the rules and regulations of the Securities and Exchange Commission. The Company believes that the disclosures are adequate to make the information presented not misleading. The results of operations for the three months ended March 31, 1998 are not necessarily indicative of the results of operations to be expected for the remainder of the year. Certain previously reported amounts have been restated to conform to the 1998 presentation. It is suggested that these consolidated financial statements be read in conjunction with the consolidated financial statements and notes thereto included in the Company's Annual Report for the year ended December 31, 1997. 2. EARNINGS PER SHARE Basic and diluted earnings per share, as adjusted for the stock dividend, have been computed based on weighted-average common and common equivalent shares outstanding as follows: Three Months Ended March 31, ------------------ 1998 1997 -------- -------- Basic 803,432 854,235 Diluted 853,472 859,523 3. NEW ACCOUNTING PRONOUNCEMENTS Effective for periods ending after December 15, 1997, Statement of Financial Accounting Standards (SFAS) No. 128, Earnings Per Share, is applicable for computing and presenting earnings per share (EPS) for entities, such as the Company, with publicly held common stock or potential common stock. This statement simplifies the standards for computing EPS, making them comparable to international EPS standards. It replaces the presentation of primary EPS with a presentation of basic EPS. It also requires dual presentation of basic and diluted EPS on the face of the income statement for all entities with complex capital structures and requires a reconciliation of the numerator and denominator of the basic EPS computation to the numerator and denominator of the diluted EPS computation. Statement of Financial Accounting Standards No. 130, Reporting Comprehensive Income, was issued in June 1997. This statement establishes standards for disclosing comprehensive income and its components in a full set of general-purpose financial statements. Comprehensive income is defined as the change in equity from transactions and other events and circumstances from nonowner sources. Comprehensive income includes net income which is adjusted for items such as unrealized gains and losses on certain investment securities and minimum pension liability adjustments. This statement is effective for fiscal years beginning after December 31, 1997. Reclassification of financial statements for earlier periods provided for comparative purposes is required. 6 Statement of Financial Accounting Standards No. 131, Disclosure about Segments of an Enterprise and Related Information, was issued in June 1997. This statement establishes standards for disclosing information about operating segments in financial statements. Operating segments are components of a business about which separate financial information is available that is evaluated by management in deciding how to allocate resources and in assessing performance. Management has not determined yet whether additional disclosure will be necessary under the requirements of SFAS No. 131. For year-end disclosure, this statement is effective for fiscal years beginning after December 15, 1997. Interim reporting disclosures would not be required in the first year of adoption, but would begin the first quarter immediately after the first year of providing year-end disclosures. For interim reporting, the preceding year's interim information must be presented on a comparative basis. 7 MANAGEMENT'S DISCUSSION AND ANALYSIS GENERAL Tri-County Financial Corporation owns 100% of the issued and outstanding common stock of Community Bank of Tri-County ("the Bank"), which is the principal asset of the Company. Tri-County Financial Corporation does not presently own or operate any subsidiaries other than the Bank and its subsidiary and the entities are collectively referred to as "the Company". The holding company's banking subsidiary, Community Bank of Tri-County has completed its first year as a commercial bank, following its thrift charter conversion on March 29, 1997. The Bank has been successful in the first phase of its evolution from a thrift to a community based commercial bank. All product lines were subjected to analysis for relevance and profitability. Strategies were implemented to broaden the scope of services to attract local business and consumers. The Bank received a favorable reaction from its customers and potential customers in its market area as it redefined its niche as a locally owned and managed financial institution. The Bank conducts operations through eight full-service offices in its market area consisting of Charles, St. Mary's and Calvert counties in Maryland. In January 1998, a new, highly visible location was acquired adjacent to Southern Maryland's only regional shopping mall and a small satellite branch was closed. The Bank is primarily engaged in the business of obtaining funds in the form of deposits from the general public in the Bank's market area, and investing such funds in loans collateralized by residential and commercial real estate, mortgage-backed securities and, to a lesser, but growing, extent, various types of consumer and other loans and investment and money market securities. The Company's earnings, therefore, are primarily dependent upon its net interest income. This is determined by the Company's interest rate spread (the difference between the yields earned on its loans, mortgage-backed securities and investment portfolios, and the rates paid on its deposits and borrowed funds) and the relative holdings of interest-earning assets and interest-bearing liabilities. Also of significance to the Company's net income is its provision for estimated loan losses, as well as the amount of noninterest income derived from activities that are not dependent on spread based lending. Transaction charges, nondeposit products and additional services are under review to augment the noninterest income contribution to the net earnings of the Bank. The Company's deposit flows and cost of funds are determined by interest rates on competing investments and general market rates of interest. Lending activities are affected by consumer demand, the interest rates in the market and the level of funds available. The Company grants loans throughout the Southern Maryland area. Its borrowers' ability to repay is, therefore, dependent upon the economy of Southern Maryland. SELECTED FINANCIAL DATA Three Months Ended March 31, ------------------- 1998 1997 Condensed Income Statement: Interest income $3,776,260 $3,576,429 Interest expense 1,842,042 1,733,631 Net interest income 1,934,218 1,842,798 Provision for loan losses 60,000 60,000 Other income 385,793 270,973 Operating expenses 1,195,968 1,129,762 Income before income taxes 1,064,043 924,009 Income tax expense 377,000 347,700 Net income 687,043 576,309 Per Common Share: Basic earnings $ .86 $ .67 Diluted earnings .81 .67 Book value 25.20 23.27 8 RESULTS OF OPERATIONS The Company reported net income of $687,043 and $576,309 during the three months ended March 31, 1998 and 1997, respectively, representing a $110,734 or 19.2% increase for the three months ended March 31, 1998 compared to the comparable period in 1997. As described in more detail in following sections of this analysis, significant changes in specific income and expense line items generated this increase, rather than an overall trend applicable to all areas. The increase in net income resulted from the $91,420 increase in net interest income, a $114,820 increase in noninterest income, an increase of $66,206 in noninterest expenses and a $29,300 increase in income tax expense relating to the increased earnings. Interest and Dividend Income Interest and dividend income on investment securities continued a generally declining trend during 1998 as a result of the exercise of calls imbedded in several of the Bank's securities and the maturity of some others. The majority of these securities were replaced with similar types of assets. However, as new investment securities were acquired, the overall interest rate level of the portfolio was reduced because the market dictated lower rates on these securities at that time. The Bank has utilized a strategy of net worth leveraging since the fourth quarter of 1996. When opportunities became available, an investment was purchased with maturity and rate terms that could be reasonably matched with available borrowings to generate a specified net yield. The Bank benefitted from the Federal Reserve Board's rate increase in March of 1997 as the adjustable rate investment and loan portfolio items repriced to higher yields. The asset side repriced at a slightly faster rate than liabilities, both deposits and borrowings, further increasing the net yield. The combination of the increased net yield and the balance sheet growth contributed to the 5.0% overall growth in net interest income for the three months ended March 31, 1998 over the comparable period results in 1997. Noninterest Income Contributing to the increase in earnings were increases in loan service charges of $26,964, or 31.5%, resulting from higher mortgage loan volume as consumers reacted to lower market rates and increased gains on sales of loans originated for the purpose of reselling. Overall loan originations increased $7.3 million, or 58.9%, for the first three months of 1998 as compared to the comparable period in 1997. The conversion to a commercial bank charter resulted in a change in the composition of originations, with an increased proportion of originations occurring in the commercial real estate and lines of credit loans. In addition, the Bank has increased its activity in originating and selling fixed rate mortgage loans, accounting for $5.8 million of the increased loan volume. Bank mergers and residential mortgage company restructurings have left the Bank as one of a few long-standing, stable and reputable sources of funds for the Southern Maryland market. Commission-based mortgage loan originators are utilized to further strengthen the Bank's presence in its market. An effort has been made to identify the customer services provided by the Bank which can be used to generate additional revenues. This led to the imposition of user fees for the use of the Bank's ATMs by noncustomers. In the two months of operations at the Bank's new facility near the mall, that location has had its ATM volume surpass every other existing branch in individual transaction levels. In addition, Bank customers have been utilizing certain negotiable order of withdrawal account features which have a related service fee and the conversion to a commercial bank has generated a small but increasing commercial deposit account base. The combined effect of these factors was a $33,610, or 29.2%, increase in service charge income in the three months ended March 31, 1998 as compared to the corresponding period in 1997. Noninterest Expense The Bank experienced an increase in noninterest expenses of $66,206 or 5.9% for the three months ended March 31, 1998 as compared to the three months ended March 31, 1997. Compensation related expenses increased $59,369, or 10.6%, as the Bank increased its salary level commensurate with inflation and reached a full staffing level for its new, larger branch which replaced a satellite branch. Occupancy expense increased $15,655, or 16.6%, as the new branch location costs are higher than the satellite branch it replaced and contractual inflation adjustments took effect. In connection with the conversion to a commercial bank, the level of advertising costs incurred to publicize and promote the conversion and its ensuing benefits to the customers and community began to be incurred. 9 Income Tax Expense Income tax expenses increased 8.4% as a result of the increase in pretax income. Earnings Per Share Basic earnings per share for the three months were $.86 per share or $.19 higher than for the corresponding period in 1997. FINANCIAL CONDITION Assets Total assets as of March 31, 1998 grew $4.5 million to $195.7 million from the December 31, 1997 level of $191.2 million. This reflects a growth rate of 2.4% as compared to 2.0% asset growth during the previous year. Increased development of the Southern Maryland area as a bedroom community for Washington, D.C. workers and military base expansion in the Bank's market area continued to keep the real estate market strong. Loan growth was $4.2 million or 3.4% for the three-month period as compared to an increase of $2.4 million or 2.2% for the three months ended March 31, 1998. In connection with the charter conversion, the Bank adopted a business plan that focused on more consumer and commercial loans, and has increased its fixed rate loan origination and sale activity in connection with the current low fixed rate loan environment. The allowance for loan losses was maintained at a level believed by management to be adequate to absorb potential losses consistent with the risk profile of the loan portfolio. Management's determination of the adequacy of the allowance is based on a periodic evaluation of the portfolio with consideration given to the overall loss experience; current economic conditions; volume, growth and composition of the loan portfolio; financial condition of the borrowers; and other relevant factors that, in management's judgment, warrant recognition in providing an adequate allowance. The Bank's allowance for loan losses was increased in part by a $60,000 provision for loan losses during the first three months of 1998 in accordance with management's policy described above. The Company's holdings of investment securities remained stable since December 31, 1997. Several securities experienced early payoff since the issuer was able to obtain better rates by calling the investment and reissuing it at the more attractive long-term rates currently available in the market. These securities were replaced by similar investments, though generally at a lower yield in response to the current market conditions at the time of purchase. The level of property and equipment balances increased $89,616 as the new location was brought into operation and the Bank continued to upgrade its computer equipment. Liabilities Liability growth was managed to reflect the change in asset levels. Deposit growth was 2.0% for the three months ended March 31, 1998. The deposit base provided a source of funds at a lower average rate than could be realized by borrowing. The Bank's strategy has been to focus on attracting customers disenfranchised by the shrinking pool of locally run banks in Southern Maryland. Loan demands were met with the funds obtained through increased deposit account balances and a $635,340 increase in borrowed funds and long-term debt. Stockholders' Equity Stockholders' equity increased $642,101 or 3.4% to $19.7 million at March 31, 1998 compared to $19.1 million at December 31, 1997. This reflects the net income of $687,043 for the three-month period and a $70,639 increase in accumulated other comprehensive income. Additionally, a cash distribution to shareholders in the form of a $.125 per share cash dividend was accrued. A shift in the components of stockholders' equity occurred as a result of the declaration of a 4% stock dividend to shareholders; this resulted in a transfer of $711,259 from retained earnings to stock dividend distributable. The cash and stock dividends were distributed to shareholders on April 13, 1998. 10 Book value on a per share basis, $25.20 at March 31, 1998, as compared to $24.38 at December 31, 1997, reflects a 3.4% increase. Beginning in the third quarter of 1997, opportunities arose for the Corporation to acquire some of its own stock. After evaluation of the offering price and consideration of alternative uses of corporate assets, the Board approved, over the last six months, the purchase of 17,000 shares. During the first three months of 1998, the Bank's Employee Stock Ownership Plan (ESOP) acquired additional shares, utilizing the line of credit available from the Corporation. When the ESOP purchases shares using such borrowed funds, the shares purchased are pledged as collateral for the loan and the loan balance is reflected as a reduction of stockholders' equity. MARKET RISK ANALYSIS The market risk of the Bank is managed through the Board's Asset and Liability Committee (ALCO). Together with the Bank's management, the committee reviews the sensitivity of the market value of the portfolio equity and interest rate sensitivity of net income. The changes in the market value of portfolio equity as well as the interest income sensitivity are caused by shifts in the market rates of interest and can cause a negative as well as a positive impact in given scenarios. The portfolio is subjected to periodic modeling to test the effects of sudden and sustained interest rate shocks on the market value and the net interest income sensitivity. The Basle Committee on Banking Supervision has set standard measures of portfolio market value equity and interest income sensitivity in a shock environment of an up or down 200 basis point shift in assumed interest rates. The impact of such a shock on the Bank's portfolio is as follows: March 31, 1998 March 31, 1997 --------------- --------------- Market value of portfolio equity: Interest rate changes - adverse scenario: Up 200 basis points -10% -13% Down 200 basis points -2% +8% Interest rate sensitivity: Interest rate changes - adverse scenario: Up 200 basis points +8% +4% Down 200 basis points -10% -5% The change in percentage for the Market Value of Portfolio Equity improved at the adverse scenario of up 200 basis points in interest rate movement, while the equity declined at a greater rate in the down 200 basis shock. Because the net income of the Bank and Company is derived through the interest spread of the portfolio, the ALCO committee is less concerned with the shock of interest rates on the market value than it is on the interest rate sensitivity because the assets are employed for their income production rather that value appreciation upon sale. The levels of change for both the market value of the portfolio equity and the net interest income sensitivity fall within the policy benchmarks established by the Board. Interest rate sensitivity reflects the change in the Bank's net interest income given assumed interest rate shifts. In the scenarios presented, the most detrimental for the Bank is a downward movement of rates. Management feels that a more difficult situation for the Bank to control would exist with rising interest rates. This is due to the composition of the cost of funds and the percentage of wholesale borrowings needed to finance the activities of the Bank. Typically, wholesale borrowings are in large denominations and reprice quickly to reflect sudden changes in the global market. Retail deposits typically are in smaller amounts and are less likely to respond to shifts in rates in a short time period. Therefore, the Bank's portfolio has been structured with an attempt to reasonably minimize the impact from sudden and prolonged upward shifts in interest rates. REGULATORY MATTERS The Bank is subject to Federal Reserve Board capital requirements as well as to statutory capital requirements imposed under Maryland law. At March 31, 1998, the Bank's tangible, leverage and risk-based capital was 9.87%, 9.87% and 18.22%, respectively. These levels are well in excess of the required 1.5%, 3.0% and 8.0% ratios required by the Federal Reserve Board. 11 TRI-COUNTY FINANCIAL CORPORATION -------------------------------- PART II - OTHER INFORMATION --------------------------- Item 6 - Exhibits A. Exhibits (27) Financial Data Schedule 12 SIGNATURES Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized. Tri-County Financial Corporation: Date: By: ------------------------ ---------------------------------- Michael L. Middleton, President and Chairman of the Board Date: By: ------------------------ ----------------------------------- Eileen M. Ramos Chief Financial Officer 13