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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-K
(MARK ONE)
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
FOR THE FISCAL YEAR ENDED DECEMBER 31, 2004
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
FOR THE TRANSITION PERIOD FROM ___________ TO ___________
COMMISSION FILE NUMBER 333-117385
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THE BANCORP, INC.
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(Exact name of registrant as specified in its charter)
DELAWARE 23-3016517
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(State or other jurisdiction of (IRS Employer
incorporation or organization) Identification No.)
405 SILVERSIDE ROAD
WILMINGTON, DE 19809
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(Address of principal executive offices) (Zip Code)
REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE: (302) 385-5000
SECURITIES REGISTERED PURSUANT TO SECTION 12(b) OF THE ACT:
NAME OF EACH EXCHANGE
TITLE OF EACH CLASS ON WHICH REGISTERED
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None None
SECURITIES REGISTERED PURSUANT TO SECTION 12(g) OF THE ACT:
COMMON STOCK
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 [ ] No [X]
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 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. [ ]
Indicate by check mark whether the registrant is an accelerated filer
(as defined in Rule 12b-2 of the Securities Exchange Act of 1934). Yes [ ]
No [X]
The aggregate market value of the common shares of the registrant held
by non-affiliates of the registrant, based upon the closing price of such shares
on March 23, 2005 of $14.00, was approximately $166.4 million.
As of March 23, 2005, 11,888,061 shares of common stock, par value $1.00
per share, of the registrant were outstanding.
DOCUMENTS INCORPORATED BY REFERENCE
Portions of the proxy statement for registrant's 2005 Annual Meeting of
Shareholders are incorporated by reference in Part III of this Form 10-K.
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PART I
ITEM 1. BUSINESS
GENERAL
We are a Delaware financial holding company with a wholly owned subsidiary, The
Bancorp Bank, which we refer to as the Bank. We were formed in 1999 and
commenced operations in July 2000. From our formation until February 2004 we
were the sole stockholder of the Bank. In February 2004, the Bank completed a
public offering of its common stock which resulted in our holding 32.7% of the
Bank's common stock. In December 2004, we completed a reorganization with the
Bank which resulted in the Bank once again becoming our wholly-owned subsidiary.
Our target market is the greater Philadelphia-Wilmington metropolitan area. We
believe that a key factor in our ability to achieve our business strategy and
financial goals and to create shareholder value is the attractiveness of this
market. This area consists of the 12 counties surrounding Philadelphia and
Wilmington and includes: Philadelphia, Delaware, Chester, Montgomery, Bucks and
Lehigh Counties in Pennsylvania, New Castle County in Delaware and Mercer,
Burlington, Camden, Ocean and Cape May Counties in New Jersey.
We believe that changes in this market have created an underserved base of small
and middle-market businesses and high net worth individuals that we can
successfully target. The Philadelphia-Wilmington market area currently is home
to 150 bank and thrift institutions and is characterized by the dominance of
large out-of-state banking organizations. Of these institutions, the five
largest banking organizations by deposits control approximately 50% of the
market by deposit share and, of the ten largest, seven are headquartered outside
of the Philadelphia-Wilmington area. 140 institutions are below $2 billion in
deposit size and control approximately 31% of the market by deposit share. We
believe that our target customers are interested in banking with a company
headquartered in, and with decision-making authority based in, the
Philadelphia-Wilmington area.
To serve our customers, we provide a full range of retail and commercial banking
services, including a variety of checking, savings and other interest-bearing
accounts. We feature accounts with no required minimum balance, no service fees,
rebates on ATM fees, free debit MasterCard, overdraft protection plans and, on
our interest-bearing accounts, competitive interest rates. Our business lending
services focus on secured loans and lines of credit, construction loans and
customized equipment and vehicle leasing programs. Our consumer lending services
focus on home equity loans, personal and home equity lines of credit, personal
installment loans and vehicle leasing.
We have a continuing program of providing banking services to the members and
employees of organizations or businesses, which we call affinity group banking.
We provide these services through a private-label website under the affinity
group's name and offer an affinity group the ability to customize the banking
services offered on the website to respond to the needs and preferences of its
members.
As part of our private-label programs, we have developed a system for processing
credit and debit card transactions for independent sales organizations and their
merchant members that is a source of fee income for us and, because the merchant
members must maintain accounts with us, a
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source of low-cost deposits. By using our services rather than those of other
banks, independent service organizations remove potential competitors from the
relationship between the independent service organization and its merchant
customers, since we do not offer any products comparable to those of the
independent service organization. Our infrastructure allows us to process high
volume transactions that permit merchant customers to access the card
associations and debit networks at a significantly lower cost. We offer
end-to-end services, which means that we believe we have the ability to fulfill
all of our customers' needs with respect to merchant card services and funds
transfers. We market our services through a variety of sales channels that
includes affinity groups and independent sales organizations and financial
institutions.
Our customers access our banking services through our website, or the website of
their affinity group, from any personal computer with a web browser, and obtain
cash withdrawals from automated teller machines. As a result, we do not maintain
a branch bank system.
Our offices are located at 405 Silverside Road, Wilmington, Delaware 19809 and
our telephone number is (302) 385-5000. We also maintain executive offices at
1818 Market Street, Philadelphia, Pennsylvania 19103. Our web address is
www.thebancorp.com. We include on our website our Annual Report on Form 10-K,
Quarterly Reports on Form 10-Q, Current Reports on Form 8-K and amendments to
those reports as soon as reasonably practicable after we file them with the SEC.
OUR STRATEGY
Our principal growth strategies are to:
Build upon the network of relationships developed by our senior management. We
seek to build upon our senior managers' network of relationships through a
division called The Philadelphia Private Bank. This division offers banking
services specifically targeted to individuals and businesses in the
Philadelphia, Pennsylvania, region with which our senior management has
developed relationships. Philadelphia Private Bank seeks to offer these
customers products and services that meet their banking and financing needs, and
to provide them with the attention of senior management which we believe is
often lacking at larger financial institutions. Philadelphia Private Bank offers
a staff of people experienced in dealing with, and solving, the banking and
financing needs of small to mid-size businesses. The website for the
Philadelphia Private Bank is www.philadelphiaprivatebank.com.
Develop relationships with affinity groups to gain sponsored access to their
membership, client or customer bases to market our banking products and
services. We seek to develop relationships with organizations with established
membership, client or customer bases. Through these relationships, we gain
access to the affinity groups' members, clients and customers through their
pre-existing relationships with the groups, and under the groups' sponsorship.
We seek to build on these relationships by offering online banking under the
name of and through the facilities of the affinity group, as described in "-The
Affinity Group Relationship," below, referred to as "privately-labeled" banking.
We believe that by marketing targeted products and services to constituencies
through their pre-existing relationships with affinity groups, we will lower our
customer acquisition costs and build close customer relationships.
Develop Relationships with Small to Mid-Size Businesses and Their Principals. We
target small to mid-size businesses and their principals. We believe that
satisfactory attention to this market requires a combination of the ability to
provide a high level of services, including customized financing to meet a
customer's needs, and the personal attention of senior management. Because
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of the significant consolidation of banking institutions in the
Philadelphia-Wilmington area, we believe that many of the financial institutions
with which we compete may have become too large to provide those services
efficiently and cost-effectively.
Use Our Existing Infrastructure as a Platform for Growth. We have made
significant investments in our banking infrastructure in order to be able to
support our growth. We believe that this infrastructure can accommodate
significant additional growth without substantial additional expenditure. We
believe that this infrastructure enables us to maximize efficiencies through
economies of scale as we grow without adversely affecting our relationships with
our customers.
PRODUCTS AND SERVICES
Deposit Products and Services. We offer our depositors a wide range of products
and services, including:
o Checking accounts, featuring no required minimum balance, no service
fees, competitive interest rates, rebates on automated teller machine
fees, free debit MasterCard and overdraft protection plans. Premium
checking accounts have free online bill paying, an enhanced debit
MasterCard or an automated teller machine card.
o Savings accounts.
o Health savings accounts.
o Money market accounts.
o Individual retirement accounts, including Roth and education IRAs as
well as traditional IRAs.
o Commercial accounts, including general commercial checking, small
business checking, business savings and business money market accounts.
o Certificates of deposit.
o Stored value and payroll cards.
Lending Activities. At December 31, 2004, we had a loan portfolio of $427.9
million, representing 74.2% of our total assets at that date. We originate
substantially all of the loans held in our portfolio, except in certain
instances we have purchased individual lease and lease pools. Where a proposed
loan exceeds our lending limit, we typically sell a participation in the loan to
another financial institution. We generally separate our lending function into
commercial term loans, commercial mortgages, commercial lines of credit,
construction, direct lease financing and personal loans. We focus primarily on
lending to small to mid-size businesses and their principals. As a result,
commercial, construction and commercial mortgage loans have comprised a majority
of our loan portfolio since we commenced operations. At December 31, 2004,
commercial, construction and commercial mortgage loans made up $327.3 million,
or 76.5%, of our total loan portfolio. These types of loans are generally viewed
as having more risk of default than residential real estate loans or consumer
loans and are typically larger than residential real estate and consumer loans.
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While in making our loans we rely upon our evaluation of the creditworthiness
and debt-servicing capability of a borrower, we typically require that our loans
be secured by tangible collateral, usually residential or commercial real
property. We do not engage in non-recourse lending (that is, lending as to which
the lender only looks to the asset securing the loan for repayment) and will
typically require the principals of any commercial borrower to personally
guarantee the loan. In general, we require that the ratio of the principal
amount of a loan to the value of the collateral securing it be no greater than
between 65% to 85% depending on the type of property and its use. The maturity
dates on our loans are generally short to mid-term. We typically seek to
structure our loans with variable rates of interest based upon either a stated
prime rate or the London Inter-Bank Offered Rate, although we do lend at fixed
rates when appropriate for a particular customer.
Commercial Term Lending. We make loans to businesses to finance fixed assets,
acquisitions and other long-term needs of our business customers. While the
loans are generally secured, the loans are underwritten principally upon our
evaluation of the future cash flows of the borrower. Maturities of these loans
are typically five years or less and have amortization schedules that do not
exceed the useful life of the asset to be acquired with the financing. As of
December 31, 2004, commercial term loans were 7.9% of our total loan portfolio.
Commercial Mortgage Lending. We make loans to businesses to finance the
acquisition of, or to refinance, income-producing real property. The principal
repayment source for these loans is the property and the income it produces,
which depends upon the operation of the property and its market value, although
we also evaluate the creditworthiness of the borrower and guarantors as a second
repayment source. These loans typically are secured by real estate which is
either for rent or sale. Maturities on these loans generally do not exceed 10
years, although they may have an extended amortization schedule resulting in a
balloon payment due at maturity. As of December 31, 2004, commercial mortgages
were 21.8% of our total loan portfolio.
Commercial lines of credit. Lines of credit are typically short-term facilities
intended to support seasonal cash needs. They may be secured or unsecured,
depending on the purpose, anticipated repayment source and financial condition
of the borrower. This form of financing is typically self-liquidating as
repayment comes from the conversion of the financed assets to cash. All lines of
credit are payable on demand and the availability of the line of credit is
subject to a periodic review of the borrower's financial information. Generally,
lines of credit terminate between one year and 18 months. Lines of credit that
have termination dates in excess of one year typically must be paid out at least
annually. As of December 31, 2004, commercial lines of credit were 23.9% of our
total loan portfolio.
Construction Loans. The majority of our construction loans are made to
residential developers for acquisition of land, site improvements and
construction of single and multi-family residential units for sale. Terms of the
loans are generally for no longer than two years. Repayment of these loans is
typically dependent on the sale of the residential units to consumers or sale of
the property to another developer. Loans to finance the construction of
commercial or industrial properties require permanent financing upon completion
of the construction. As of December 31, 2004, construction loans were 22.7% of
our total loan portfolio.
Direct Lease Financing. Substantially all of our leases are for financing small
commercial automobile fleets. The term of our leases is typically 48 months or
less and they are open ended, meaning that potential residual risk, or the
difference between the fair market value of the automobile and the amount owed
to us, lies with the customer. As of December 31, 2004, direct lease financing
made up 10.5% of our total loan portfolio.
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Consumer Loans. We provide loans to consumers to finance personal residences,
automobiles, home improvements and other personal wants. The majority of our
consumer loans are secured by the borrower's residence in either a first or
second lien position. The ratio of loan amount to the value of the collateral
securing the loan is typically less than 85%; however, based on a borrower's
financial strength, we may increase the ratio. As of December 31, 2004, consumer
loans were 13.2% of total loan portfolio.
OTHER OPERATIONS
Account Activity. Account holders may access our products and services through
the websites of their affinity groups, or through our website, from any personal
computer with a secure web browser, regardless of its location. This access
allows account holders to apply for loans, review account activity, enter
transactions into an on-line account register, pay bills electronically, receive
statements by mail and print bank statement reports. To open a new account, a
customer must complete a simple on-line enrollment form. Customers can make
deposits into an open account via direct deposit programs, by transferring funds
between existing accounts, by wire transfer, by mail, at any deposit-taking
automated teller machine, at any of the more than 3,400 UPS Stores throughout
the United States, or in person at our Delaware offices (although we do not
maintain a teller line and do not currently intend to establish a physical
branch system). Customers may also make withdrawals and have access to their
accounts at automated teller machines.
Call Center. We have a call center as a customer support service as well as for
outbound telemarketing efforts. The call center provides account holders or
potential account holders with assistance in opening accounts, applying for
loans or otherwise accessing the Bank's products and services, and in resolving
any problems that may arise in the servicing of accounts, loans or other banking
products. The call center operates from 8:00 a.m. to 8:00 p.m., Delaware time,
on weekdays. Outside these hours, and on weekends, we outsource call center
operations to a third-party service provider. We currently employ eight persons
in our call center, including one supervisor.
Third-Party Service Providers. To reduce operating costs and to capitalize on
the technical capabilities of selected vendors, we arrange for the outsourcing
of specific bank operations and systems to third-party service providers,
principally the following:
o fulfillment functions and similar operating services, including check
processing, check imaging, electronic bill payment and statement
rendering;
o issuance and servicing of debit cards;
o compliance and internal audit;
o access to automated teller machine networks;
o processing and temporarily funding residential mortgage loans where we
will not hold the loans in our portfolio;
o bank accounting and general ledger system; and
o data warehousing services.
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Because we outsource these operational functions to experienced third-party
service providers that have the capacity to process a high volume of
transactions, we believe it allows us to more readily and cost-effectively
respond to growth than if we sought to develop these capabilities internally.
Should any of our current relationships terminate, we believe we could secure
the required services from an alternative source without material interruption
of our operations.
THE AFFINITY GROUP RELATIONSHIP
We seek to create a unique banking website for each affinity group, enabling the
affinity group to provide its members with the full banking services and
products we offer or just those banking services and products it believes will
be of interest to its members. We design each website to carry the brand of the
affinity group and carry the "look and feel" of the affinity group's own
website. Each such website, however, indicates that we provide all banking
services. To facilitate the creation of these individualized banking websites,
we have packaged our products and services into a series of modules, with each
module providing a specific service, such as basic banking, electronic payment
systems and loan and mortgage centers. Each affinity group selects from our menu
of service modules those services that it wants to offer its members or
customers. We and the affinity group also may create products and services, or
modify products and services already on our menu, that specifically relate to
the needs and interests of the affinity group's members or customers. We pay
fees to the affinity group based upon deposits and loans it generates through
our program with it. The fees typically range from between 25 to 100 basis
points (0.25% to 1.00%) of average deposits and loans generated by the
relationship and outstanding in the period, with the lower fees being charged on
interest-bearing deposits and loans with lower interest rates. We include these
fees as a component of expense in calculating our net interest margin. In the
year ended December31, 2004, these fees aggregated $356,000.
As a result of our initial investment in developing private-label banking
software, we have reduced the time, personnel and expense in establishing a
privately-labeled banking website providing core banking products and services
to an affinity group to approximately two weeks of dedicated time of one of our
technical staff members, at a cost of approximately $9,000.
We currently have 91 affinity group relationships, as follows:
o Forty-nine affinity group relationships are with independent service
organizations. These organizations provide operating and settlement
accounts to their merchant members, enabling the merchants to service
their client base from the point at which a credit or debit card
transaction occurs through settlement of that transaction. For
independent service organizations, we have created banking products that
enable those organizations to more easily process electronic payments
and maintain reserve accounts as protection against chargebacks and
losses from the parties with which they deal. Our services also enable
independent service organizations to provide their members with access
to their account balances through the Internet. By using our services
rather than those of other banks, independent service organizations
remove potential competitors from the relationship between the
independent service organization and its merchant customers, since we do
not offer any products comparable to those of the independent service
organization. In addition to the customary banking fees generated by
these relationships (which we share with the independent service
organizations), these relationships are a source of low-cost deposits
for us because of the settlement and reserve checking accounts that
merchants affiliated with the independent service organization must
maintain with us.
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o Twenty-seven affinity group relationships are with businesses and a
twenty-eighth relationship is with a university. We offer these
organizations, and other institutions with which we may develop
relationships, privately-labeled full service retail banking or, at the
organization's option, a selection of banking services and products
targeted to the needs or preferences of its members. In addition, we
separately market a treasury program to these organizations,
particularly university endowment funds, that provides transaction
processing and maintenance services to managers of the organization.
o Fourteen affinity group relationships are with employers providing their
employees health savings accounts. Our health savings account program
provides qualified entities a turnkey, low-cost way to provide this
benefit to their employees. Under this program, we open all of the
accounts offered by an employer in a privately-labeled banking
environment, and enable their employees to access account information
and process payments to health care providers through the Internet.
SALES AND MARKETING
Philadelphia Private Bank. Our marketing program for the Philadelphia Private
Bank targets a customer base of successful individuals and business owners in
the Philadelphia area and uses a personal contact/targeted media advertising
approach. This program consists of:
o direct e-mail and letter introductions of the Philadelphia Private Bank
to senior management's contacts;
o invitation-only, private receptions with prominent business leaders in
the Philadelphia community;
o advertisements in local media outlets, principally newspapers and radio
stations; and
o charitable sponsorships.
Affinity Group Marketing. We pursue affinity group relationships through the
contacts of our senior management. We seek to attract customers from an affinity
group's community not only by our presence on the affinity group's website and
through targeted marketing programs to the affinity group's members, but also
through the quality of our products and services.
Loan Production Offices. We maintain two loan production offices in the
Philadelphia metropolitan area. We established these offices to serve suburban
areas south (our Exton, Pennsylvania office) and north (our Warminster,
Pennsylvania office) of center city Philadelphia. In addition, we maintain three
offices to market and administer our automobile leasing programs, one in
Maryland, one in Alabama in connection with a portfolio of automobile leases we
acquired in 2003 and one in Florida in connection with our acquisition of
Mears Motor Livery in 2005.
Marketing Staff. We have a marketing department, currently consisting of eight
people that focus on developing marketing campaigns to particular affinity group
communities and the targeted audience of the Philadelphia Private Bank.
TECHNOLOGY
Core and Internet Banking Systems. We obtain a significant portion of our core
and internet banking systems and operations under non-exclusive licenses between
us and Metavante
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(previously M&I Data Services). These systems include, principally, those for
general ledger, deposit and loan processing, Internet banking and processing
checks and other items.
Software. Our proprietary data assets also support our online and traditional
banking products and services. We have developed a series of financial services
modules that are easy to deploy and that we can readily adopt to serve its
customers' needs. We developed these modules using an open architecture and
object-oriented technologies. We use the modules to extend the functionality of
our core and internet banking systems and to personalize financial services to
the constituencies we serve.
System Architecture. We provide financial products and services through a
highly-secured four-tiered architecture using the Microsoft Windows 2000
operating system, Microsoft Internet Information Server web server software,
Microsoft SQL 2000, Macromedia JRun, CheckPoint Systems and Cisco Systems
firewalls, and our licensed and proprietary financial services software. User
activity is distributed and load-balanced across multiple servers on each tier
through our proprietary software and third-party equipment, which maintain
replicated, local storage of underlying software and data, resulting in minimal
interdependencies among servers. Each server has its own local storage, and all
data and software are replicated across all servers. The system's flexible
architecture is designed to have the capacity, or to be easily expanded to add
capacity, to meet future demand. In addition to built-in redundancies, we
continuously operate automated internal monitoring tools and independent third
parties continuously monitor our websites.
Our primary website hosting facility is in Wilmington, Delaware and connects to
the Internet by Cisco routers through Internap's New York and FastNet's
Philadelphia, Pennsylvania network operating centers. We also maintain a
completely redundant standby hosting facility at our Philadelphia offices.
Internap's Philadelphia network operating center provides Internet connectivity
to the Philadelphia offices.
INTELLECTUAL PROPERTY AND OTHER PROPRIETARY RIGHTS
Since a significant portion of the core and internet banking systems and
operations we use come from third-party providers, our primary proprietary
intellectual property is the software for creating affinity group bank websites.
We rely principally upon trade secret and trademark law to protect our
intellectual property. We do not typically enter into confidentiality agreements
with our employees or our affinity group customers because we maintain control
over the software used to create the sites and their banking functions rather
than licensing them for customers to use. Moreover, we believe that factors such
as the relationships we develop with our affinity group and banking customers,
the quality of our banking products, the level and reliability of the service we
provide, and the customization of our products and services to meet the need of
our affinity group and other customers are substantially more significant to our
ability to succeed.
COMPETITION
We believe that our principal competition is mid-Atlantic regional banks such as
Citizens Bank, Sovereign Bank, Commerce Bank, Royal Bank and Republic First
Bank. While we also believe that we face competition from Internet-based banks
or bank divisions such as Net.Bank and E-Trade Bank, we compete more directly
with National Interbanc and Virtual Bank, Internet-based banks that provide
private labeled financial services to affinity groups and communities. We also
compete more generally with numerous other banks and thrift institutions,
mortgage brokers and other financial institutions such as finance companies,
credit unions, insurance companies, money
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market funds, investment firms and private lenders, as well as on-line
computerized services and other non-traditional competitors. We believe that our
ability to compete successfully depends on a number of factors, including:
o our ability to build upon the customer relationships developed by our
senior management;
o our ability to expand our affinity group banking program;
o competitors' interest rates and service fees;
o the scope of our products and services;
o the relevance of our products and services to customer needs and demands
and the rate at which we and our competitors introduce them;
o satisfaction of our customers with our customer service;
o ease of use of our banking website;
o the capacity, reliability and security of our network infrastructure;
and
o industry and general economic trends.
If we experience difficulty in any of these areas, our competitive position
could be materially adversely affected, which will affect our consolidated
growth, our profitability and, possibly, our ability to continue operations.
While the banking industry is highly competitive, we believe we can compete
effectively as a result of our focus on small to mid-size businesses and their
principals, a market segment we believe is under-served in our region. However,
many of our competitors have larger customer bases, greater name recognition and
brand awareness, greater financial and other resources and longer operating
histories which may make it difficult for it to compete effectively. Our future
success will depend on our ability to compete effectively in a highly
competitive market and geographic area.
EMPLOYEES
As of March 1, 2005, we had 139 employees and believe our relationships
with our employees to be good. Our employees are not represented by a collective
bargaining agreement.
RISKS RELATING TO THE BUSINESS AND OPERATIONS OF THE COMPANY
We have a limited operating history, which makes it difficult to predict our
future prospects and financial performance following the reorganization.
We were formed in 1999 and began banking operations in July 2000. Because of our
limited operating history, it may be difficult to evaluate our business
prospects or performance. Our prospects are subject to the risks and
uncertainties frequently encountered by companies in their early stages of
development, including the risk that we will not be able to implement our
business strategies. Accordingly, our financial performance to date may not be
representative of our long-term future performance or indicative of whether our
business strategies will be successful.
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We may have difficulty managing our growth which may divert resources and limit
our ability to successfully expand our operations.
We expect to continue to experience significant growth in the amount of our
assets, the level of our deposits and the scale of our operations. Our future
profitability will depend in part on our continued ability to grow; however, we
may not be able to sustain our historical growth rate or even be able to grow at
all.
In our first years of operation, we incurred substantial expenses to build our
management team and personnel, develop our delivery systems and establish our
infrastructure to support our future growth. Our future success will depend on
the ability of our officers and key employees to continue to implement and
improve our operational, financial and management controls, reporting systems
and procedures, and manage a growing number of customer relationships. We may
not implement improvements to our management information and control systems in
an efficient or timely manner and may discover deficiencies in existing systems
and controls. Consequently, our continued growth may place a strain on our
administrative and operational infrastructure. Any such strain could increase
our costs, reduce or eliminate our profitability and reduce the price at which
our common shares trade.
Changes in interest rates could reduce our income, cash flows and asset values.
Our consolidated income and cash flows and the value of our consolidated assets
will depend to a great extent on the difference between the interest rates we
earn on interest-earning assets, such as loans and investment securities, and
the interest rates we pay on interest-bearing liabilities such as deposits and
borrowings. We discuss the effects of interest rate changes on the market value
of our portfolio equity and net interest income in "Management's Discussion and
Analysis of Financial Condition and Results of Operations -- Asset and Liability
Management." Interest rates are highly sensitive to many factors which are
beyond our control, including general economic conditions and policies of
various governmental and regulatory agencies and, in particular, the Federal
Reserve. Changes in monetary policy, including changes in interest rates, will
influence not only the interest we receive on our loans and investment
securities and the amount of interest we pay on deposits, it will also affect
our ability to originate loans and obtain deposits and our costs in doing so. If
the rate of interest we pay on our deposits and other borrowings increases more
than the rate of interest we earn on its loans and other investments, our
consolidated net interest income, and therefore our consolidated earnings, could
be adversely affected. These earnings could also be adversely affected if the
rates on our loans and other investments fall more quickly than those on our
deposits and other borrowings.
We are subject to lending risks.
There are risks inherent in making all loans. These risks include interest rate
changes over the time period in which loans may be repaid and changes in the
national economy or the economy of our regional market that impact the ability
of our borrowers to repay their loans or the value of the collateral securing
those loans. Our loan portfolio contains a high percentage of commercial,
construction and commercial mortgage loans in relation to its total loans and
total assets. At December 30, 2004, commercial loans were 20.9% of total loans,
construction loans were 22.7% of total loans and commercial mortgage loans were
32.9% of total loans. These types of loans are generally viewed as having more
risk of default than residential real estate loans or consumer loans. These
types of loans are also typically larger than residential real estate loans and
consumer loans. Because our loan portfolio contains a significant number of
commercial,
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construction and commercial mortgage loans with relatively large balances, the
deterioration of one or a few of these loans would cause a significant increase
in nonperforming loans. On a consolidated basis, an increase in nonperforming
loans could result in an increase in our provision for loan losses or in loan
charge-offs and a consequent reduction of our earnings.
Lack of seasoning of our loan portfolio may increase the risk of credit defaults
in the future.
All of the loans in our loan portfolio were originated within the past four
years. In general, loans do not begin to show signs of credit deterioration or
default until they have been outstanding for some period of time, a process
referred to as "seasoning." As a result, a portfolio of older loans will usually
behave more predictably than a portfolio of recently originated loans. Because
our loan portfolio is relatively unseasoned, the current level of delinquencies
and defaults may be below the level that will prevail when the portfolio becomes
more seasoned.
Until Our Portfolio Becomes More Seasoned, We Must Rely In Part On The
Historical Loan Loss Experience Of Other Financial Institutions And Our
Management's Past Experience In Determining The Allowance For Loan And Lease
Losses, Which May Result In Our Having Inadequate Reserves.
Because most of our loans were originated relatively recently, our loan
portfolio does not provide an adequate history of loan losses for management to
rely upon in establishing its allowance for loan and lease losses. We therefore
rely to a significant extent upon other financial institutions' histories of
loan losses and their allowance for loan and lease losses, as well as
management's estimates based on their experience in the banking industry, when
determining our loss allowance. The history of loan and lease losses, the
reserving policies of other financial institutions and management's judgment may
not result in reserving policies that will be adequate for our consolidated
business and operations.
Our operations are concentrated in the Philadelphia-Wilmington metropolitan
area.
Our loan activities are largely based in the Philadelphia-Wilmington
metropolitan area. To a lesser extent, our deposit base is also generated from
this area. As a result, our consolidated financial performance depends largely
upon economic conditions in this area. Adverse local economic conditions could
cause us to experience an increase in loan delinquencies, a reduction in
deposits, an increase in the number of borrowers who default on their loans and
a reduction in the value of the collateral securing their loans, all of which
would adversely affect our consolidated profitability.
We depend to a significant extent upon wholesale and brokered deposits to
satisfy funding needs.
We have relied to a significant extent on funds provided by wholesale and
brokered deposits to support the growth of our loan portfolio. These funding
sources amounted to 41.4% of our total deposits at December 31, 2004. If we are
not successful in obtaining wholesale funding or increasing our current deposit
base to a level commensurate with our funding needs, we may be unable to
continue our growth, or could experience contraction in our total assets.
Moreover, to the extent that we are unable to match the maturities of the
interest rates we pay for wholesale and brokered funds to the maturities of the
loans we make using those funds, increases in the interest rates we pay for such
funds could decrease our consolidated net interest income.
13
Our future success will depend on our ability to compete effectively in a highly
competitive market and geographic area.
We will face substantial competition in all phases of our operations from a
variety of different competitors, including commercial banks and their holding
companies, savings and loan associations, mutual savings banks, credit unions,
consumer finance companies, factoring companies, insurance companies and money
market mutual funds. Competition for financial services in the
Philadelphia-Wilmington metropolitan area, which is our principal service area,
is very strong. This geographic area includes offices of many of the largest
financial institutions in the nation. Most of those competing institutions have
much greater financial and marketing resources than we have and, because we are
relatively newly-formed entities, far greater name recognition. Due to their
size, many of our competitors can achieve economies of scale and, as a result,
may offer a broader range of products and services as well as better pricing
structures for those products and services. Moreover, because we are smaller and
less well-established, we may have to pay higher rates on our deposits or offer
more free or reduced-cost services in order to attract and retain customers.
Some of the financial services organizations with which we compete are not
subject to the same degree of regulation as federally-insured and regulated
financial institutions such as ours. As a result, those competitors may be able
to access funding and provide various services more easily or at less cost than
we can.
Our affinity group marketing strategy has been adopted by other institutions
with which we compete.
As a result of the high costs encountered by Internet banks in acquiring
customers through traditional marketing and advertising or for other reasons,
several online banking operations as well as the online banking programs of
conventional banks have instituted affinity group marketing strategies similar
to ours. As a consequence, we have encountered competition in this area and
anticipate that we will continue to do so in the future. This competition may,
on a consolidated basis, increase our costs, reduce our revenues or revenue
growth or, because we are a relatively new banking operation without the name
recognition of other, more established banking operations, make it difficult for
us to compete effectively in obtaining affinity group relationships.
Our lending limit may adversely affect our competitiveness.
Our regulatory lending limit as of December 31, 2004 to any one customer or
related group of customers was $17.6 million. Our lending limit is substantially
smaller than those of most financial institutions with which we compete. While
we believe that our lending limit is sufficient for our targeted market of small
to mid-size businesses, individuals and affinity group members, it may affect
our ability to attract or maintain customers or to compete with other financial
institutions. Moreover, to the extent that we incur losses and do not obtain
additional capital, our lending limit, which depends upon the amount of our
capital, will decrease.
Environmental liability associated with lending activities could result in
losses.
In the course of our business, we may foreclose on and take title to properties
securing our loans. If hazardous substances were discovered on any of these
properties, we may be liable to governmental entities or third parties for the
costs of remediation of the hazard, as well as for personal injury and property
damage. Many environmental laws can impose liability regardless of whether we
knew of, or were responsible for, the contamination. In addition, if we arrange
for the
14
disposal of hazardous or toxic substances at another site, we may be liable for
the costs of cleaning up and removing those substances from the site, even if we
neither own nor operate the disposal site. Environmental laws may require us to
incur substantial expenses and may materially limit use of properties we acquire
through foreclosure, reduce their value or limit our ability to sell them in the
event of a default on the loans they secure. In addition, future laws or more
stringent interpretations or enforcement policies with respect to existing laws
may increase our exposure to environmental liability.
As a financial institution whose principal medium for delivery of banking
services is the internet, we are subject to risks particular to that medium.
We operate an independent Internet bank, as distinguished from the Internet
banking service of an established conventional bank. Independent Internet banks
often have found it difficult to achieve profitability and revenue growth.
Several factors contribute to the unique problems that Internet banks face.
These include concerns for the security of personal information, the absence of
personal relationships between bankers and customers, the absence of loyalty to
a conventional hometown bank, the customer's difficulty in understanding and
assessing the substance and financial strength of an Internet bank, a lack of
confidence in the likelihood of success and permanence of Internet banks and
many individuals' unwillingness to trust their personal assets to a relatively
new technological medium such as the Internet. As a result, many potential
customers may be unwilling to establish a relationship with us.
Conventional financial institutions, in growing numbers, are offering the option
of Internet banking and financial services to their existing and prospective
customers. The public may perceive conventional financial institutions as being
safer, more responsive, more comfortable to deal with and more accountable as
providers of their banking and financial services, including their Internet
banking services. We may not be able to offer Internet banking and financial
services and personal relationship characteristics that have sufficient
advantages over the Internet banking and financial services and other
characteristics of established conventional financial institutions to enable us
to compete successfully.
Moreover, both the Internet and the financial services industry are undergoing
rapid technological changes, with frequent introductions of new
technology-driven products and services. In addition to improving the ability to
serve customers, the effective use of technology increases efficiency and
enables financial institutions to reduce costs. Our future success will depend,
in part, upon our ability to address the needs of our customers by using
technology to provide products and services that will satisfy customer demands,
as well as to create additional efficiencies in our operations. Many of our
competitors have substantially greater resources to invest in technological
improvements. We may not be able to implement effectively new technology-driven
products and services or be successful in marketing these products and services
to our customers.
Our operations may be interrupted if our network or computer systems, or those
of our providers, fail.
Because we deliver our products and services over the Internet and outsource
several critical functions to third parties, our operations depend on our
ability, as well as that of our service providers, to protect computer systems
and network infrastructure against interruptions in service due to damage from
fire, power loss, telecommunications failure, physical break-ins, computer
hacking or similar catastrophic events. Our operations also depend upon our
ability to replace a
15
third-party provider if it experiences difficulties that interrupt our
operations or if an operationally essential third-party service terminates.
Service interruptions to customers may adversely affect our ability to obtain or
retain customers and could result in regulatory sanctions. Moreover, if a
customer were unable to access his or her account or complete a financial
transaction due to a service interruption, we could be subject to a claim by the
customer for his or her loss. While our accounts and other agreements contain
disclaimers of liability for these kinds of losses, we cannot predict the
outcome of litigation if a customer were to make a claim against us.
Security concerns may adversely affect internet banking.
A significant barrier to on-line financial transactions is the secure
transmission of confidential information over public networks. The systems we
use rely on encryption and authentication technology to provide secure
transmission of confidential information. Advances in computer capabilities, new
discoveries in the field of cryptography or other developments could result in a
compromise or breach of the algorithms used to protect customer transaction
data. If we, or another provider of financial services through the Internet,
were to suffer damage from a security breach, public acceptance and use of the
Internet as a medium for financial transactions could suffer. Any security
breach could deter potential customers or cause existing customers to leave,
thereby materially adversely affecting our ability to grow and maintain
profitability and, possibly, our ability to continue delivering our products and
services through the Internet. Although we, with the help of third-party service
providers, intend to continue to implement security technology and establish
operational procedures to prevent security breaches, these measures may not be
successful.
We outsource many essential services to third-party providers who may terminate
their agreements with us, resulting in interruptions to our banking operations.
We obtain essential technological and customer services support for the systems
used by the Company from third-party providers. We outsource our check
processing, check imaging, electronic bill payment, statement rendering,
internal audit and other services to third party vendors. For a description of
these services, you should read "-Other Operations -Third Party Service
Providers." Our agreements with each service provider are generally cancelable
without cause by either party upon specified notice periods. If one of our
third-party service providers terminates its agreement with us and we are unable
to replace it with another service provider, our operations may be interrupted.
If an interruption were to continue for a significant period of time, our
consolidated operations, revenues and profitability could be materially
adversely affected.
We may be adversely affected by government regulation.
We are subject to extensive federal and state banking regulation and
supervision. The regulations are intended primarily to protect our depositors'
funds, the federal deposit insurance funds and the safety and soundness of the
Bank, not our shareholders. Regulatory requirements affect lending practices,
capital structure, investment practices, dividend policy and growth. A failure
by either the Bank or us to meet minimum capital requirements will result in the
imposition of limitations on our operations that would adversely impact our
operations and could, if capital levels drop significantly, result in our being
required to cease operations. Changes in governing law, regulations or
regulatory practices could impose additional costs on us or adversely affect our
ability to obtain deposits or make loans and, as a consequence, our consolidated
revenues and profitability.
16
As a Delaware-chartered bank whose depositors and financial services customers
are located in several states, the Bank may be subject to additional licensure
requirements or other regulation of its activities by state regulatory
authorities and laws outside of Delaware. If the Bank's compliance with
licensure requirements or other regulation becomes overly burdensome, we may
seek to convert its state charter to a federal charter in order to gain the
benefits of federal preemption of some of those laws and regulations. Conversion
of the Bank to a federal charter will require the prior approval of the relevant
federal bank regulatory authorities, which we may not be able to obtain.
Moreover, even if we obtain approval, there could be a significant period of
time between our application and receipt of the approval, and/or any approval we
do obtain may be subject to burdensome conditions or restrictions.
Our success will depend on our ability to retain Betsy Z. Cohen, our Chief
Executive Officer.
We believe that the future success of the Company will depend upon the expertise
of, and customer relationships established by Betsy Z. Cohen, our chief
executive officer. If Mrs. Cohen were to become unavailable for any reason, or
if we are unable to hire highly qualified and experienced personnel with similar
relationships to replace her, our ability to attract deposits or loan customers
may be materially adversely affected. We do not have an employment agreement
with, nor do we have key man life insurance on Mrs. Cohen.
REGULATION UNDER BANKING LAW
We are extensively regulated under both federal and state banking
law. We are a Delaware corporation and a registered bank holding company that is
also a registered financial holding company. We are subject to supervision and
regulation by the Federal Reserve and the Delaware State Bank Commissioner.
The Bank, as a state-chartered depository institution, is supervised by the
Delaware State Bank Commissioner, as well as the Federal Deposit Insurance
Company, or FDIC. The Bank is subject to requirements and restrictions under
federal and state law, including requirements to maintain reserves against
deposits, restrictions on the types and amount of loans that may be made and the
interest that may be charged, and limitations on the types of investments that
may be made and the types of services that may be offered. Various consumer laws
and regulations also affect the Bank's operations.
Federal Regulation
As a bank holding company, we must file annual reports with the Federal Reserve,
provide any additional information that the Federal Reserve may request, and are
subject to regular examination by it.
Gramm-Leach-Bliley Act. The Gramm-Leach-Bliley Act, or GLBA, made extensive
changes in the rules governing the financial services industry, particularly
banking. It eliminated many of the restrictions placed upon the activities of
bank holding companies and established a new type of bank holding company called
a financial holding company. We were registered as a financial holding company
in 2004. Financial holding companies are granted the authority to engage in
"financial activities" that are beyond those of conventional bank holding
companies and to affiliate with entities engaged in financial activities. While
the Federal Reserve (together with the Treasury Secretary) is authorized to
determine what a financial activity is, the GLBA provides that financial
activities include:
17
o lending, investing for others or safeguarding money or securities;
o Underwriting insurance and annuities as principal, agent or broker;
o providing financial, investment or economic advisory services;
o issuing or selling interests in pools of assets permissible for a bank
to hold directly;
o engaging in any activity that the Federal Reserve found before the act
to be a proper incident to banking; and
o insurance portfolio investing.
The GLBA directs the Federal Reserve to define the following activities as
financial in nature and the extent to which they are financial in nature:
o lending, exchanging, transferring, investing for others or safeguarding
financial assets other than money or securities; and
o arranging financial transactions for the account of third parties.
The banking and nonfinancial subsidiaries of a financial holding company may not
cross sell each other's products and services where the financial holding
company owns the non-financial subsidiary through the financial holding
company's merchant banking authority or through its insurance subsidiary under
its investment portfolio authority. However, insurance products or services may
be marketed by Internet websites or statement inserts with Federal Reserve
approval if there is no illegal tying arrangement. A bank also may not engage in
a "covered transaction" with a controlled affiliate of a financial holding
company. A "covered transaction" includes loans to, investments in, purchases of
assets from or guaranteeing loans of the affiliate, or accepting securities of
the affiliate as collateral for a loan.
Transactions with Affiliates. There are various legal restrictions on the extent
to which a bank holding company and certain of its nonbank subsidiaries can
borrow or otherwise obtain credit from banking subsidiaries or engage in certain
other transactions with or involving those banking subsidiaries. In general,
these restrictions require that any such transactions must be on terms that
would ordinarily be offered to unaffiliated entities and secured by designated
amounts of specified collateral. Transactions between a banking subsidiary and
its holding company or any nonbank subsidiary are limited to 10% of the banking
subsidiary's capital stock and surplus and, as to the holding company and all
such nonbank subsidiaries in the aggregate, up to 20% of the bank's capital
stock and surplus.
Regulatory Restrictions on Dividends. It is the policy of the Federal Reserve
that bank holding companies should pay cash dividends on common stock only out
of income available over the past year and only if prospective earnings
retention is consistent with the organization's expected future needs and
financial condition. The policy provides that bank holding companies should not
maintain a level of cash dividends that undermines the bank holding company's
ability to serve as a source of strength to its banking subsidiaries. See "--
Holding Company Liability," below. Federal Reserve policies also affect the
ability of a bank holding company to pay in kind dividends.
18
Various federal and state statutory provisions limit the amount of dividends
that subsidiary banks can pay to their holding companies without regulatory
approval. The Bank is also subject to limitations under state law regarding the
payment of dividends, including the requirement that dividends may be paid only
out of net profits. See "-- Delaware Regulation." In addition to these explicit
limitations, federal and state regulatory agencies are authorized to prohibit a
banking subsidiary or bank holding company from engaging in an unsafe or unsound
banking practice. Depending upon the circumstances, the agencies could take the
position that paying a dividend would constitute an unsafe or unsound banking
practice.
Because we are a legal entity separate and distinct from the Bank, our right to
participate in the distribution of assets of the Bank, or any other subsidiary,
upon the Bank's or the subsidiary's liquidation or reorganization will be
subject to the prior claims of the Bank's or subsidiary's creditors. In the
event of a liquidation or other resolution of an insured depository institution,
the claims of depositors and other general or subordinated creditors have
priority of payment over the claims of holders of any obligation of the
institution's holding company or any of its shareholders or creditors.
Holding Company Liability. Under Federal Reserve policy, a bank holding company
is expected to act as a source of financial strength to each of its banking
subsidiaries and commit resources to their support. Such support may be required
at times when, absent this Federal Reserve policy, a holding company may not be
inclined to provide it. As discussed below under "-- Prompt Corrective Action,"
a bank holding company in certain circumstances could be required to guarantee
the capital plan of an undercapitalized banking subsidiary.
In the event of a bank holding company's bankruptcy under Chapter 11 of the U.S.
Bankruptcy Code, the trustee will be deemed to have assumed, and is required to
cure immediately, any deficit under any commitment by the debtor holding company
to any of the federal banking agencies to maintain the capital of an insured
depository institution, and any claim for breach of such obligation will
generally have priority over most other unsecured claims.
Capital Adequacy. The Federal Reserve and FDIC have issued standards for
measuring capital adequacy for bank holding companies and banks. These standards
are designed to provide risk-based capital guidelines and to incorporate a
consistent framework. The risk-based guidelines are used by the agencies in
their examination and supervisory process, as well as in the analysis of any
applications to them to obtain approvals, including our applications for
approval of the reorganization and for registration as a financial holding
company. As discussed under "-- Prompt Corrective Action," a failure to meet
minimum capital requirements could subject us or the Bank to a variety of
enforcement remedies available to federal regulatory authorities, including, in
the most severe cases, termination of deposit insurance by the FDIC and placing
the Bank into conservatorship or receivership.
In general, the risk-related standards require banks and bank holding companies
to maintain capital based on "risk-adjusted" assets so that the categories of
assets with potentially higher credit risk will require more capital backing
than categories with lower credit risk. In addition, banks and bank holding
companies are required to maintain capital to support off-balance sheet
activities such as loan commitments.
The standards classify total capital for this risk-based measure into two tiers,
referred to as Tier 1 and Tier 2. Tier 1 capital consists of common
stockholders' equity, certain non-cumulative perpetual preferred stock, and
minority interests in equity accounts of consolidated subsidiaries,
19
less certain adjustments. Tier 2 capital consists of the allowance for loan and
lease losses (within certain limits), perpetual preferred stock not included in
Tier 1, hybrid capital instruments, term subordinate debt, and intermediate-term
preferred stock, less certain adjustments. Together, these two categories of
capital comprise a bank's or bank holding company's "qualifying total capital."
However, capital that qualifies as Tier 2 capital is limited in amount to 100%
of Tier 1 capital in testing compliance with the total risk-based capital
minimum standards. Banks and bank holding companies must have a minimum ratio of
8% of qualifying total capital to risk-weighted assets, and a minimum ratio of
4% of qualifying Tier 1 capital to risk-weighted assets. At December 31, 2004,
we and the Bank had a total capital to risk-adjusted assets ratios of 27.04% and
24.49%, respectively, and Tier 1 capital to risk-adjusted assets ratios of
26.29% and 23.74%, respectively.
In addition, the Federal Reserve and the FDIC have established minimum leverage
ratio guidelines. The principal objective of these guidelines is to constrain
the maximum degree to which a financial institution can leverage its equity
capital base. It is intended to be used as a supplement to the risk-based
capital guidelines. These guidelines provide for a minimum ratio of Tier 1
capital to adjusted average total assets of 3% for bank holding companies that
meet certain specified criteria, including those having the highest regulatory
rating. Other financial institutions generally must maintain a leverage ratio of
at least 3% plus 100 to 200 basis points. The guidelines also provide that
financial institutions experiencing internal growth or making acquisitions will
be expected to maintain strong capital positions substantially above minimum
supervisory levels, without significant reliance on intangible assets.
Furthermore, the banking agencies have indicated that they may consider other
indicia of capital strength in evaluating proposals for expansion or new
activities. At December 31, 2004, we and the Bank had leverage ratios of 22.88%
and 20.54%, respectively.
The federal banking agencies' standards provide that concentration of credit
risk and certain risks arising from nontraditional activities, as well as an
institution's ability to manage these risks, are important factors to be taken
into account by them in assessing a financial institution's overall capital
adequacy. The risk-based capital standards also provide for the consideration of
interest rate risk in the agency's determination of a financial institution's
capital adequacy. The standards require financial institutions to effectively
measure and monitor their interest rate risk and to maintain capital adequate
for that risk.
These standards can be expected to be amended from time to time.
Prompt Corrective Action. Under the Federal Deposit Insurance Corporation
Improvement Act of 1991, federal banking agencies must take prompt supervisory
and regulatory actions against undercapitalized depository institutions.
Depository institutions are assigned one of five capital categories -- "well
capitalized ," "adequately capitalized," "undercapitalized," "significantly
undercapitalized," and "critically undercapitalized" -- and subjected to
differential regulation corresponding to the capital category within which the
institution falls. Under certain circumstances, a well capitalized, adequately
capitalized or undercapitalized institution may be treated as if the institution
were in the next lower capital category. As we describe in "Management's
Discussion and Analysis of Financial Condition and Results of Operations --
Liquidity and Capital Resources," an institution is deemed to be well
capitalized if it has a total risk-based capital ratio of at least 10.0%, a Tier
1 risk-based capital ratio of at least 6.0% and a leverage ratio of at least
5.0%. An institution is adequately capitalized if it has a total risk-based
capital ratio of at least 8.0%, a Tier 1 risk-based capital ratio of at least
4.0% and a leverage ratio of at least 4.0%. At December 31, 2004, our total
risk-based capital ratio was 27.04%, our Tier 1 risk-based capital ratio was
26.29% and our leverage ratio was 22.88%, while the Bank's ratios
20
were 24.49%, 23.74% and 20.54%, respectively. A depository institution is
generally prohibited from making capital distributions (including paying
dividends) or paying management fees to a holding company if the institution
would thereafter be undercapitalized. Adequately capitalized institutions cannot
accept, renew or roll over brokered deposits except with a waiver from the FDIC,
and are subject to restrictions on the interest rates that can be paid on such
deposits. Undercapitalized institutions may not accept, renew, or roll over
brokered deposits. As of December 31, 2004, both we and the Bank were "well
capitalized" within the meaning of the regulatory categories.
Banking regulatory agencies are permitted or, in certain cases, required to take
action with respect to institutions falling within one of the three
undercapitalized categories. Depending on the level of an institution's capital,
the agency's corrective powers include, among other things:
o prohibiting the payment of principal and interest on subordinated debt;
o prohibiting the holding company from making distributions without prior
regulatory approval;
o placing limits on asset growth and restrictions on activities;
o placing additional restrictions on transactions with affiliates;
o restricting the interest rate the institution may pay on deposits;
o prohibiting the institution from accepting deposits from correspondent
banks; and
o in the most severe cases, appointing a conservator or receiver for the
institution.
A banking institution that is undercapitalized must submit a capital restoration
plan. This plan will not be accepted unless, among other things, the banking
institution's holding company guarantees the plan up to an agreed-upon amount.
Any guarantee by a depository institution's holding company is entitled to a
priority of payment in bankruptcy. Failure to implement a capital plan, or
failure to have a capital restoration plan accepted, may result in a
conservatorship or receivership.
Community Reinvestment Act. Under the Community Reinvestment Act of 1977, which
we refer to as the CRA, a federally-insured institution has a continuing and
affirmative obligation to help meet the credit needs of its community, including
low-and moderate-income neighborhoods, consistent with the safe and sound
operation of the institution. The CRA requires the board of directors of
federally-insured institutions, such as the Bank, to adopt a CRA statement for
its assessment area that, among other things, describes its efforts to help meet
community credit needs and the specific types of credit that the institution is
willing to extend. The CRA further requires that a record be kept of whether a
financial institution meets its community's credit needs, which record will be
taken into account when evaluating applications for, among other things,
domestic branches and mergers and acquisitions. The regulations promulgated
pursuant to the CRA contain three evaluation tests:
o a lending test which compares the institution's market share of loans in
low- and moderate- income areas to its market share of loans in its
entire service area and the percentage of the institution's outstanding
loans to low- and moderate-income areas or individuals;
21
o a services test, which evaluates the provision of services that promote
the availability of credit to low- and moderate-income areas; and
o an investment test, which evaluates an institution's record of
investments in organizations designed to foster community development,
small- and minority-owned businesses and affordable housing lending,
including state and local government housing or revenue bonds.
The Bank was examined for CRA compliance in 2002 and received a "satisfactory"
rating.
Control Acquisitions. The Change in Bank Control Act, which we refer to as the
CBCA, prohibits a person or group of persons from acquiring "control" of a bank
holding company unless the Federal Reserve has been notified and has not
objected to the transaction. Under a rebuttable presumption established by the
Federal Reserve, the acquisition of 10% or more of any class of voting
securities of a bank holding company is presumed to be an acquisition of control
of the holding company if:
o the bank holding company has a class of securities registered under
Section 12 of the Securities Exchange Act of 1934 or
o no other person will own or control a greater percentage of that class
of voting securities immediately after the transaction.
An acquisition of 25% or more of the outstanding shares of any class of voting
securities of a bank holding company is conclusively deemed to be the
acquisition of control. In determining percentage ownership for a person,
Federal Reserve policy is to count securities obtainable by that person through
option or warrant exercise, even if the options or warrants have not then
vested.
Insurance of Deposit Accounts. The Bank's deposits are insured to the maximum
extent permitted by the Bank Insurance Fund, or BIF. As the insurer, the FDIC is
authorized to conduct examinations of, and to require reporting by, FDIC-insured
institutions. It also may prohibit any FDIC-insured institution from engaging in
any activity the FDIC determines by regulation or order to pose a serious threat
to the FDIC. The FDIC also has the authority to initiate enforcement actions
against banks. The FDIC has implemented a risk-based assessment system under
which FDIC-insured depository institutions pay annual premiums at rates based on
their risk classification. A bank's risk classification is based on its capital
levels and the level of supervisory concern the bank poses to the regulators.
Institutions assigned to higher risk classifications (that is, institutions that
pose a greater risk of loss to the BIF) pay assessments at higher rates than
institutions that pose a lower risk. A decrease in a bank's capital ratios or
the occurrence of events that have an adverse effect on a bank's asset quality,
management, earnings or liquidity could result in a substantial increase in
deposit insurance premiums paid by a bank, which would adversely affect
earnings. In addition, the FDIC can impose special assessments in certain
instances. The range of assessments in the risk-based system is a function of
the reserve ratio in the BIF. The current range of BIF assessments is between 0%
and 0.27% of deposits because the BIF reserve ratio was greater than 1.25% when
the ratios were set. In 2002, the BIF reserve ratio fell below 1.25%, creating
the possibility that the FDIC would raise assessment rates, but in 2003 the
ratio was slightly above 1.25%. At December 31, 2003 and December 31, 2004, the
Bank's BIF assessment rate was 0%. If the BIF reserve ratio were to fall below
1.25% again, the FDIC would consider whether to levy higher assessments.
Congress has also recently
22
considered proposals that would increase assessments on certain types of rapidly
growing institutions.
Loans-to-One Borrower. Generally, a bank may not make a loan or extend credit to
a single or related group of borrowers in excess of 15% of its unimpaired
capital and surplus. An additional amount may be lent, equal to 10% of
unimpaired capital and surplus, if such loan is secured by specified collateral,
generally readily marketable collateral (which is defined to include certain
financial instruments and bullion) and real estate. At December 31, 2004, the
Bank's limit on loans-to-one borrower was $17.6 million ($29.3 million for
secured loans). At December 31, 2004, the Bank's largest aggregate outstanding
balance of loans-to-one borrower was $19.5 million, which was secured. As a
general policy, the Bank seeks to limit secured loans-to-one borrower to a
maximum of $10.0 million.
Transactions with Related Parties. The Bank's authority to engage in
transactions with related parties or "affiliates" (that is, any company that
controls or is under common control with an institution, including us and our
non-bank subsidiaries) is limited by Sections 23A and 23B of the Federal Reserve
Act and Regulation W promulgated thereunder. Section 23A restricts the aggregate
amount of covered transactions with any individual affiliate to 10% of the
Bank's capital and surplus. At December 31, 2004, we owed the Bank $-0-. The
aggregate amount of covered transactions with all affiliates is limited to 20%
of the Bank's capital and surplus. Certain transactions with affiliates are
required to be secured by collateral in an amount and of a type described in
Section 23A and the purchase of low quality assets from affiliates is generally
prohibited. Section 23B generally provides that certain transactions with
affiliates, including loans and asset purchases, must be on terms and under
circumstances, including credit standards, that are substantially the same or at
least as favorable to the institution as those prevailing at the time for
comparable transactions with non-affiliated companies.
Enforcement. Under the Federal Deposit Insurance Act, the FDIC has the authority
to bring actions against a bank and all affiliated parties, including
stockholders, attorneys, appraisers and accountants, who knowingly or recklessly
participate in wrongful action likely to have an adverse effect on the bank.
Formal enforcement action may range from the issuance of a capital directive or
cease and desist order to removal of officers and/or directors to institution of
receivership, conservatorship or termination of deposit insurance. Civil
penalties cover a wide range of violations and can amount to $25,000 per day, or
even $1 million per day in especially egregious cases. Federal law also
establishes criminal penalties for certain violations.
Standards for Safety and Soundness. The Federal Deposit Insurance Act requires
each federal banking agency to prescribe for all insured depository institutions
standards relating to, among other things, internal controls, information and
audit systems, loan documentation, credit underwriting, interest rate risk
exposure, asset growth, and compensation, fees, benefits and such other
operational and managerial standards as the agency deems appropriate. The
federal banking agencies have adopted final regulations and Interagency
Guidelines Prescribing Standards for Safety and Soundness to implement these
safety and soundness standards. The guidelines set forth the safety and
soundness standards that the federal banking agencies use to identify and
address problems at insured depository institutions before capital becomes
impaired. If the appropriate federal banking agency determines that an
institution fails to meet any standard prescribed by the guidelines, the agency
may require the institution to submit to the agency an acceptable plan to
achieve compliance with the standard.
23
Federal Reserve System. Federal Reserve regulations require banks to maintain
non-interest bearing reserves against their transaction accounts (primarily NOW
and regular checking accounts). Federal Reserve regulations generally required
for 2004 that reserves be maintained against aggregate transaction accounts as
follows: for accounts aggregating $45.4 million or less (subject to adjustment
by the Federal Reserve), the reserve requirement is 3%; and, for accounts
aggregating greater than $45.4 million, the reserve requirement is $1.164
million plus 10% (subject to adjustment by the Federal Reserve between 8% and
14%) of that portion of total transaction accounts in excess of $45.4 million.
The first $6.6 million of otherwise reservable balances (subject to adjustments
by the Federal Reserve) are exempt from the reserve requirements. At December
31, 2004, the Bank met these requirements.
USA Patriot Act. The Uniting and Strengthening America by Providing Appropriate
Tools Required to Intercept and Obstruct Terrorism Act was intended to detect,
and prevent, the use of the United States' financial system for money laundering
and terrorist financing activities. The Act requests financial institutions,
such as banks, to prohibit correspondent accounts with foreign shell banks, to
establish an anti-money laundering program that includes employee training and
an independent audit, to follow minimum standards for identifying customers and
maintaining records of the identification information, and to make regular
comparisons of customers against agency lists of suspected terrorists, terrorist
organizations and money launderers.
DELAWARE REGULATION
General. As a Delaware bank holding company, we are subject to the supervision
of and periodic examination by the Delaware State Bank Commissioner and must
comply with the reporting requirements of the Delaware State Bank Commissioner.
The Bank, as a banking corporation chartered under Delaware law, is subject to
comprehensive regulation by the Delaware State Bank Commissioner, including
regulation of the conduct of its internal affairs, the extent and exercise of
its banking powers, the issuance of capital notes or debentures, any mergers,
consolidations or conversions, its lending and investment practices and its
revolving and closed-end credit practices. The Bank also is subject to periodic
examination by the Delaware State Bank Commissioner and must comply with the
reporting requirements of the Delaware State Bank Commissioner. The Delaware
State Bank Commissioner has the power to issue cease and desist orders
prohibiting unsafe and unsound practices in the conduct of a banking business.
Limitation on Dividends. Under Delaware banking law, the Bank's directors may
declare dividends on common or preferred stock of so much of its net profits as
they judge expedient, but the Bank must, before the declaration of a dividend on
common stock from net profits, carry 50% of its net profits of the preceding
period for which the dividend is paid to its surplus fund until its surplus fund
amounts to 50% of its capital stock and thereafter must carry 25% of its net
profits for the preceding period for which the dividend is paid to its surplus
fund until its surplus fund amounts to 100% of its capital stock.
PENDING LEGISLATION
Deposit Insurance Reform. On April 2, 2003, the U.S. House of Representatives
passed H.R. 522, the Federal Deposit Insurance Reform Act of 2003. This proposed
legislation would reform the deposit insurance system by:
o merging the BIF and the Savings Association Insurance Fund;
24
o ending the 23 basis point premium "rate cliff" that occurs when the
reserve ratio of deposits insured to premiums held falls beneath 1.25%
for more than one year;
o creating a reserve range within which a bank's reserve ratio can float;
o increasing insurance coverage limits for municipal deposits;
o increasing insurance coverage limits for individual accounts to $130,000
and indexing future coverage limits to inflation; and
o doubling insurance coverage limits for certain types of IRAs and 401(k)
plans.
ITEM 2. PROPERTIES
We are the lessor of eight premises. Our banking and operations facilities
occupy 20,236 square feet in Wilmington, Delaware under a lease expiring in
2010. The rent is currently $36,062 per month and escalates yearly based upon
scheduled increases in base rent and actual increases in taxes and premises
operating costs over specified base rates. We provided a letter of credit,
$106,000 in outstanding principal amount as of December 31, 2004, as security
under the lease. The letter of credit reduces $65,000 per year. We also hold a
lease on 24,531 square feet of space in Philadelphia, Pennsylvania expiring in
2014. The rent is currently $49,922 per month and escalates yearly based upon
scheduled increases in base rent and actual increases in taxes and premises
operating costs over specified base rates. We provided a letter of credit,
$391,000 in outstanding principal amount as of December 31, 2004, as security
under the lease which reduces $80,000 per year. We sublease portions of our
Philadelphia space to affiliated entities. We use the Philadelphia space for our
executive offices. We pay aggregate rent of $9,845 per month for our two
Philadelphia-area loan production offices, and an aggregate of $10,961 per month
for our Maryland, Alabama and Florida automobile leasing offices. We also pay
rent of $603 per month for a customer service space, principally an ATM and
computer interfaces. We believe these facilities are adequate for our current
needs and for the reasonably foreseeable future.
ITEM 3. LEGAL PROCEEDINGS
None.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
None.
25
PART II
ITEM 5. MARKET FOR OUR COMMON EQUITY AND RELATED SHAREHOLDER MATTERS
Our common stock trades on the NASDAQ National Market under the symbol "TBBK."
Prior to our reorganization, which became effective on December 22, 2004, there
had been no public market for our common stock. The following table sets forth
the range of high and low sales prices for the indicated periods for our common
stock after the reorganization.
2004 HIGH LOW
- ------------------------- -------- --------
Fourth quarter (beginning
December 23, 2004) $ 16.38 $ 14.50
As of March 23, 2005 there were 11,888,061 shares of common stock outstanding
held of record by 183 persons.
We have not paid cash dividends on our common stock since our inception, and do
not plan to pay cash dividends on our common stock for the foreseeable future.
We intend to retain earnings, if any, to fund the development and growth of our
operations. Our board of directors will determine any changes in our dividend
policy based upon its analysis of factors it deems relevant. We expect that
these factors will include our earnings, financial condition, cash requirements
and available investment opportunities.
Our payment of dividends is subject to restrictions which we disclose in
"Regulations under Banking Law." In addition, before we may pay a cash dividend
on our common stock in any quarter, we must pay that quarters dividend on our
Series A preferred stock.
ITEM 6. SELECTED FINANCIAL DATA
The following table sets forth selected financial data as of and for the years
ended December 31, 2004, 2003, 2002 and 2001, and for the period July 28, 2000
(date of inception of operations) through December 31, 2000. We derived the
selected financial data for the years ended December 31, 2004, 2003, 2002 and
2001 and for the period July 28, 2000 (date of inception of operations) through
December 31, 2000 from our financial statements for those periods, which have
been audited by Grant Thornton LLP, independent registered public accounting
firm. You should read the selected financial data in this table together with,
and such selected financial data is qualified by reference to our financial
statements, the notes to those financial statements and "Management's Discussion
and Analysis of Financial Condition and Results of Operations" in Item 7 of this
report.
26
For the
period
July 28,
As of or for the 2000
Year Ended through
--------------------------------------------------------- ------------
December 31, December 31, December 31, December 31, December 31,
2004 2003 2002 2001 2000
------------ ------------ ------------ ------------ ------------
Income Statement Data:
Interest income $ 24,673 $ 14,797 $ 12,060 $ 7,474 $ 2,458
Interest expense 7,077 5,423 4,590 3,566 1,295
------------ ------------ ------------ ------------ ------------
Net interest income 17,596 9,374 7,470 3,908 1,163
Provision for loan and lease
losses 1,632 685 600 435 350
------------ ------------ ------------ ------------ ------------
Net interest income after
provision for loan and
lease losses 15,964 8,689 6,870 3,473 813
Non-interest income 8,904 10,487 4,342 1,719 518
Non-interest expense 22,193 18,355 11,703 8,706 5,673
------------ ------------ ------------ ------------ ------------
Net income (loss) from
continuing operations 2,675 821 (491) (3,514) (4,342)
Income tax benefit (1,043) (250) (500)
Discontinued operations - - - (104) (1,877)
------------ ------------ ------------ ------------ ------------
Net income (loss) 3,718 1,071 9 (3,618) (6,219)
Less preferred stock dividends
and accretion (817) (881) (750) (278) -
Income allocated to Series A
preferred shareholders (323) (61) - - -
------------ ------------ ------------ ------------ ------------
Net income (loss) available
to common stock $ 2,578 $ 129 $ (741) $ (3,896) $ (6,219)
============ ============ ============ ============ ============
Balance Sheet Data:
Total assets $ 576,279 $ 304,161 $ 233,424 $ 155,006 $ 84,823
Total loans, net of unearned
costs (fees) 427,881 232,397 163,337 106,208 27,926
Allowance for loan and lease
losses 3,593 1,991 1,379 780 350
Total cash and cash equivalents 19,503 42,183 30,148 5,866 51,542
Deposits 388,081 276,765 209,443 137,517 72,516
Federal Home Loan Bank advances 55,000 - - - -
Shareholders' equity 121,402 21,673 16,969 14,239 10,963
Selected Operating Ratios:
Return on average assets 0.79% 0.41% nm nm nm
Return on average common equity 3.94% 4.93% nm nm nm
Net interest margin 3.86% 3.77% 4.05% 3.73% 3.13%
Selected Capital and Asset Quality
Ratios:
Equity/assets 21.07% 7.13% 7.27% 9.19% 12.92%
Tier 1 capital to average
assets 22.88% 8.46% 9.76% 10.19% 14.86%
Tier 1 capital to total
risk-weighted assets 26.29% 10.26% 11.60% 11.65% 23.29%
Total capital to total
risk-weighted assets 27.04% 11.05% 12.33% 12.23% 24.10%
Allowance for loan and lease
losses to total loans 0.84% 0.86% 0.84% 0.73% 1.25%
27
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
In the following discussion we provide information about our results of
operations, financial condition, liquidity and asset quality. We intend that
this information facilitate your understanding and assessment of significant
changes and trends related to our financial condition and results of operations.
OVERVIEW
We are a registered financial holding company whose principal asset is our
wholly owned subsidiary bank. Since July 2000, when the Bank began banking
operations, we have grown to $576.3 million in consolidated assets as of
December 31, 2004. To sustain this growth, we raised additional capital in 2001,
2002 and 2003 and invested substantially all of the net proceeds in the Bank. In
February 2004, the Bank completed its own offering of its common stock that
resulted in its obtaining $82.9 million of additional capital, after
underwriting discounts and commissions and expenses of the offering. After the
offering, we owned approximately 32.7% of the Bank. In December 2004 we
completed our reorganization at which time the Bank again became a wholly-owned
subsidiary.
We focus on two markets: small to mid-size businesses and their principals and
affinity groups with their established membership, client or customer bases. We
concentrate our lending activities in the Philadelphia-Wilmington area, while we
draw our deposits from that area and from out of area, principally through our
merchant card processing operation. To a lesser extent, we obtain deposits from
the open market as required to meet our loan funding needs. Our lending
activities emphasize commercial, industrial and construction loans secured by
real estate and commercial real estate loans.
CRITICAL ACCOUNTING POLICIES AND ESTIMATES
Our accounting and reporting policies conform with accounting principles
generally accepted in the United States and general practices within the
financial services industry. The preparation of financial statements in
conformity with accounting principles generally accepted in the United States
requires management to make estimates and assumptions that affect the amounts
reported in the financial statements and the accompanying notes. Actual results
could differ from those estimates.
We believe that the determination of our allowance for loan and lease losses
involves a higher degree of judgment and complexity than our other significant
accounting policies. We determine our allowance for loan and lease losses with
the objective of maintaining a reserve level we believe to be sufficient to
absorb our estimated probable credit losses. We base our determination of the
adequacy of the allowance on periodic evaluations of our loan portfolio and
other relevant factors. However, this evaluation is inherently subjective as it
requires material estimates, including, among others, expected default
probabilities, the amount of loss we may incur on a defaulted loan, expected
commitment usage, the amounts and timing of expected future cash flows on
impaired loans, value of collateral, estimated losses on consumer loans and
residential mortgages, and general amounts for historical loss experience. We
also evaluate economic conditions and uncertainties in estimating losses and
inherent risks in our loan portfolio. All of these factors may be susceptible to
significant change. To the extent actual outcomes differ from
28
our estimates, we may need additional provisions for loan losses. Any such
additional provision for loan losses will be a direct charge to our earnings.
We capitalize costs associated with internally developed and purchased software
systems for new products and enhancements to existing products that have reached
the application stage and meet recoverability tests. Capitalized costs include
external direct costs of materials and services used in developing or obtaining
internal-use software, payroll and payroll related expenses for employees who
are directly associated with and devote time to the internal-use software
project and interest costs incurred, if material, while developing internal-use
software. Capitalization of these costs begins when we complete the preliminary
project stage, and ceases no later than the point at which the project is
substantially complete and ready for its intended purpose.
We account for income taxes under the liability method whereby we determine
deferred tax assets and liabilities based on the difference between the carrying
values on our financial statements and the tax basis of assets and liabilities
as measured by the enacted tax rates which will be in effect when these
differences reverse. Deferred tax expense (benefit) is the result of changes in
deferred tax assets and liabilities.
RESULTS OF OPERATIONS
Net Income: fiscal 2004 compared to fiscal 2003. Net income for fiscal 2004 was
$3.7 million, compared to net income of $1.1 million for fiscal 2003. Preferred
stock dividends and accretion for fiscal 2004 were $818,000, compared to
$881,000 for fiscal 2003, which resulted in a net income available to common
stock of $2.6 million for fiscal 2004 as compared to net income of $129,000 for
fiscal 2003. Diluted earnings per share were $0.24 for fiscal 2004 as compared
to $0.06 for fiscal 2003. Return on average assets was .79% and return on
average equity was 3.94% for fiscal 2004.
Net Interest Income: fiscal 2004 compared to fiscal 2003. Our interest income
for fiscal 2004 increased to $19.5 million from $12.5 million for fiscal 2003,
while our net interest income increased to $17.6 million from $9.4 million. Our
average loans increased to $315.1 million for fiscal 2004 from $192.2 million
for the prior year period. The primary reason for the increases in our interest
income and net interest income was our ability to increase our earning assets
through continued organic growth of our loan portfolio as well as through
purchases of investment securities with the proceeds from the Bank's public
offering. We expect that the new capital obtained from the offering will enable
us to continue growth in our loan portfolio for the foreseeable future.
Our net interest margin (representing the spread between our cost of funds and
the rates we receive on our interest-earning assets) for fiscal 2004 increased
to 3.86% from 3.77% for 2003, an increase of 9 basis points (.09%). For fiscal
2004 the average yield on our interest-earning assets decreased to 5.42% from
5.94% for fiscal 2003, a decrease of 52 basis points (.52%). The decrease in
yield was the result of declines in the overall interest rate environment as
well as a change in the mix of our earning assets as average investment
securities increased as a percentage of earning assets to 22.6% for fiscal 2004
from 11.5% for fiscal 2003. The change in mix of earning assets resulted from
the deployment of the proceeds from our initial public offering into investment
securities. It is our intention to shift the mix in the future as we leverage
our capital through growth in the loan portfolio. Cost of interest-bearing
deposits decreased to 2.14% for fiscal 2004 from 2.47% for fiscal 2003, a
decrease of 33 basis points (.33%) due to declines in the overall interest rate
environment. Average interest-bearing deposits increased to $279.3 million from
$197.0 million, an increase of $82.3 million or 41.8%.
29
Net Interest Income: fiscal 2003 compared to fiscal 2002. Our interest income
for fiscal 2003 increased to $14.8 million from $12.1 million in the prior year,
while our net interest income increased to $9.4 million from $7.5 million. Our
average loans increased to $192.2 million for fiscal 2003 from $137.3 million
for fiscal 2002. The primary reason for the increases in our interest income and
net interest income was our ability to increase our earning assets, primarily
net loans, as we increased our deposit base and deployed an additional $4.0
million of capital we obtained in 2003.
Net interest income for 2003 was reduced by $551,000 of interest expense related
to the trust preferred securities of The Bancorp Capital Trust I and the related
debenture issued by us, as discussed in Note B. 13. in the Notes to Consolidated
Financial Statements, as compared to $305,000 of such expense for fiscal 2002.
The trust preferred securities and the related debenture were issued in June
2002 resulting in only a partial-year interest expense for 2002.
Our net interest margin for fiscal 2003 decreased to 3.77% from 4.05% for fiscal
2002, a decrease of 28 basis points (.28%). The decrease in fiscal 2003 resulted
from a timing difference between the rates we obtained on our loans and rates on
our deposits that we had determined to lock in on a longer-term basis.
For fiscal 2003, the average yield on our interest-earning assets decreased to
5.94% from 6.55% for fiscal 2002, a decrease of 61 basis points (.61%). The
decrease was the result of decreases in the discount rate by the Federal
Reserve, which resulted in decreases in both our prime rate and the rates we
received on federal funds sold. While the low interest rate environment in
fiscal 2003 primarily resulted from rate reductions that occurred in fiscal
2001, there were a total of 50 basis points (.50%) of reductions in 2002 and an
additional 25 basis points (.25%) of reductions in 2003.
The rate decreases by the Federal Reserve also had an impact on the costs of our
interest-bearing deposits, which decreased to 2.47% in fiscal 2003 from 2.86% in
fiscal 2002. Except for immaterial amounts of securities sold under agreements
to repurchase and overnight federal funds for liquidity management purposes, we
did not borrow funds during fiscal 2003.
Average Daily Balances. The following table presents the average daily balances
of assets, liabilities and stockholders' equity and the respective interest
earned or paid on interest-earning assets and interest-bearing liabilities, as
well as average rates for the periods indicated:
Year Ended December 31,
---------------------------------------------------------------------------
2004 2003
------------------------------------- -----------------------------------
Average Average Average Average
Balance Interest Rate Balance Interest Rate
--------- --------- ----------- --------- --------- -----------
(dollars in thousands)
ASSETS:
Interest-earning assets:
Loans net of unearned discount $ 315,088 $ 19,472 6.18% $ 192,206 $ 12,508 6.51%
Investment securities 102,967 4,710 4.57% 28,612 1,984 6.93%
Interest bearing deposits 827 11 1.33% 1,025 8 0.78%
Federal funds sold 36,532 480 1.31% 27,119 297 1.10%
--------- --------- --------- ---------
Net interest-earning assets 455,414 24,673 5.42% 248,962 14,797 5.94%
Allowance for loan and lease losses (2,530) (1,640)
Other assets 16,747 16,167
--------- ---------
$ 469,631 $ 263,489
========= =========
LIABILITIES AND SHAREHOLDERS' EQUITY:
Deposits:
Demand (non-interest bearing
deposits) $ 57,669 $ 40,687
Interest checking 22,070 $ 262 1.19% 14,605 $ 219 1.50%
Savings and money market 126,166 2,576 2.04% 81,158 2,082 2.57%
Time 131,023 3,145 2.40% 101,211 2,556 2.53%
--------- --------- --------- ---------
Total interest-bearing deposits 279,259 5,983 2.14% 196,974 4,857 2.47%
Subordinated debt 5,250 551 10.50% 5,250 551 10.50%
FHLB advances 29,057 516 1.78%
Other borrowed funds 1,507 27 1.79% 660 15 2.27%
--------- --------- --------- ---------
Net interest-bearing liabilities 315,073 7,077 2.25% 202,884 5,423 2.67%
Other liabilities 2,415 597
Shareholders' equity 94,474 19,321
--------- ---------
$ 469,631 $ 263,489
========= =========
Net yield on average interest
earning assets $ 17,596 3.86% $ 9,374 3.77%
========= =========== ========= ===========
Year Ended December 31,
-----------------------------------
2002
-----------------------------------
Average Average
Balance Interest Rate
--------- --------- -----------
(dollars in thousands)
ASSETS:
Interest-earning assets:
Loans net of unearned discount $ 137,278 $ 9,469 6.90%
Investment securities 34,994 2,403 6.87%
Interest bearing deposits 1,103 7 0.63%
Federal funds sold 10,887 181 1.66%
--------- ---------
Net interest-earning assets 184,262 12,060 6.55%
Allowance for loan and lease losses (1,054)
Other assets 13,921
---------
$ 197,129
=========
LIABILITIES AND SHAREHOLDERS' EQUITY:
Deposits:
Demand (non-interest bearing
deposits) 26,882
Interest checking $ 7,872 $ 150 1.91%
Savings and money market 74,917 2,141 2.86%
Time 65,433 1,950 2.98%
--------- ---------
Total interest-bearing deposits 148,222 4,241 2.86%
Subordinated debt 2,905 305 10.50%
FHLB advances
Other borrowed funds 1,556 44 2.83%
--------- ---------
Net interest-bearing liabilities 152,683 4,590 3.01%
Other liabilities 1,857
Shareholders' equity 15,707
---------
$ 197,129
=========
Net yield on average interest
earning assets $ 7,470 4.05%
========= ===========
30
In fiscal 2004, average interest-earning assets increased to $455.4 million, an
increase of $206.4 million, or 82.9%, from fiscal 2003. During the same period,
average loan balances increased $122.9 million, or 63.9%. In fiscal 2003,
average interest-earning assets increased to $249.0 million, an increase of
$64.6 million, or 35.1%, from fiscal 2002. During the same period, average loan
balances increased $54.9 million, or 40.0%. Average interest-bearing deposits
increased to $279.3 million in fiscal 2004 from $197.0 million for fiscal 2003
and $148.2 million for fiscal 2002, an increase of $82.3 million or 41.8% in
2004 and $48.8 million or 32.9% in 2003.
Volume and Rate Analysis. The following table sets forth the changes in net
interest income attributable to either changes in volume (average balances) or
to changes in average rates from 2002 through 2004. The changes attributable to
the combined impact of volume and rate have been allocated proportionately to
the changes due to volume and the changes due to rate.
2004 versus 2003 2003 versus 2002
-------------------------------- --------------------------------
Due to change in: Due to change in:
-------------------- --------------------
Volume Rate Total Volume Rate Total
-------- -------- -------- -------- -------- --------
INTEREST INCOME:
Loans net of unearned
discount $ 7,559 $ (595) $ 6,964 $ 3,539 $ (500) $ 3,039
Investment securities 3,137 (411) 2,726 (443) 24 (419)
Interest bearing deposits (1) 4 3 - 1 1
Federal funds sold 116 67 183 150 (34) 116
-------- -------- -------- -------- -------- --------
Total interest earning
assets 10,811 (935) 9,876 3,246 (509) 2,737
INTEREST EXPENSE:
Interest checking $ 73 $ (30) 43 $ 92 $ (23) 69
Savings and money market 763 (269) 494 258 (317) (59)
Time 708 (119) 589 841 (235) 606
-------- -------- -------- -------- -------- --------
Total deposit interest
expense 1,544 (418) 1,126 1,191 (575) 616
Subordinated debt - - - 246 - 246
FHLB advances 516 - 516 - - -
Other borrowed funds 14 (2) 12 (22) (7) (29)
-------- -------- -------- -------- -------- --------
Total interest expense 2,074 (420) 1,654 1,415 (582) 833
-------- -------- -------- -------- -------- --------
Net interest income $ 8,737 $ (515) $ 8,222 $ 1,831 $ 73 $ 1,904
======== ======== ======== ======== ======== ========
31
Provision for Loan and Lease Losses. Our provision for loan and lease losses was
$1.6 million for fiscal 2004, $685,000 for 2003 and $600,000 for 2002. At
December 31, 2004, our allowance for loan and lease losses amounted to $3.6
million or .84% of total loans. We believe that our allowance is adequate to
cover expected losses. For more information about our provisions and allowance
for loan and lease losses and our loss experience see " -- Allowance for Loan
and Lease Losses" and " -- Summary of Loan and Lease Loss Experience," below.
Non-Interest Income. Non-interest income, exclusive of gains on sales of
investment securities, was $8.4 million for fiscal 2004 as compared to $9.7
million for fiscal 2003, a decrease of $1.3 million or 15.2%. The gains on sales
of investment securities totaled $481,000 for fiscal 2004 compared to a $787,000
gain on sale investment securities for fiscal 2003. Gains (or losses) on sales
of investment securities vary from transaction to transaction, and the timing of
these transactions also may vary. As a result, there may be significant
variation in the amount of our gains (or losses) from period to period. The
principal reasons for the decrease of non-interest income, exclusive of gains on
sales of investment securities, were a decrease in service fees on deposit
accounts and a decrease in merchant credit card fees. Service fees on deposit
accounts for fiscal 2004 decreased $183,000 to $695,000 as compared to fiscal
2003. The decrease was the result of a discontinuation of a deposit program,
which created fee income. Management's review of the program led it to the
conclusion that the fee income did not mitigate the potential risk involved. Our
merchant credit card income was $6.8 million for fiscal 2004, a decrease of $1.2
million, or 14.9% as compared to fiscal 2003 which resulted from the termination
of a high-volume, thin-spread relationship. This decrease was substantially
offset by a similar decrease in related expenses, as discussed in " --
Non-Interest Expense," below. The net fees generated from the merchant credit
card processing support the infrastructure associated with the merchant
division. We believe that our merchant card program generally will expand as we
grow and that fee income from this source will likewise expand.
Total non-interest income for fiscal 2003 was $10.5 million, an increase of $6.1
million or 141.5% over fiscal 2002. The principal reasons for the increase were
an increase in merchant credit card deposit fees to $8.0 million from $3.3
million, gains from sales of investment securities, which amounted to $787,000
for fiscal 2003 as compared to $20,000 in fiscal 2002, and an increase in our
service fees on deposit accounts to $878,000 from $431,000. The increase in
merchant credit card fees resulted from increased transactional volume arising
out of the relationship that we discussed above where there was high volume and
a thin spread, together with a growth in existing relationships. These fees were
substantially offset by related expenses, as discussed in " -- Non-Interest
Expense," below. The increase in service fees on deposit accounts resulted from
an overall increase in account relationships, in particular from the deposit
program discussed above that was discontinued in fiscal 2004.
Non-Interest Expense. Total non-interest expense was $22.2 million for fiscal
2004, as compared to $18.3 million for fiscal 2003, an increase of $3.8 or
20.9%. Salaries and employee benefits amounted to $7.9 million for fiscal 2004
as compared to $5.0 million for fiscal 2003. The increase reflects additional
staff required for the commercial lending, call center and merchant processing
areas as we increased in size from $304.2 million in total assets at December
31, 2003 to $576.3 million in total assets at December 31, 2004. It also
reflects annual salary increases of 3% to 5% to our employees and our payment of
compensation to executives who had not received
32
salaries and/or bonuses in the second quarter of 2003, principally our chief
executive officer. We expect salaries and employee benefits expense to increase
in future periods as we increase our staff to accommodate our expected growth in
assets. Merchant credit card deposit expense amounted to $6.1 million for fiscal
2004, a decrease of $1.3 million, or 17.6% over fiscal 2003. As discussed above,
the decrease resulted from the termination of a high-volume, thin-spread
relationship. Advertising costs increased to $442,000 for fiscal 2004, as
compared to $242,000 for fiscal 2003, an increase of $200,000 or 82.6%. The
increase was the result of targeted events for the Philadelphia Private Bank
customers. Other expense was $4.0 million for fiscal 2004 as compared to $3.1
million for fiscal 2003, an increase of $509,000 or 30.6%. Of this increase,
insurance costs increased by $448,000 primarily due to the premium increase for
directors' and officers' insurance after our initial public offering. We expect
that other expenses will increase over at least the next 12 months as a result
of compliance measures required by recent legislative and regulatory initiatives
such as the Sarbanes-Oxley Act of 2002.
Total non-interest expense was $18.4 million for fiscal 2003, as compared to
$11.7 million in fiscal 2002, an increase of $6.7 million or 56.8%. Salaries and
employee benefits amounted to $5.0 million for fiscal 2003 as compared to $3.7
million for fiscal 2002. The increase reflects additional staff for the
commercial lending, call center and merchant processing areas as well as annual
salary increases of 3% to 5%. Merchant credit card deposit expense amounted to
$7.4 million for fiscal 2003, an increase of $4.5 million, or 179.8%, over
fiscal 2002. As discussed above, the increase resulted from the increased
transactional volume arising out of the new relationships we established
together with growth in existing relationships.
Total non-interest expense was $11.7 million for fiscal 2002 as compared to $8.7
million for fiscal 2001, an increase of $3.0 million or 34.4%. Merchant credit
card deposit expense amounted to $2.6 million for fiscal 2002, an increase of
$1.6 million, which was substantially offset by related income. Data processing
expense was $704,000 for fiscal 2002, which reflected $553,000 in data
processing fees to our service providers. Advertising expense was $292,000 for
fiscal 2002 as compared to $248,000 for fiscal 2001, an increase of $44,000. The
increase resulted from an increase in our affinity group marketing.
In fiscal 2003, non-interest expense included a one-time charge of $188,000 in
salary and employee benefits for compensation paid to a former executive. In
September 2002, we paid a settlement of $800,000 in connection with an action
brought by a shareholder of a financial institution with which certain members
of our management had previously been associated. The plaintiff alleged that we
had misappropriated an opportunity properly belonging to the other financial
institution. We did not record an expense at the time of settlement since, based
upon the advice of counsel and insurance advisors, we expected a favorable
outcome of our claim under our directors' and officers' insurance policy. We
evaluated our claim in each succeeding period and, based upon advice of counsel,
determined that the claim would have a favorable outcome. In October 2002,
counsel advised us that significant further litigation would be required to
pursue our claim and, to avoid further expense, we settled our claim for
$250,000 and recorded an expense of $691,000, representing the difference
between settlement amount plus related expenses and the settlement payment
received.
INCOME TAX BENEFIT, NET OPERATING LOSS CARRYFORWARDS
We reported a benefit for income taxes for fiscal 2004 of $1.0 million, for
fiscal 2003 of $250,000, and $500,000 for fiscal 2002 as a result of a reversal
of our deferred tax valuation allowance. As of December 31, 2004 we recognized
our remaining valuation allowance because management believes it is more likely
than not that we will continue to generate income, and as a result, we will
become a full tax paying company in fiscal 2005.
33
LIQUIDITY AND CAPITAL RESOURCES
Liquidity defines our ability to generate funds to support asset growth, meet
deposit withdrawals, satisfy borrowing needs and otherwise operate on an ongoing
basis. We invest the funds we do not need for operation primarily in overnight
federal funds.
Until the Bank's public offering in February 2004, the primary source of funds
for our investing activities had been cash inflows from net increases in
deposits, which were $111.3 million in fiscal 2004, $67.3 million in fiscal
2003, and $71.9 million in 2002. While we do not have a traditional branch
system, we feel that our core deposits have similar characteristics to those of
a bank with a branch system. We seek to set rates on our deposits at competitive
levels with the rates offered in our market; however we do not seek to compete
principally on rate. The focus of our business model is to identify affinity
groups that control significant amounts of deposits as part of their business. A
key component to the model is that the deposits are both stable and "sticky," in
the sense of they do not react to fluctuations in the market. Because of the
model, we have not experienced significant swings in liquidity and would expect
that to continue in the future. We have also derived funds from offerings in
2001, 2002 and 2003 amounting to $13.4 million.
In fiscal 2004, we obtained $82.9 million in net offering proceeds from the
Bank's public offering, which significantly increased liquidity. We initially
invested the proceeds of this offering in highly liquid investment securities.
As we invest this capital, and increase the deposit base that the capital
supports, into loans our liquidity will decrease to more normal levels.
We have also used sources outside of our core deposit products to fund our loan
growth, in particular the Federal Home Loan Bank and repurchase agreements. As
of December 31, 2004, we had $55.0 million of outstanding Federal Home Loan Bank
advances and $5.1 million in repurchase agreements. We also have a $5 million
line of credit with Atlantic Central Bankers Bank. No amounts were outstanding
on the line of credit as of December 31, 2004. We expect to continue to use our
facility with the Federal Home Loan Bank, as well as repurchase agreements, as a
supplemental funding source. We have also used the broker certificate of deposit
market as a supplemental funding source. Brokered funds amounted to $160.8
million, $102.9 million and $70.8 million, at December 31, 2004, 2003 and 2002,
respectively. As part of our asset and liability management process, we review
the maturities of our broker certificates of deposit in light of our expected
deposit inflows and the amount of funding we anticipate will be necessary for
lending purposes. The use of broker certificates of deposit as a funding source
is a strategy we employ to match funds against fixed rate loans. While broker
certificates of deposit can be a volatile source of funding, we believe that the
principal factor in attracting such deposits, as with other time deposits, is
the interest rate offered. As a result, in a rising interest rate environmental
our cost of funds will also rise to the extent we seek to replace maturing
broker certificates of deposit with similar funds rather than with increased
core deposits or borrowings under our Federal Home Loan Bank and Atlantic
Central Bankers Bank facilities.
Funding was directed primarily at cash outflows required for loans, which were
$195.5 million in fiscal 2004, $69.1 million in fiscal 2003 and $57.1 million in
fiscal 2002. At December 31, 2004, we had outstanding commitments to fund loans,
including unused lines of credit, of $134.9 million.
We must comply with capital adequacy guidelines issued by the Federal Reserve,
while the Bank must comply with similar FDIC guidelines. Under both sets of
guidelines, an institution must, in
34
general, have a leverage ratio of 5.0%, a ratio of Tier 1 capital to
risk-weighted assets of 6.0% and a ratio of total capital to risk-weighted
assets of 10.0% in order to be considered "well capitalized." A Tier 1 leverage
ratio is the ratio of Tier 1 capital to average assets for the period. "Tier 1
capital" includes common shareholders' equity, certain qualifying perpetual
preferred stock and minority interests in equity accounts of consolidated
subsidiaries, less goodwill. At December 31, 2004 both we and the Bank were
"well capitalized" under banking regulations. As a result of the Bank's public
offering, both of our capital ratios at December 31, 2004 had significantly
increased as compared to December 31, 2003. The capital from the public offering
will allow us to grow substantially over our current asset size.
The following tables set forth the regulatory capital amounts and ratios for
both us and the Bank at the dates indicated:
Tier 1 capital Tier 1 capital Total capital
to average to risk-weighted to risk-weighted
assets ratio assets ratio assets ratio
------------------ ------------------ ------------------
AS OF DECEMBER 31, 2004:
The Company 22.88% 26.29% 27.04%
The Bancorp Bank 20.54% 23.74% 24.49%
"Well capitalized" institution (under
FDIC regulations) 5.00% 6.00% 10.00%
AS OF DECEMBER 31, 2003:
The Company 7.13% 8.65% 9.44%
The Bancorp Bank 8.46% 10.26% 11.05%
"Well capitalized" institution (under
FDIC regulations) 5.00% 6.00% 10.00%
ASSET AND LIABILITY MANAGEMENT
The management of rate sensitive assets and liabilities is essential to
controlling interest rate risk and optimizing interest margins. An interest rate
sensitive asset or liability is one that, within a defined time period, either
matures or experiences an interest rate change in line with general market
rates. Interest rate sensitivity measures the relative volatility of an
institution's interest margin resulting from changes in market interest rates.
As a financial institution, our potential interest rate volatility is a primary
component of our market risk. Fluctuations in interest rates will ultimately
impact the level of our earnings and the market value of all of our
interest-earning assets, other than those with short term maturities. We do not
own any trading assets and we do not have any hedging transactions in place,
such as interest rate swaps.
We have adopted policies designed to stabilize net interest income and preserve
capital over a broad range of interest rate movements. To effectively administer
the policies and to monitor our exposure to fluctuations in interest rates, we
maintain an asset/liability committee, consisting of the chief executive
officer, chief financial officer, president and chief credit officer. This
committee meets quarterly to review our financial results and to develop
strategies to implement the policies and to respond to market conditions. The
primary goal of our policies is to maximize interest income while minimizing
fluctuations, subject to overall policy constraints.
35
We monitor and control interest rate risk through a variety of techniques,
including use of traditional interest rate sensitivity analysis (also known as
"gap analysis") and an interest rate risk management model. With the interest
rate risk management model, we project future net interest income, and then
estimate the effect of various changes in interest rates and balance sheet
growth rates on that projected net interest income. We also use the interest
rate risk management model to calculate the change in net portfolio value over a
range of interest rate change scenarios. Traditional gap analysis involves
arranging our interest-earning assets and interest-bearing liabilities by
repricing periods and then computing the difference (or "interest rate
sensitivity gap") between the assets and liabilities that are estimated to
reprice during each time period and cumulatively through the end of each time
period.
Both interest rate sensitivity modeling and gap analysis are done at a specific
point in time and involve a variety of significant estimates and assumptions.
Interest rate sensitivity modeling requires, among other things, estimates of
how much and when yields and costs on individual categories of interest-earning
assets and interest-bearing liabilities will respond to general changes in
market rates, future cash flows and discount rates. Gap analysis requires
estimates as to when individual categories of interest-sensitive assets and
liabilities will reprice, and assumes that assets and liabilities assigned to
the same repricing period will reprice at the same time and in the same amount.
Gap analysis does not account for the fact that repricing of assets and
liabilities is discretionary and subject to competitive and other pressures. A
gap is considered positive when the amount of interest rate sensitive assets
exceeds the amount of interest rate sensitive liabilities. A gap is considered
negative when the amount of interest rate sensitive liabilities exceeds interest
rate sensitive assets. During a period of falling interest rates, a positive gap
would tend to adversely affect net interest income, while a negative gap would
tend to result in an increase in net interest income. During a period of rising
interest rates, a positive gap would tend to result in an increase in net
interest income while a negative gap would tend to affect net interest income
adversely.
The following table sets forth the estimated maturity/repricing structure of our
interest-earning assets and interest-bearing liabilities at December 31, 2004.
Except as stated below, the amounts of assets or liabilities shown which reprice
or mature during a particular period were determined in accordance with the
contractual terms of each asset or liability. The majority of interest-bearing
demand deposits and savings deposits are assumed to be "core" deposits, or
deposits that will generally remain with us regardless of market interest rates.
Therefore, 50% of the core interest checking deposits and 25% of core savings
and money market deposits are shown as maturing or repricing within the "1 - 90
days" column with the remainder shown in the "1 - 3 years" column. We estimate
the repricing characteristics of these deposits based on historical performance,
past experience at other institutions and other deposit behavior assumptions.
However, we may choose not to reprice liabilities proportionally to changes in
market interest rates for competitive or other reasons. The table does not
assume any prepayment of fixed-rate loans and mortgage-backed securities are
scheduled based on their anticipated cash flow, including prepayments based on
historical data and current market trends. The table does not necessarily
indicate the impact of general interest rate movements on our net interest
income because the repricing of certain categories of assets and liabilities is
beyond our control as, for example, prepayments of loans and withdrawal of
deposits. As a result, certain assets and liabilities indicated as repricing
within a stated period may in fact reprice at different times and at different
rate levels.
36
1-90 91-364 1-3 3-5 Over 5
Days Days Years Years Years
------------ ------------ ------------ ------------ ------------
(dollars in thousands)
INTEREST EARNING ASSETS:
Loans net of unearned discount $ 213,965 $ 20,414 $ 93,778 $ 48,094 $ 51,630
Investments, available for sale 3,553 4,793 8,154 39,824 63,928
Interest bearing deposits 1,028 - - - -
Federal funds sold 8,291 - - - -
------------ ------------ ------------ ------------ ------------
Total interest earning assets 226,837 25,207 101,932 87,918 115,558
------------ ------------ ------------ ------------ ------------
INTEREST BEARING LIABILITIES:
Interest checking 9,824 - 9,824 - -
Savings and money market 33,442 - 100,327 - -
Time deposits 46,703 89,497 46,531 101
Securities sold under agreements
to repurchase 5,052 - - - -
Federal Home Loan Bank advances 55,000
Subordinated debt - - 5,413 - -
------------ ------------ ------------ ------------ ------------
Total interest bearing liabilities 150,021 89,497 162,095 101 -
------------ ------------ ------------ ------------ ------------
Gap $ 76,816 $ (64,290) $ (60,163) $ 87,817 $ 115,558
============ ============ ============ ============ ============
Cumulative gap $ 76,816 $ 12,526 $ (47,637) $ 40,180 $ 155,738
============ ============ ============ ============ ============
Gap to assets ratio 13% -11% -10% 15% 20%
Cumulative gap to assets ratio 13% 2% -8% 7% 27%
The method used to analyze interest rate sensitivity in this table has a number
of limitations. Certain assets and liabilities may react differently to changes
in interest rates even though they reprice or mature in the same or similar time
periods. The interest rates on certain assets and liabilities may change at
different times than changes in market interest rates, with some changing in
advance of changes in market rates and some lagging behind changes in market
rates. Additionally, the actual prepayments and withdrawals we experience when
interest rates change may deviate significantly from those assumed in
calculating the data shown in the table.
Because of the limitations in the gap analysis discussed above, we believe that
the interest sensitivity modeling more accurately reflects the effects and
exposure to changes in interest rates. Net interest income simulation considers
the relative sensitivities of the balance sheet including the effects of
interest rate caps on adjustable rate mortgages and the relatively stable
aspects of core deposits. As such, net interest income simulation is designed to
address the probability of interest rate changes and the behavioral response of
the balance sheet to those changes. Market Value of Portfolio Equity, or MVPE,
represents the fair value of the net present value of assets, liabilities and
off-balance-sheet items.
We believe that the assumptions utilized in evaluating our estimated net
interest income are reasonable; however, the interest rate sensitivity of our
assets, liabilities and off-balance sheet financial instruments as well as the
estimated effect of changes in interest rates on estimated net interest income
could vary substantially if different assumptions are used or actual experience
differs from the experience on which the assumptions were based. The following
table shows the effects of interest rate shocks on our MVPE and net interest
income. Rate shocks assume that current interest rates change immediately and
sustain parallel shifts. For interest rate increases or decreases of 100 and 200
basis points, our policy dictates that our MPVE ratio should not fluctuate more
than 10% and 20%, and that net interest income should not fluctuate more than
37
15% and 20%, respectively. As illustrated in the following table, we complied
with our asset/liability policy at December 31, 2004.
Net portfolio value at
December 31, 2004 Net interest income
--------------------------- ---------------------------
Percentage Percentage
Rate scenario Amount change Amount change
- ------------------------------ ------------ ------------ ------------ ------------
(dollars in thousands)
+200 basis points $ 129,434 -1.58% $ 26,870 10.27%
+100 basis points 130,410 -0.84% 25,627 5.17%
Flat rate 131,511 24,368
- -100 basis points 129,338 -1.65% 21,997 -9.73%
- -200 basis points 127,405 -3.12% 19,834 -18.61%
If we should experience a mismatch in our desired gap ranges or an excessive
decline in our MVPE subsequent to an immediate and sustained changed in interest
rate, we have a number of options which we could utilize to remedy such
mismatch. We could restructure our investment portfolio through the sale or
purchase of securities with more favorable repricing attributes. We could also
emphasize loan products with appropriate maturities or repricing attributes, or
we could emphasize deposits or obtain borrowings with desired maturities.
Historically, we have primarily used variable rate commercial loans to limit
fluctuations in our earnings. We seek to lock in a positive interest rate spread
by using longer-term brokered funds to offset a portion of our fixed-rate loan
portfolio. Our asset/liability strategy will be to maintain a positive gap
position (that is, to continue to have interest-bearing assets subject to
repricing that exceed in amount interest-earning liabilities subject to
repricing) for periods up to a year. We continue to evaluate market conditions
and may change our current gap strategy in response to changes in those
conditions. Effective monitoring of these interest sensitivity gaps is the
priority of our asset/liability management committee.
FINANCIAL CONDITION
General. Our total assets at December 31, 2004 were $576.3 million, of which
total loans were $427.9 million, or 74.2%, while our total assets at December
31, 2003 were $304.2 million, of which total loans were $232.4 million, or
76.4%, and at December 31, 2002 our total assets were $233.4 million, of which
total loans were $163.3 million, or 69.4%. Our portfolio of commercial,
commercial mortgage and construction loans grew $55.5 million, or 47.6%, from
year-end 2002 to $171.9 million at December 31, 2003 and by $155.4 million, or
90.4%, to $327.3 million at December 31, 2004.
Investment portfolio. The following table presents the book value and the
approximate fair value for each major category of our investment securities
portfolio. At December 31, 2004, 2003 and 2002, all of our investments were
categorized as available for sale.
38
December 31, 2004 December 31, 2003 December 31, 2002
--------------------------- --------------------------- ---------------------------
Amortized Fair Amortized Fair Amortized Fair
cost value cost value cost value
------------ ------------ ------------ ------------ ------------ ------------
(in thousands)
U.S. Government agency securities $ 80,000 $ 79,753 $ - $ - $ - $ -
Mortgage backed securities 7,318 6,900 10,604 10,251 17,567 17,854
Other securities 33,284 33,599 14,019 14,136 15,624 15,815
------------ ------------ ------------ ------------ ------------ ------------
$ 120,602 $ 120,252 $ 24,623 $ 24,387 $ 33,191 $ 33,669
============ ============ ============ ============ ============ ============
Investment securities with a carrying value of $40.3 million at December 31,
2004, $8.5 million at December 31, 2003 and $11.0 million at December 31, 2002
were pledged as collateral for merchant processing accounts, Federal Home Loan
Bank advances and to secure securities sold under repurchase agreements as
required or permitted by law.
The following tables show the contractual maturity distribution and the weighted
average yields of our investment securities portfolio as of December 31, 2004:
After After
one to Five to Over
five Average ten Average ten Average
years yield years yield years yield Total
----------- ----------- ----------- ----------- ----------- ----------- -----------
Available for Sale:
US Government agencies $ 39,824 3.72% $ 39,929 4.01% $ - 0.00% 79,753
Mortgage backed securities - - 3,865 4.00% 3,035 5.38% 6,900
Equity securities - - - - 33,599 6.24% 33,599
----------- ----------- ----------- -----------
Total available for sale $ 39,824 $ 43,794 $ 36,634 $ 120,252
=========== =========== =========== ===========
Weighted average yield 3.72% 4.01% 6.17%
=========== =========== ===========
Loan Portfolio: We have developed an extensive credit policy to cover all facets
of our lending activities. All of the commercial loans in our portfolio go
through our loan committee for approval. Our chief executive officer, Mrs.
Cohen, who has over 25 years experience in real estate lending, chairs our loan
committee. The remainder of the committee is made up of our president, chief
lending officer, head commercial lender, lenders, loan analysts and our chief
credit officer, who is present to insure adherence to both regulatory compliance
and our internal credit policy. All of the key committee members have lengthy
experience and have had similar positions at substantially larger institutions.
We originate substantially all of our portfolio loans, except in certain
instances where we purchased individual leases and lease pools. Where a proposed
loan exceeds our lending limit, we typically sell a participation in the loan to
another financial institution. At December 31, 2004, we had $51.0 million in
participations sold, all of which were sold without recourse to us. Our loan
39
portfolio grew at an annual rate of 84.1% in 2004, 42.3% in 2003, 54.0% in 2002
and 277.7% in 2001, reflecting the build-up of our lending operations. We focus
primarily on lending to small to mid-size businesses and their principals. We
typically require that all commercial mortgages and construction loans be
secured, generally by real estate. At December 31, 2004, commercial,
construction and commercial mortgage loans made up $327.3 million or 76.5% of
our total loan portfolio, of which 80.5% were secured by real estate. We expect
that the percentage of our loan portfolio represented by commercial,
construction and commercial mortgage loans will remain at or about the current
percentage for the foreseeable future. However, we from time to time consider
acquisitions of loan or lease portfolios and, as a result of any such
acquisition, the percentage could change.
We typically seek to structure our loans with variable rates of interest based
upon either a stated prime rate or the London Inter-Bank Offered Rate, although
we do lend at fixed rates when appropriate for a customer.
The following table summarizes our loan portfolio by loan category for the
periods indicated:
2004 2003 2002 2001
Amount Amount Amount Amount
------------ ------------ ------------ ------------
Commercial $ 89,327 $ 53,130 $ 36,037 $ 30,250
Commercial mortgage 140,755 89,772 71,016 37,939
Construction 97,239 29,026 9,400 4,441
------------ ------------ ------------ ------------
Total commercial loans 327,321 171,928 116,453 72,630
Direct financing leases, net 44,795 38,405 30,958 25,405
Residential mortgage 31,388 6,473 4,433 3,228
Consumer loans and others 24,894 14,989 10,815 4,336
------------ ------------ ------------ ------------
428,398 231,795 162,659 105,599
Unamortized costs (517) 602 678 609
------------ ------------ ------------ ------------
Total loans, net of
unamortized fees and costs $ 427,881 $ 232,397 $ 163,337 $ 106,208
============ ============ ============ ============
The following loan table presents selected loan categories by maturity for the
periods indicated:
December 31, 2004
---------------------------------------------------------
Within One to Five After
One Year Years Five Years Total
------------ ------------ ------------ ------------
(in thousands)
Commercial and commercial
mortgage $ 88,452 $ 109,935 $ 31,695 $ 230,082
Construction 34,356 56,303 6,580 97,239
------------ ------------ ------------ ------------
$ 122,808 $ 166,238 $ 38,275 $ 327,321
============ ============ ============ ============
Loans at fixed rates $ 47,052 $ 6,649 $ 53,701
Loans at variable rates 119,186 31,626 150,812
------------ ------------ ------------
Total $ 166,238 $ 38,275 $ 204,513
============ ============ ============
Allowance for Loan and Lease Losses. Management reviews the adequacy of our
allowance for loan and lease losses on at least a quarterly basis to ensure that
the provision for loan losses which
40
has been charged against earnings is in the amount necessary to maintain our
allowance at a level that is appropriate, based on management's estimate of
probable losses. Our estimates of loan and lease losses are intended to, and, in
management's opinion, do, meet the criteria for accrual of loss contingencies in
accordance with Statement of Financial Accounting Standards, or SFAS, No. 5,
"Accounting for Contingencies," and SFAS No. 114, "Accounting by Creditors for
Impairment of a Loan." The process of evaluating this adequacy has two basic
elements: first, the identification of problem loans or leases based on current
financial information and the fair value of the underlying collateral; and
second, a methodology for estimating general loss reserves. For loans or leases
classified as "special mention," "substandard" or "doubtful," we record all
estimated losses at the time we classify the loan or lease. This "specific"
portion of the allowance is the total of potential, although unconfirmed, losses
for individually classified loans. Because we immediately charge off all
identified losses, no portion of the allowance for loan losses is restricted to
any individual loan or groups of loans, and the entire allowance is available to
absorb any and all loan losses.
The second phase of our analysis represents an allocation of the allowance. This
methodology analyzes pools of loans that have similar characteristics and
applies historical loss experience and other factors for each pool to determine
its allocable portion of the allowance. This estimate is intended to represent
the potential unconfirmed and inherent losses within the portfolio. Individual
loan pools are created for major loan categories: commercial loans, commercial
mortgages, construction loans and direct lease financing, and for the various
types of loans to individuals. The historical experience for each loan pool is
augmented by accounting for such items as: current economic conditions, current
loan portfolio performance, loan policy or management changes, loan
concentrations, increases in our lending limit, the average loan size, and other
factors as appropriate. For example, as a result of significant growth in
construction lending, which was the result of a construction lending group being
hired at the end of the third quarter of 2003, our allocation to the
construction loan pool increased in the last half of 2003 and the first half of
2004. In fiscal 2004 we enhanced our allowance methodology through the efforts
of our newly-hired chief risk officer, who directly oversees the loan review
processes and measures the adequacy of the allowance independently from
management. The chief risk officer reports directly to our audit committee. The
chief risk officer's individual loan oversight parameters include: borrower
relationships over $2.0 million and loans 90 days or more past due or that have
been previously classified as substandard. Pursuant to these parameters,
approximately 67% of our loans are subject to the chief risk officer's
oversight.
Although the performance of our loan portfolio has been above that of our peers,
and we do not currently foresee a change in that performance, our analysis for
purposes of deriving the historical loss component of the allowance includes
factors in addition to our historical loss experience, such as management's
experience with similar loan and lease portfolios at other institutions, the
historic loss experience of our peers and statistical information from various
industry reports such as the FDIC's Quarterly Banking Profile.
While we consider our allowance for loan and lease losses to be adequate based
on information currently available, future additions to the allowance may be
necessary due to changes in economic conditions or management's assumptions as
to future delinquencies, recoveries and losses and management's intent with
regard to the disposition of loans and leases.
The following table presents an allocation of the allowance for loan and lease
losses among the types of loans or leases in our portfolio at December 31, 2004,
2003 and 2002:
41
December 31, 2004 December 31, 2003 December 31, 2002
--------------------------- --------------------------- ---------------------------
% Loan % Loan % Loan
Type to Type to Type to
Total Total Total
Allowance Loans Allowance Loans Allowance Loans
------------ ------------ ------------ ------------ ------------ ------------
(dollars in thousands)
Commercial $ 862 20.85% $ 531 22.92% $ 400 22.15%
Commercial mortgage 1,257 32.86% 673 38.73% 445 43.66%
Construction 646 22.70% 261 12.52% 150 5.78%
Direct financing leases, net 535 10.46% 364 16.57% 280 19.03%
Consumer loans 70 7.33% 70 2.79% 45 2.73%
Residential mortgage 143 5.81% 80 6.47% 45 6.65%
Unallocated 80 - 12 - 14 -
------------ ------------ ------------ ------------ ------------ ------------
$ 3,593 100.00% $ 1,991 100.00% $ 1,379 100.00%
============ ============ ============ ============ ============ ============
Summary of Loan and Lease Loss Experience. The following table summarizes our
credit loss experience for each of the periods indicated:
December 31,
------------------------------------------------------------------------
2004 2003 2002 2001 2000
------------ ------------ ------------ ------------ ------------
(dollars in thousands)
Balance in the allowance for loan
and lease losses at beginning of
period $ 1,991 $ 1,379 $ 780 $ 350 $ -
------------ ------------ ------------ ------------ ------------
Loans charged-off:
Commercial 10
Lease financing - 65 1 5
Consumer 20 9 - - -
------------ ------------ ------------ ------------ ------------
Total 30 74 1 5 -
------------ ------------ ------------ ------------ ------------
Recoveries:
Lease financing - 1 - - -
------------ ------------ ------------ ------------ ------------
Total - 1 - - -
------------ ------------ ------------ ------------ ------------
Net charge-offs 30 73 1 5 -
Provision charged to operations 1,632 685 600 435 350
------------ ------------ ------------ ------------ ------------
Balance in allowance for loan and
lease losses at end of period $ 3,593 $ 1,991 $ 1,379 $ 780 $ 350
============ ============ ============ ============ ============
Net charge-offs/average loans 0.01% 0.04% * * *
* Less than .01%
Non-Performing Loans. Loans are considered to be non-performing if they are on a
non-accrual basis or terms have been renegotiated to provide a reduction or
deferral of interest or principal because of a weakening in the financial
positions of the borrowers. A loan which is past due 90 days or more and still
accruing interest remains on accrual status only when it is both adequately
secured as to principal and is in the process of collection. We had $205,000 in
non-accrual loans at December 31, 2004 and no non-accrual loans in any of the
prior year periods. We did not have any real estate owned as a result of
foreclosures of delinquent or defaulted loans. Loans past due
42
90 days or more still accruing interest amounted to $23,000, $44,000 and $40,000
at December 31, 2004, 2003 and 2002, respectively.
Deposits. A primary source for funding our growth is deposit accumulation. We
offer a variety of deposit accounts with a range of interest rates and terms,
including savings accounts, checking accounts, money market savings accounts and
certificates of deposit. While the flow of deposits is influenced significantly
by general economic conditions, changes in money market rates, prevailing
interest rates and competition, as a result of the February 2004 public offering
by the Bank which significantly increased our capital base, we expect that our
current deposit growth will continue. At December 31, 2004, we had total
deposits of $388.1 million as compared to $276.8 million at December 31, 2003,
an increase of $111.3 million or 40.2%. The following table presents the average
balance and rates paid on deposits for the periods indicated:
December 31, 2004 December 31, 2003 December 31, 2002
--------------------------- --------------------------- --------------------------
Average Average Average Average Average Average
balance Rate Balance rate balance rate
------------ ------------ ------------ ------------ ------------ ------------
(dollars in thousands)
Demand (non-interest bearing) $ 57,669 - $ 40,687 - $ 26,882 -
Interest checking 22,070 1.19% 14,605 1.50% 7,872 1.91%
Savings and money market 126,166 2.04% 81,158 2.57% 74,917 2.86%
Time 131,023 2.40% 101,211 2.53% 65,433 2.98%
------------ ------------ ------------
Total deposits $ 336,928 1.78% $ 237,661 2.04% $ 175,104 2.44%
============ ============ ============
The remaining maturity on certificates of deposit of $100,000 or more as of
December 31, 2004 was as follows:
Amount
--------------
(in thousands)
Maturity:
Three months or less $ 10,674
Three to six months 2,312
Six to twelve months 1,855
Greater than twelve months 210
--------------
$ 15,051
==============
At December 31, 2004, we had $136.3 million of certificate of deposit accounts
maturing in one year or less. We rely primarily on customer service and customer
relationships to attract and retain deposits. However, market interest rates and
rates offered by competing financial institutions significantly affect our
ability to attract and retain deposits. At December 31, 2004, 2003, and 2002,
approximately 41.4%, 37.0% and 33.4%, respectively, of our deposits consisted of
brokered or wholesale deposits. Our strategy is to use brokered or wholesale
deposits to match loan funding needs as they arise. Brokered and wholesale
deposits tend to be more sensitive to movements in market interest rates when
compared with other types of deposits, and thus may result in our deposit base
being less stable than if we had a greater proportion of our deposits in core
deposits such as savings and checking accounts. Use of brokered or wholesale
deposits may also increase our cost of deposits. We believe that we will
continue to have access to sufficient
43
amounts of brokered or wholesale deposits which, together with our other funding
sources, will provide us with the means of funding our loan growth.
BORROWINGS
At December 31, 2004, we had $55.0 million in advances outstanding from the
Federal Home Loan Bank. The advances mature on a daily basis and are
collateralized with investment securities. We also use the federal funds market
to cover short-term (generally one day or less) cash demands. To a lesser
extent, we have used securities sold under agreements to repurchase to fund
short-term cash demands. The Bank also has a $5.0 million line of credit with
the Atlantic Central Bankers Bank. No amounts were outstanding under this line
of credit at December 31, 2004. We do not have any policy prohibiting us from
incurring debt. We anticipate that, under current circumstances, any borrowing,
other than through the federal funds market, securities sold under agreements to
repurchase or the line of credit, will continue to be from the Federal Home Loan
Bank system.
As of or for the year ended December 31,
------------------------------------------
2004 2003 2002
------------ ------------ ------------
(dollars in thousands)
Securities sold under repurchase agreements
and federal funds purchased
Balance at year-end $ 5,052 $ 3 $ 1,008
Average during the year 1,507 660 1,556
Maximum month-end balance 5,052 1,021 6,561
Weighted average rate during the year 1.79% 2.27% 2.83%
Rate at December 31 1.76% 1.05% 2.30%
Federal Home Loan Bank advances
Balance at year-end $ 55,000 $ - $ -
Average during the year 29,057 - -
Maximum month-end balance 55,000 - -
Weighted average rate during the year 1.78% - -
Rate at December 31 2.24% - -
OFF-BALANCE SHEET COMMITMENTS
We are party to financial instruments with off-balance sheet risk in the normal
course of business to meet the financing needs of our customers. These financial
instruments include commitments to extend credit and standby letters of credit.
These instruments involve, to varying degrees, elements of credit and interest
rate risk in excess of the amount recognized in our financial statements.
Credit risk is defined as the possibility of sustaining a loss due to the
failure of the other parties to a financial instrument to perform in accordance
with the terms of the contract. The maximum exposure to credit loss under
commitments to extend credit and standby letters of credit is represented by the
contractual amount of these instruments. We use the same underwriting standards
and policies in making credit commitments as we do for on-balance-sheet
instruments.
44
Financial instruments whose contract amounts represent potential credit risk for
us at December 31, 2004 were our commitments to extend credit, which were
approximately $134.9 million, and standby letters of credit, which were
approximately $5.9 million at December 31, 2004, respectively.
Commitments to extend credit are agreements to lend to a customer as long as
there is no violation of any condition established in the contract. Commitments
generally have fixed expiration dates or other termination clauses and many
require the payment of a fee. Standby letters of credit are conditional
commitments issued that guarantee the performance of a customer to a third
party. Since we expect that many of the commitments or letters of credit we
issue will not be fully drawn upon, the total commitment or letter of credit
amounts do not necessarily represent future cash requirements. We evaluate each
customer's creditworthiness on a case-by-case basis. We base the amount of
collateral we obtain when we extend credit on our credit evaluation of the
customer. Collateral held varies but may include real estate, marketable
securities, pledged deposits, equipment and accounts receivable.
CONTRACTUAL OBLIGATIONS AND OTHER COMMITMENTS
The following table sets forth our contractual obligations and other
commitments, including off-balance sheet commitments, representing required and
potential cash outflows as of December 31, 2004:
Less than One to Four to After
Total one year three years five years five years
------------ ------------ ------------ ------------ ------------
(in thousands)
Minimum annual rentals on
noncancellable operating leases $ 9,171 $ 1,251 $ 2,471 $ 2,389 $ 3,060
Remaining contractual maturities
of time deposits 182,832 136,300 46,431 101
Loan commitments 134,902 64,538 52,168 7,297 10,899
Standby letters of credit 5,879 4,167 1,007 266 439
------------ ------------ ------------ ------------ ------------
Total $ 151,736 $ 63,671 $ 80,516 $ 4,371 $ 3,178
============ ============ ============ ============ ============
IMPACT OF INFLATION
The primary impact of inflation on our operations is on our operating costs.
Unlike most industrial companies, virtually all of the assets and liabilities of
a financial institution are monetary in nature. As a result, interest rates have
a more significant impact on a financial institution's performance than the
effects of general levels of inflation. Interest rates do not necessarily move
in the same direction or in the same magnitude as the price of goods and
services. We have not been materially affected by inflation because we are a
relatively newly- formed institution. While we anticipate that inflation will
affect our future operating costs, we cannot predict the timing or amounts of
any such effects.
RECENTLY ISSUED ACCOUNTING STANDARDS
In October 2003, the American Institute of Certified Public Accountants issued
Statement of Policy, or SOP, 03-3, "Accounting for Loans or Certain Debt
Securities Acquired in a Transfer." SOP 03-3 applies to a loan that we acquire
where it is probable, at acquisition, that we will be unable to collect all
contractually required payments receivable. SOP 03-3 requires us to
45
recognize, as accretable yield, the excess of all cash flows expected at
acquisition over the investor's initial investment in the loan as interest
income on a level-yield basis over the life of the loan. The amount by which the
loan's contractually required payments exceed the amount of its expected cash
flows at acquisition may not be recognized as an adjustment to yield, a loss
accrual or a valuation allowance for credit risk. SOP 03-3 is effective for
loans acquired in fiscal years beginning after December 31, 2004. Early adoption
is permitted. We have evaluated the provisions of SOP 03-3 and adoption will not
have a material effect on our financial statements.
In November 2003, the Emerging Issues Task Force, or EITF, of the FASB issued
EITF Issue No. 03-1, "The Meaning of Other-Than-Temporary Impairment and its
Application to Certain Investments." The quantitative and qualitative disclosure
provisions of EITF 03-1 were effective for years ending after December 15, 2003.
In March 2004, the EITF issued a Consensus on Issue 03-1 requiring that the
provisions of EITF 03-1 be applied for reporting periods beginning after June
15, 2004 to investments accounted for under SFAS No. 115 and 124. EITF 03-1
establishes a three-step approach for determining whether an investment is
considered impaired, whether that impairment is other-than-temporary, and the
measurement of an impairment loss. We are in the process of determining the
impact that this EITF will have on our financial statements. In September 2004,
the FASB issued a proposed Staff Position, EITF Issue 03-1-a, "Implementation
Guidance for the Application of Paragraph 16 of EITF 03-1 (EITF 03-1-a)." EITF
03-1-a would provide implementation guidance with respect to debt securities
that are impaired solely due to interest rates and/or sector spreads and
analyzed for other-than-temporary impairment under paragraph 16 of EITF 03-1. In
September 2004, the FASB issued a Staff Position, EITF Issue 03-1-1, "Effective
Date of Paragraphs 10-20 of EITF Issue No. 03-1" (EITF 03-1-1). FSP EITF Issue
No. 03-1-1, "Effective Date of Paragraphs 10-20 of EITF Issue No. 03-1, 'The
Meaning of Other-Than-Temporary Impairment and Its Application to Certain
Investments'" delays the effective date of certain provisions of EITF Issue
03-1, including steps two and three of the Issue's three-step approach for
determining whether an investment is other-than-temporarily impaired. However,
step one of that approach must still be initially applied for impairment
evaluations in reporting periods beginning after June 15, 2004. The delay of the
effective date for paragraphs 10-20 of EITF Issue 03-1 will be superseded with
the final issuance of proposed FSP EITF Issue 03-1-a, "Implementation Guidance
for the Application of Paragraph 16 of EITF Issue No. 03-1, The Meaning of
Other-Than-Temporary Impairment and Its Application to Certain Investments."
In March 2004, the FASB approved EITF Issue No. 03-6 "Participating Securities
and the Two-Class Method under FASB Statement No. 128, Earnings Per Share." EITF
03-6 supersedes the guidance in Topic No. D-95, "Effect of Participating
Convertible Securities on the Computation of Basic Earnings per Share," and
requires the use of the two-class method for the computation of basic earnings
per share for companies that have participating securities. The two-class method
is an earnings allocation formula that determines earnings per share for each
class of common stock and participating security according to dividends declared
(or accumulated) and participation rights in undistributed earnings. In
addition, EITF 03-6 addresses other forms of participating securities, including
options, warrants, forwards and other contracts to issue an entity's common
stock, with the exception of stock-based compensation (unvested options and
restricted stock) subject to the provisions of Accounting Principles Board
Opinion No. 25 and SFAS No. 123. EITF 03-6 became effective for reporting
periods beginning after March 31, 2004 and must be applied by restating
previously reported earnings per share information. Our Series A preferred stock
qualifies as a participating security under EITF 03-6. Accordingly, we adopted
the use of the two-class method for computation of earnings per share in the
second quarter of 2004. EITF 03-6 provides a new method for calculating per
share earnings and does not otherwise affect our financial statements or have
any economic or operating impact on us.
The Commission recently released Staff Accounting Bulletin, or SAB, No. 105,
"Application of Accounting Principles to Loan Commitments." SAB 105 provides
guidance about the measurement of loan commitments recognized at fair value
under SFAS No. 133, "Accounting for Derivative Instruments and Hedging
Activities." SAB 105 also requires companies to disclose their accounting policy
for those loan commitments including methods and assumptions used to estimate
fair value and associated hedging strategies. SAB 105 is effective for all loan
commitments accounted for as derivatives that are entered into after March 31,
2004. We do not expect that the adoption of SAB 105 will have a material effect
on our consolidated financial statements.
In December 2004, the Financial Accounting Standards Board (FASB) issued SFAS
123(R), "Share-Based Payment," that addresses the accounting for share-based
payment transactions in which an enterprise receives employee services in
exchange for (a) equity instruments of the enterprise or (b) liabilities that
are based on the fair value of the enterprise's equity instruments or that may
be settled by the issuance of such equity instruments. Under SFAS No. 123(R),
all forms of share-based payments to employees, including employee stock
options, would be treated the same as other forms of compensation by recognizing
the related cost in the income statement. The expense of the award would
generally be measured at fair value at the grant date. Current accounting
guidance requires that the expense relating to so-called fixed plan employee
stock options only be disclosed in the footnotes to the financial statements.
SFAS No. 123(R) eliminates the ability to account for share-based compensation
transactions using APB Opinion No. 25, "Accounting for Stock Issued to
Employees." SFAS No. 123(R) is effective for public companies as of the
beginning of the first interim or annual reporting period that begins after June
15, 2005. All public companies that used the fair-value-based method for either
recognition or disclosure under SFAS No. 123 will apply SFAS No. 123(R) using a
modified method of prospective application. Under this transition method,
compensation cost is recognized on or after the required effective date for the
portion of outstanding awards for which the requisite service has not yet been
rendered based on the grant-date fair value of those awards calculated under
SFAS No. 123 for either recognition or pro forma disclosures. The impact of this
new standard, if it had been in effect, on the net earnings and related per
share amounts the years ended December 31, 2004, 2003 and 2002 is disclosed in
Note B - Summary of Accounting Policies No.8 Stock-based compensation.
46
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Information with respect to quantitative and qualitative disclosures
about market risk is included in the information provided under "Management's
Discussion and Analysis of Financial Condition and Results of Operations" at
Item 7 hereof.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
47
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
Board of Directors
The Bancorp, Inc.
We have audited the accompanying consolidated balance sheets of The
Bancorp, Inc. and subsidiary as of December 31, 2004 and 2003, and the related
consolidated statements of income, stockholders' equity, and cash flows for each
of the three years in the period ended December 31, 2004. 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 the standards of the Public
Company Accounting Oversight Board (United States). Those standards require that
we plan and perform the audit to obtain reasonable assurance about whether the
financial statements are free of material misstatement. The Company is not
required to have, nor were we engaged to perform an audit of its internal
control over financial reporting. Our audits included consideration of internal
control over financial reporting as a basis for designing audit procedures that
are appropriate in the circumstances, but not for the purpose of expressing an
opinion on the effectiveness of the Company's internal control over financial
reporting. Accordingly, we express no such opinion. An audit also includes
examining, on a test basis, evidence supporting the amounts and disclosures in
the financial statements, assessing the accounting principles used and
significant estimates 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 financial statements referred to above present
fairly, in all material respects, the consolidated financial position of The
Bancorp, Inc. as of December 31, 2004 and 2003, and the consolidated results of
its operations and its cash flows for the each of the three years in the period
ended December 31, 2004, in conformity with accounting principles generally
accepted in the United States of America.
/s/ Grant Thornton LLP
Philadelphia, Pennsylvania
March 30, 2005
48
THE BANCORP, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
December 31, December 31,
2004 2003
------------ ------------
(in thousands)
ASSETS
Cash and cash equivalents
Cash and due from banks $ 10,184 $ 11,650
Interest bearing deposits 1,028 1,027
Federal funds sold 8,291 29,506
------------ ------------
Total cash and cash equivalents 19,503 42,183
Investment securities, available-for-sale 120,252 24,387
Loans, net of unearned fees (costs) 427,881 232,397
Allowance for loan and lease losses (3,593) (1,991)
------------ ------------
Loans, net 424,288 230,406
Premises and equipment, net 2,958 2,377
Accrued interest receivable 3,439 1,219
Other assets 5,839 3,589
------------ ------------
Total assets $ 576,279 $ 304,161
============ ============
LIABILITIES
Deposits
Demand (non-interest bearing) $ 51,832 $ 48,006
Savings, money market and interest checking 153,417 111,438
Time deposits 166,682 104,410
Time deposits, $100,000 and over 16,150 12,911
------------ ------------
Total deposits 388,081 276,765
Securities sold under agreements to repurchase 5,052 3
Federal Home Loan Bank advances 55,000 -
Accrued interest payable 407 218
Subordinated debt 5,413 -
Guaranteed preferred interests in Company's
subordinated debentures - 5,250
Other liabilities 924 252
------------ ------------
Total liabilities 454,877 282,488
------------ ------------
SHAREHOLDERS' EQUITY
Preferred stock -authorized 5,000,000
shares of $0.01 par value; issued and
outstanding, 1,133,237 and 1,083,829
shares for 2004 and 2003, respectively 11 11
Common stock - authorized, 20,000,000
shares of $1.00 par value; issued
shares 11,888,061 and 2,284,200 for
2004 and 2003, respectively 11,888 2,284
Additional paid-in capital 117,668 30,369
Accumulated deficit (7,934) (10,835)
Accumulated other comprehensive loss (231) (156)
------------ ------------
Total shareholders' equity 121,402 21,673
Total liabilities and shareholders' equity $ 576,279 $ 304,161
============ ============
The accompanying notes are an integral part of these statements.
49
THE BANCORP, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
For the year
ended December 31,
------------------------------------------
2004 2003 2002
------------ ------------ ------------
Interest income
Loans, including fees $ 19,472 $ 12,508 $ 9,469
Investment securities 4,710 1,984 2,403
Federal funds sold 480 297 181
Interest bearing deposits 11 8 7
------------ ------------ ------------
24,673 14,797 12,060
------------ ------------ ------------
Interest expense
Deposits 5,983 4,857 4,241
Securities sold under agreements to
repurchase 27 15 44
Federal Home Loan Bank advances 516 - -
Subordinated debt 551 551 305
------------ ------------ ------------
7,077 5,423 4,590
------------ ------------ ------------
Net interest income 17,596 9,374 7,470
Provision for loan and lease losses 1,632 685 600
------------ ------------ ------------
Net interest income after provision for
loan and lease losses 15,964 8,689 6,870
------------ ------------ ------------
Non-interest income
Service fees on deposit accounts 695 878 431
Merchant credit card deposit fees 6,793 7,980 3,273
Gain on sales of investment securities 481 787 20
Leasing income 256 205 256
Other 679 637 362
------------ ------------ ------------
Total non-interest income 8,904 10,487 4,342
------------ ------------ ------------
Non-interest expense
Salaries and employee benefits 7,859 5,004 3,663
Occupancy expense 1,688 1,531 1,675
Merchant credit card deposit 6,104 7,410 2,648
Data processing expense 1,051 886 704
Advertising 442 242 292
Professional fees 589 230 262
Other 3,973 3,052 1,768
Litigation settlement expense - - 691
Reorganization expense 487 - -
------------ ------------ ------------
Total non-interest expense 22,193 18,355 11,703
------------ ------------ ------------
Income before income tax benefit 2,675 821 (491)
Income tax benefit (1,043) (250) (500)
------------ ------------ ------------
Net income 3,718 1,071 9
------------ ------------ ------------
Less preferred stock dividends and
accretion (817) (881) (750)
Income allocated to Series A preferred
shareholders (323) (61) -
------------ ------------ ------------
Net (loss) income available to common
shareholders $ 2,578 $ 129 $ (741)
============ ============ ============
Net income (loss) per share - basic $ 0.25 $ 0.06 $ (0.39)
============ ============ ============
Net income (loss) per share - diluted $ 0.24 $ 0.06 $ (0.39)
============ ============ ============
The accompanying notes are an integral part of these statements.
50
THE BANCORP, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENT OF CHANGES IN SHAREHOLDERS' EQUITY
Years ended December 31, 2004, 2003 and 2002
Accumulated
Additional other
Common Preferred paid-in Accumulated comprehensive Comprehensive
stock stock capital deficit income (loss) income Total
----------- ----------- ----------- ----------- ------------- ------------- -----------
(in thousands)
Balance at January 1, 2002 $ 1,884 $ 7 $ 22,923 $ (10,284) $ (291) $ 14,239
Net income - - - 9 9 9
Issuance of Series A preferred
stock 2 1,521 1,523
Stock dividends on Series A
preferred Stock 1 237 (238)
Issuance of common stock
warrants 592 592
Accretion of Series A
preferred Stock - - 512 (512) -
Other comprehensive gain, net
of reclassification
adjustments and tax - - - - 606 606 606
----------- ----------- ----------- ----------- ------------- ------------- -----------
Total comprehensive income $ 615
=============
Balance at December 31, 2002 1,884 10 25,785 (11,025) 315 16,969
----------- ----------- ----------- ----------- ------------- -----------
Net income - - - 1,071 1,071 1,071
Issuance of common stock 400 3,704 4,104
Stock dividends on Series A
preferred Stock 1 252 (253)
Accretion of Series A
preferred Stock - - 628 (628) -
Other comprehensive loss, net
of reclassification
adjustments and tax - - - - (471) (471) (471)
----------- ----------- ----------- ----------- ------------- ------------- -----------
Total comprehensive income $ 600
=============
Balance at December 31, 2003 2,284 11 30,369 (10,835) (156) 21,673
----------- ----------- ----------- ----------- ------------- -----------
Net income - - - 3,718 - 3,718 3,718
Warrant exercise 1,337 - 12,031 - - 13,368
Common stock issued in
reorganization 8,266 - 74,612 - - 82,878
Common stock issued from
option exercise 1 - 8 - - 9
Cash dividends on Series A
preferred (169) - (169)
Stock dividends on Series A
preferred Stock - 200 (200) - -
Accretion of Series A
preferred Stock - - 448 (448) - -
Other comprehensive loss, net
of reclassification
adjustments and tax - - - - (75) (75) (75)
----------- ----------- ----------- ----------- ------------- ------------- -----------
Total comprehensive income $ 3,643
=============
Balance at December 31, 2004 $ 11,888 $ 11 $ 117,668 $ (7,934) $ (231) $ 121,402
=========== =========== =========== =========== ============= ===========
The accompanying notes are an integral part of this statement.
51
THE BANCORP, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
Year ended December 31,
------------ ------------ ------------
2004 2003 2002
------------ ------------ ------------
Operating activities
Net income $ 3,718 $ 1,071 $ 9
Adjustments to reconcile net income
to net cash provided by (used in)
operating activities
Depreciation and amortization 821 777 1,151
Provision for loan and lease losses 1,632 685 600
Net amortization (accretions) of
premium (discount) (136) 16 (80)
Net gain on sales of investment
securities (481) (787) (20)
Deferred income tax benefit (1,043) (250) (500)
Increase in accrued interest
receivable (2,220) (282) (394)
Increase (decrease) in interest
payable 189 (200) 179
(Increase) decrease in other assets (1,006) 932 (952)
Increase (decrease) in other
liabilities 672 (84) (167)
------------ ------------ ------------
Net cash provided by (used in)
operating activities 2,146 1,878 (174)
------------ ------------ ------------
Investing activities
Purchase of investment securities (123,135) (25,218) (8,551)
Proceeds from sales of investment
securities 9,065 22,623 2,121
Proceeds from maturity of investment
securities 18,709 11,895 10,594
Net increase in loans (195,514) (69,133) (57,130)
Purchases of premises and equipment (1,402) (431) (369)
------------ ------------ ------------
Net cash used in investing
activities (292,277) (60,264) (53,335)
------------ ------------ ------------
Financing activities
Net increase in deposits 111,316 67,322 71,926
Net increase (decrease) in securities
sold under agreements to repurchase 5,049 (1,005) (1,500)
Proceeds from Federal Home Loan Bank
advances 55,000 - -
Dividends on Series A preferred stock (169)
Proceeds from issuance of common
stock, net 82,878 4,104 -
Proceeds from the exercise of common
stock warrants 13,368 - -
Proceeds from the exercise of common
stock options 9 - -
Proceeds from issuance of Series A
preferred stock, net - - 2,115
Proceeds from the issuance of
beneficial interest in the Company's
subordinated debentures - - 5,250
------------ ------------ ------------
Net cash provided by financing
activities 267,451 70,421 77,791
------------ ------------ ------------
Net (decrease) increase in cash
and cash equivalents (22,680) 12,035 24,282
Cash and cash equivalents, beginning
of year 42,183 30,148 5,866
------------ ------------ ------------
Cash and cash equivalents, end of year $ 19,503 $ 42,183 $ 30,148
============ ============ ============
The accompanying notes are an integral part of these statements.
52
THE BANCORP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE A - FORMATION AND STRUCTURE OF COMPANY
The Bancorp, Inc. (the Company) was incorporated in the state of
Delaware and is a registered financial holding company under the
Gramm-Leach-Bliley Act of 1999. The Company operates as a financial holding
company with a wholly owned subsidiary bank, The Bancorp Bank (the Bank). In
2002, the Company changed its name to The Bancorp, Inc. The Bank is a Delaware
chartered commercial bank located in Wilmington, Delaware and is an FDIC-insured
institution. Through the Bank, the Company provides retail and commercial
banking services in the Philadelphia, Pennsylvania and Wilmington, Delaware
areas. The principal medium for the delivery of the Company's banking services
is the internet. The Company commenced operations on July 28, 2000.
The financial service industry is highly competitive in general. Many of
the Company's principal competitors, including traditional banks and thrifts,
other Internet banks and other financial service providers, such as brokerage
and insurance companies, have greater financial and other resources than the
Company does and may offer services, such as trust services, that the Company
does not provide or will not be authorized to provide. Because there are few
barriers to on-line market entry for existing chartered financial institutions,
the Company's potential competitors could implement Internet banking operations
with relative ease. Furthermore, brokerage companies and other financial service
providers may not be subject to the same degree of regulation as are the Company
and the Bank.
The Company and the Bank are subject to regulation by certain state and
federal agencies and, accordingly, they are examined periodically by those
regulatory authorities. As a consequence of the extensive regulation of
commercial banking activities, the Company's and the Bank's businesses will be
susceptible to being affected by state and federal legislation and regulations.
NOTE B - SUMMARY OF ACCOUNTING POLICIES
1. Basis of Presentation
The accounting and reporting policies of the Bank conform to accounting
principles generally accepted in the United States of America and predominant
practices within the banking industry. The consolidated financial statements
include the accounts of the Company and the Bank. All material inter-company
balances have been eliminated.
The preparation of financial statements requires management to make
estimates and assumptions that affect the reported amounts of assets and
liabilities and disclosure of contingent assets and liabilities at the date of
the financial statements and the reported amounts of revenues and expenses
during the reporting period. Actual results could differ from those revenues.
The principal estimate that is particularly susceptible to significant
change in the near term relates to the allowance for loan and lease losses. The
evaluation of the adequacy of the allowance for loan and lease losses includes,
among other factors considered, an analysis of historical loss rates, by
category, applied to current loan totals. However, actual losses may be higher
or lower than historical trends, which vary. Actual losses on specified problem
loans,
53
which also are provided for in the evaluation, may vary from those estimated
loss percentages, which are established based upon a limited number of potential
loss classifications.
2. Cash and Cash Equivalents
Cash and cash equivalents are defined as cash on hand and amounts due
from banks with an original maturity of three months or less and federal funds
sold. Cash paid for interest was approximately $6,898,000, $5,623,000 and
$4,411,000 for the years ended December 31, 2004, 2003 and 2002, respectively.
3. Investment Securities
The Company accounts for its investment securities in accordance with
Statement of Financial Accounting Standards (SFAS) No. 115, Accounting for
Certain Investments in Debt and Equity Securities. Investments in debt and
equity securities which management has both the ability and intent to hold to
maturity are carried at cost, adjusted for the amortization of premiums and
accretion of discounts computed by the level interest method. At December 31,
2004 and 2003, the Company does not have investment securities classified as
held to maturity. Investments in debt and equity securities, which management
believes may be sold prior to maturity due to changes in interest rates,
prepayment risk, liquidity requirements, or other factors, are classified as
available for sale. Net unrealized gains and losses for such securities, net of
tax effect, are reported as other comprehensive income and excluded from the
determination of net income. The Company does not engage in securities trading.
Gains or losses on disposition of investment securities are based on the net
proceeds and the adjusted carrying amount of the securities sold using the
specific identification method.
SFAS No. 133, Accounting for Derivative Instruments and Hedging
Activities, as amended, requires that entities recognize all derivatives as
either assets or liabilities in the statement of financial condition and measure
those instruments at fair value. Depending upon the effectiveness of the hedge
and/or the transaction being hedged, any changes in the fair value of the
derivative instrument is either recognized in earnings in the current year,
deferred to future periods, or recognized in other comprehensive income. Changes
in the fair value of all derivative instruments not recognized as hedge
accounting are recognized in current year earnings. The Company did not engage
in hedging as of December 31, 2004 and 2003.
The Company adopted Emerging Issues Task Force (EITF) Issue No. 03-1,
The Meaning of Other than Temporary Impairment and Its Application to Certain
Investments," as of December 31, 2003. EITF 03-1 includes certain disclosures
regarding quantitative and qualitative disclosures for investment securities
accounted for under SFAS 115 that are impaired at the balance sheet date, but an
other-than-temporary impairment has not been recognized. The disclosures under
EITF 03-1 are required for financial statements for years ending after December
15, 2003. The Company includes the required disclosures in these financial
statements. In September 2004, the FASB issued a proposed Staff Position, EITF
Issue 03-1-a, "Implementation Guidance for the Application of Paragraph 16 of
EITF 03-1 (EITF 03-1-a)." EITF 03-1-a would provide implementation guidance with
respect to debt securities that are impaired solely due to interest rates and/or
sector spreads and analyzed for other-than-temporary impairment under paragraph
16 of EITF 03-1. In September 2004, the FASB issued a Staff Position, EITF Issue
03-1-1, "Effective Date of Paragraphs 10-20 of EITF Issue No. 03-1" (EITF
03-1-1). FSP EITF Issue No. 03-1-1, "Effective Date of Paragraphs 10-20 of EITF
Issue No. 03-1, 'The Meaning of Other-Than-Temporary Impairment and Its
Application to Certain Investments'" delays the effective date of certain
provisions of EITF Issue 03-1, including steps two and three of the Issue's
three-step approach for determining whether an investment is
other-than-temporarily impaired. However, step one of that approach must still
be initially applied for impairment evaluations in reporting periods beginning
after June 15, 2004. The delay of the effective date for paragraphs 10-20 of
EITF Issue 03-1 will be superseded with the final issuance of proposed FSP EITF
Issue 03-1-a, "Implementation Guidance for the Application of Paragraph 16 of
EITF Issue No. 03-1, The Meaning of Other-Than-Temporary Impairment and Its
Application to Certain Investments."
4. Loans and Allowance for Loan and Lease Losses
Loans that management has the intent and ability to hold for the
foreseeable future or until maturity or payoff are stated at the amount of
unpaid principal and are net of unearned discount, unearned loan fees and an
allowance for loan and lease losses. The allowance for loan and lease losses is
established through a provision for loan and lease losses charged to expense.
54
Loan principal considered to be uncollectible by management is charged against
the allowance for loan and lease losses. The allowance is an amount that
management believes will be adequate to absorb possible losses on existing loans
that may become uncollectible based upon an evaluation of known and inherent
risks in the loan portfolio. The evaluation takes into consideration such
factors as changes in the nature and size of the loan portfolio, overall
portfolio quality, specific problem loans, and current economic conditions which
may affect the borrowers' ability to pay. The evaluation also details historical
losses by loan category, the resulting loss rates for which are projected at
current loan total amounts. Loss estimates for specified problem loans are also
detailed.
Interest income is accrued as earned on a simple interest basis. Accrual
of interest is discontinued on a loan when management believes, after
considering economic and business conditions and collection efforts, that the
borrower's financial condition is such that collection of interest is doubtful.
When a loan is placed on non-accrual status, all accumulated accrued interest
receivable applicable to periods prior to the current year is charged off to the
allowance for loan and lease losses. Interest that had accrued in the current
year is reversed out of current period income. Loans 90 days or more past due
and still accruing interest must have both principal and accruing interest
adequately secured and must be in the process of collection.
The Company accounts for impaired loans in accordance with SFAS No. 114,
Accounting by Creditors for Impairment of a Loan, as amended by SFAS No. 118,
Accounting by Creditors for Impairment of a Loan - Income Recognition and
Disclosures. This standard requires that a creditor measure impairment based on
the present value of expected future cash flows discounted at the loan's
effective interest rate, except that as a practical expedient, a creditor may
measure impairment based on a loan's observable market price, or the fair value
of the collateral if the loan is collateral-dependent. Regardless of the
measurement method, a creditor must measure impairment based on the fair value
of the collateral when the creditor determines that foreclosure is probable.
SFAS No. 140, Accounting for Transfers and Servicing of Financial Assets
and Extinguishments of Liabilities, revised the standards for accounting for the
securitization and other transfers of financial assets and collateral.
FASB Interpretation No. (FIN) 45, Guarantor's Accounting and Disclosure
Requirements for Guarantees, Including Indirect Guarantees of Indebtedness of
Others, requires a guarantor entity, at the inception of a guarantee covered by
the measurement provisions of the interpretation, to record a liability for the
fair value of the obligation undertaken in issuing the guarantee. The Company
previously did not record an initial liability when guaranteeing obligations,
except for fees received at issuance, unless it became probable that the Company
would have to perform under the guarantee. FIN 45 applied prospectively to
guarantees the Company issued or modified subsequent to December 31, 2002. The
required disclosures are included in these financial statements.
In October 2003, the American Institute of Certified Public Accountants
(AICPA) issued Statement of Position (SOP) 03-3, Accounting for Loans or Certain
Debt Securities Acquired in a Transfer. SOP 03-3 applies to a loan that has
evidenced a deterioration in credit quality since origination, and that was
acquired by completion of a transfer for which it is probable, at acquisition,
that the Company will be unable to collect all contractually required payments
receivable. SOP 03-3 requires that the Company recognize the excess of all cash
flows expected at acquisition over the amount of its initial investment in the
loan as interest income on a level-yield basis over the life of the loan as the
accretable yield. The loan's contractually required
55
payments receivable in excess of the amount of its cash flows expected at
acquisition (nonaccretable difference) should not be recognized as an adjustment
to yield, a loss accrual or a valuation allowance for credit risk. SOP 03-3 is
effective for loans acquired in fiscal years beginning after December 31, 2004.
Early adoption is permitted. Management is currently evaluating the provisions
of SOP 03-3.
5. Premises and Equipment
Premises and equipment, including leasehold improvements, are stated at
cost less accumulated depreciation. Depreciation expense is computed on the
straight-line method over the useful lives of the assets. Leasehold improvements
are depreciated over the shorter of the estimated useful lives of the
improvements or the terms of the related leases.
6. Internal Use Software
Under the provisions of SOP 98-1, Accounting for the Costs of Computer
Software Developed or Obtained for Internal Use, the Company capitalizes costs
associated with internally developed and/or purchased software systems for new
products and enhancements to existing products that have reached the application
stage and meet recoverability tests. Capitalized costs include external direct
costs of materials and services utilized in developing or obtaining internal-use
software, payroll and payroll related expenses for employees who are directly
associated with and devote time to the internal-use software project and
interest costs incurred, if material, while developing internal-use software.
Capitalization of such costs begins when the preliminary project stage is
complete and ceases no later than the point at which the project is
substantially complete and ready for its intended purpose.
The carrying value of the software is periodically reviewed and a loss
is recognized if the value of the estimated undiscounted cash flow benefit
related to the asset falls below the unamortized cost. Amortization is provided
using the straight-line method over the estimated useful life of the related
software, which is generally three to seven years. As of December 31, 2004 and
2003, the Company had capitalized total software costs of approximately
$1,210,000. The Company has recorded amortization expense of approximately
$235,000, $278,000 and $173,000 for the years ended December 31, 2004, 2003 and
2002, respectively.
7. Income Taxes
The Company accounts for income taxes under the liability method whereby
deferred tax assets and liabilities are determined based on the difference
between their carrying values on the financial statements and their tax basis as
measured by the enacted tax rates which will be in effect when these differences
reverse. Deferred tax expense (benefit) is the result of changes in deferred tax
assets and liabilities.
8. Stock-Based Compensation
The Company accounts for its stock options under SFAS No. 123,
Accounting for Stock-Based Compensation, which contains a fair value-based
method for valuing stock-based compensation that entities may use, and which
measures compensation cost at the grant date based on the fair value of the
award. Alternatively, the standard permits entities to continue accounting for
employee stock options and similar equity instruments under Accounting
Principles Board (APB) Opinion No. 25, Accounting for Stock Issued to Employees.
Entities that
56
continue to account for stock options using APB 25 are required to make pro
forma disclosures of net income and earnings per share, as if the fair
value-based method of accounting defined in SFAS 123 had been applied.
At December 31, 2004, the Company had a stock-based compensation plan,
which is more fully described in note L. The Company accounts for that plan
under the recognition and measurement principles of APB 25 and related
interpretations. Stock-based employee compensation costs are not reflected in
net income, as all options granted under the plan had an exercise price equal to
the market value of the underlying common stock on the date of grant. The
following table illustrates the effect on net income (loss) and income (loss)
per share if the Company had applied the fair value recognition provisions of
SFAS No. 123, Accounting for Stock-Based Compensation, to stock-based employee
compensation (in thousands):
Year ended December 31,
------------------------------------------
2004 2003 2002
------------ ------------ ------------
(in thousnads except share data)
Net income (loss), as reported $ 3,718 $ 1,071 $ 9
Less stock-based compensation
costs under fair value based
method for all awards (3,736) (534) (524)
------------ ------------ ------------
Pro forma net income (loss) (18) 537 (515)
------------ ------------ ------------
Less preferred stock dividends
and accretion (817) (881) (750)
------------ ------------ ------------
Net income (loss) available to
common shareholders $ (836) $ (344) $ (1,265)
============ ============ ============
Basic earnings per share $ 0.25 $ 0.06 $ (0.39)
============ ============ ============
Pro forma basic earnings per share $ (0.08) $ (0.17) $ (0.67)
============ ============ ============
Diluted earnings per share $ 0.24 $ 0.06 $ (0.39)
============ ============ ============
Pro forma diluted earnings per
share $ (0.08) $ (0.17) $ (0.67)
============ ============ ============
The fair value of each option grant is estimated on the date of grant
using the Black-Scholes options-pricing model with the following weighted
average assumptions used for grants in 2004, 2003 and 2002: dividend yield of
4.01%; 4.25% and 5.85% risk-free interest rate, respectively; expected
volatility of 38.33%, 10.00% and 10.00%, respectively; and expected lives of ten
years. In December 2004, the Financial Accounting Standards Board (FASB) issued
SFAS 123(R), "Share-Based Payment," that addresses the accounting for
share-based payment transactions in which an enterprise receives employee
services in exchange for (a) equity instruments of the enterprise or (b)
liabilities that are based on the fair value of the enterprise's equity
instruments or that may be settled by the issuance of such equity instruments.
Under SFAS No. 123(R), all forms of share-based payments to employees, including
employee stock options, would be treated the same as other forms of compensation
by recognizing the related cost in the income statement. The expense of the
award would generally be measured at fair value at the grant date. Current
accounting guidance requires that the expense relating to so-called fixed plan
employee stock options only be disclosed in the footnotes to the financial
statements. SFAS No. 123(R) eliminates the ability to account for share-based
compensation transactions using APB Opinion No. 25, "Accounting for Stock Issued
to Employees." SFAS No. 123(R) is effective for public companies as of the
beginning of the first interim or annual reporting period that begins after June
15, 2005. All public companies that used the fair-value-based method for either
recognition or disclosure under SFAS No. 123 will apply SFAS No. 123(R) using a
modified method of prospective application. Under this transition method,
compensation cost is recognized on or after the required effective date for the
portion of outstanding awards for which the requisite service has not yet been
rendered based on the grant-date fair value of those awards calculated under
SFAS No. 123 for either recognition or pro forma disclosures. The impact of this
new standard, if it had been in effect, on the net earnings and related per
share amounts the years ended December 31, 2004, 2003 and 2002 is disclosed in
the table above.
9. Advertising Costs
The Company expenses advertising cost as incurred.
10. Earnings per Share
The Company calculates earnings per share under the provisions of SFAS
No. 128, Earnings Per Share. Basic earnings per share exclude dilution and are
computed by dividing income available to common shareholders by the weighted
average common shares outstanding during the period. Diluted earnings per share
take into account the potential dilution that could occur if securities or other
contracts to issue common stock were exercised and converted into common stock.
57
Year ended December 31, 2004
------------------------------------------
Income Shares Per share
(numerator) (denominator) Amount
------------ ------------ ------------
(dollars in thousands)
Basic earnings per share
Net income available to common
shareholders $ 2,578 10,307,481 $ 0.25
Effect of dilutive securities
Options - 58,052 -
Warrants - 51,447 -
------------ ------------ ------------
Diluted earnings per share
Net income available to common
stockholders plus assumed conversions $ 2,578 10,416,980 $ 0.24
============ ============
At December 31, 2004 1,133,237 shares of convertible Series A Preferred
Stock were outstanding but were not included in the computation of diluted
earnings per share because upon conversion to common stock they were
anti-dilutive to diluted earnings per share.
Year ended December 31, 2003
---------------------------------------------
Income Shares Per share
(numerator) (denominator) Amount
------------- ------------- -------------
(in thousands)
Basic earnings per share
Net income available to common shareholders $ 190 2,010,529 $ 0.09
Effect of dilutive securities
Options - 14,390 -
Warrants - 51,988 -
------------- ------------- -------------
Diluted earnings per share
Net income available to common stockholders
plus assumed conversions $ 190 2,076,907 $ 0.09
============= ============= =============
At December 31, 2003, 1,083,529 shares of convertible Series A Preferred
Stock were outstanding but were not included in the computation of diluted
earnings per share because upon conversion to common stock they were
anti-dilutive to diluted earnings per share.
The weighted average shares for December 31, 2002, were 1,883,594. Stock
options and warrants for 464,750 and 1,946,579 shares of common stock,
respectively, at an exercise price of $10.00 per share were outstanding at
December 31, 2002 but were not included in the weighted average shares because
the exercise price equaled the market price.
At December 31, 2002, 1,021,198 shares of Convertible Series A Preferred
Stock were outstanding but were not included in the computation of diluted
earnings per share because upon conversion to common stock, they were
anti-dilutive to diluted earnings per share.
In March 2004, the Financial Accounting Standards Board (FASB) approved
EITF Issue No. 03-6, Participating Securities and the Two-Class Method under
FASB Statement No. 128, Earnings Per Share (EITF 03-6). EITF 03-6 supersedes the
guidance in Topic No. D-95, Effect of Participating Convertible Securities on
the Computation of Basic Earnings per Share, and requires the use of the
two-class method for the computation of basic earnings per share for companies
that have participating securities. The two-class method is an earnings
allocation formula that determines earnings per share for each class of common
stock and participating security according to dividends declared (or
accumulated) and participation rights in undistributed earnings. In addition,
EITF 03-6 addresses other forms of participating securities, including options,
warrants, forwards and other contracts to issue an entity's common stock, with
the exception of stock-based compensation (unvested options and restricted
stock) subject to the provisions of Accounting Principles Board Opinion No. 25
and SFAS 123. EITF 03-6 became effective for reporting periods beginning after
March 31, 2004 and must be applied by restating previously reported earnings per
share information. The Company's Series A preferred stock
58
qualifies as a participating security under EITF 03-6. Accordingly, the Company
has adopted the use of the two-class method for computation of earnings per
share in the second quarter of 2004. EITF 03-6 provides a new method for
calculating per share earnings and does not otherwise affect the Company's
financial statements or have any economic or operating impact on it.
11. Comprehensive Income
Comprehensive income consists of net income or loss for the current
period and income, expenses, gains, and losses that bypass the statement of
operations and are reported directly in a separate component of equity.
The income tax effects allocated to comprehensive income (loss) are as
follows (in thousands):
December 31, 2004
------------------------------------------
Before Tax Net of
tax benefit tax
amount (expense) amount
------------ ------------ ------------
Unrealized losses on investment securities
Unrealized holding gains arising during period $ 595 $ 203 $ 392
Less reclassification adjustment for gains
realized in net loss 481 (164) 317
------------ ------------ ------------
Other comprehensive loss, net $ (114) $ (39) $ (75)
============ ============ ============
December 31, 2003
------------------------------------------
Before Tax Net of
tax benefit tax
amount (expense) amount
------------ ------------ ------------
Unrealized losses on investment securities
Unrealized holding gains arising during period $ 33 $ (11) $ 22
Less reclassification adjustment for gains
realized in net loss 747 (254) 493
------------ ------------ ------------
Other comprehensive income, net $ (714) $ (243) $ (471)
============ ============ ============
December 31, 2002
------------------------------------------
Before Tax Net of
tax benefit tax
amount (expense) amount
------------ ------------ ------------
Unrealized losses on investment securities
Unrealized holding losses arising during period $ 940 $ (321) $ 619
Less reclassification adjustment for gains
realized in net loss 20 (7) 13
------------ ------------ ------------
Other comprehensive loss, net $ 920 $ (314) $ 606
============ ============ ============
12. Restrictions on Cash and Due From Banks
The Bank is required to maintain reserves against customer demand
deposits by keeping cash on hand or balances with the Federal Reserve Bank in a
non-interest bearing account. The
59
amount of those reserves and cash balances at December 31, 2004 and 2003 were
approximately $4,868,000 and $3,203,000, respectively.
13. Variable Interest Entities
In January 2003, the FASB issued FIN 46, Consolidation of Variable
Interest Entities. FIN 46 clarifies the application of Accounting Research
Bulletin 51, Consolidated Financial Statements, to certain entities in which
voting rights are not effective in identifying the investor with the controlling
financial interest. An entity is subject to consolidation under FIN 46 if the
investors either do not have sufficient equity at risk for the entity to finance
its activities without additional subordinated financial support, are unable to
direct the entity's activities, or are not exposed to the entity's losses or
entitled to its residual returns ("variable interest entities"). Variable
interest entities within the scope of FIN 46 will be required to be consolidated
by their primary beneficiary. The primary beneficiary of a variable interest
entity is determined to be the party that absorbs a majority of the entity's
expected losses, receives a majority of its expected returns, or both.
Management has determined that The Bancorp Capital Trust (the Trust)
qualifies as a variable interest entity under FIN 46. The Trust issued
mandatorily redeemable preferred stock to investors and loaned the proceeds to
the Company. The Trust holds, as its sole asset, subordinated debentures issued
by the Company in 2002. The Trust is currently included in the Company's
consolidated balance sheet and statements of income. The Company has evaluated
the impact of FIN 46 and concluded it should continue to consolidate the Trust
as of December 31, 2003, in part due to its ability to call the preferred stock
prior to the mandatory redemption date and thereby benefit from a decline in
required dividend yields.
Subsequent to the issuance of FIN 46, the FASB issued a revised
interpretation, FIN 46(R), the provisions of which must be applied to certain
variable interest entities by March 31, 2004. The Company adopted the provisions
under the revised interpretation in the first quarter of 2004. FIN 46(R) will
require the Company to deconsolidate the Trust as of January 1, 2005. FIN 46(R)
precludes consideration of the call option embedded in the preferred securities
when determining if the Company has the right to a majority of the Trust's
expected residual returns. Accordingly, the Company will deconsolidate the Trust
at the end of the first quarter of 2005, which will result in an increase in
outstanding debt by $163,000. On March 3, 2005, the Federal Reserve issued
guidance on the regulatory capital treatment of the trust-preferred securities
as a result of the adoption of FIN 46(R). The rule retains the current maximum
percentage of total capital permitted for trust preferred securities at 25%, but
enacts other changes to the rules governing trust preferred securities that
affect their use as part of the collection of entities known as "restricted core
capital elements". The rule takes effect March 31, 2009; however, a five year
transition period leading up to that date would allow bank holding companies to
continue to count trust preferred securities as Tier 1 Capital after applying
FIN-46(R). Management has evaluated the effects of the rule and does not
anticipate a material impact on its capital ratios.
14. Deferred Financing Costs
Deferred financing costs related to the issuance of subordinated debt
are being amortized over fifteen years and are included in other assets. The
unamortized balance at December 31, 2004 and 2003 is $466,000 and $504,000. The
Company recognized amortization expense of $38,000, $38,000 and $18,000 for the
years ended December 31, 2004, 2003 and 2002.
60
15. Reclassifications
Certain reclassifications have been made to the 2003 and 2002 financial
statements to conform to the 2004 presentation.
NOTE C - INVESTMENT SECURITIES
The amortized cost, gross unrealized gains and losses, and fair values
of the Company's investment securities available-for-sale are summarized as
follows (in thousands):
December 31, 2004
---------------------------------------------------------
Gross Gross
Amortized unrealized unrealized Fair
cost gains Losses value
------------ ------------ ------------ ------------
U.S. Government agency securities $ 80,000 $ - $ (247) $ 79,753
Mortgage backed securities 7,318 8 (426) 6,900
Other securities 33,284 470 (155) 33,599
------------ ------------ ------------ ------------
$ 120,602 $ 478 $ (828) $ 120,252
============ ============ ============ ============
December 31, 2003
---------------------------------------------------------
Gross Gross
Amortized unrealized unrealized Fair
cost gains Losses value
------------ ------------ ------------ ------------
Mortgage-backed securities $ 10,604 $ 10 $ (363) $ 10,251
Other securities 14,019 266 (149) 14,136
------------ ------------ ------------ ------------
$ 24,623 $ 276 $ (512) $ 24,387
============ ============ ============ ============
The amortized cost and fair value of the Company's investment securities
available-for-sale at December 31, 2004 by contractual maturity, are shown
below. Expected maturities will differ from contractual maturities because
borrowers may have the right to call or prepay obligations with or without call
or prepayment penalties.
December 31, 2004
---------------------------
Amortized Fair
cost Value
------------ ------------
Due after one year through five years $ 40,000 $ 39,824
Due after five years through ten years 43,867 43,794
Due after ten years 33,782 33,681
Federal Home Loan and Atlantic
Central Bankers Bank stock 2,953 2,953
------------ ------------
$ 120,602 $ 120,252
============ ============
At December 31, 2004 and 2003, investment securities with a book value
of approximately $68,302,000 and $8,538,000, respectively, were pledged to
secure deposits and advances as required or permitted by law. Gross gains on
sales were $481,000, $787,000 and
61
$20,000 for the years ended December 31, 2004, 2003 and 2002, respectively.
Gross losses were not material for the years ended December 31, 2004, 2003 and
2002.
The table below indicates the length of time individual securities have
been in continuous unrealized loss position at December 31, 2004:
Less than 12 months 12 months or longer Total
Number ----------------------- ----------------------- -----------------------
of Fair Unrealized Fair Unrealized Fair Unrealized
Description of securities securities value losses value Losses value losses
- ----------------------------------- ---------- ---------- ---------- ---------- ---------- ---------- ----------
(dollars in thousands)
U.S. Government agency securities 2 $ 79,753 $ (247) $ - $ - $ 79,753 $ (247)
Mortgage-backed securities 13 284 (4) 6,564 (422) 6,848 (426)
Other securities 8 11,403 (39) 4,109 (116) 15,512 (155)
---------- ---------- ---------- ---------- ---------- ---------- ----------
Total temporarily impaired
investment securities 23 $ 91,440 $ (290) $ 10,673 $ (538) $ 102,113 $ (828)
========== ========== ========== ========== ========== ========== ==========
Management has evaluated the securities in the above table and has
concluded that none of these securities have impairments that are other than
temporary. In its evaluation, management considered the types of securities and
what the credit rating was on the securities. Most of the securities that are in
an unrealized loss position are in a loss position because of changes in
interest rates since the securities were purchased. The securities that have
been in an unrealized loss position for 12 months or longer include
mortgage-backed securities whose market values are sensitive to interest rates.
NOTE D - LOANS
Major classifications of loans are as follows:
December 31,
---------------------------
2004 2003
Amount Amount
------------ ------------
Commercial $ 89,327 $ 53,130
Commercial mortgage 140,755 89,772
Construction 97,239 29,026
------------ ------------
Total commercial loans 327,321 171,928
Direct financing leases, net 44,795 38,405
Residential mortgage 31,388 6,473
Consumer loans and others 24,894 14,989
------------ ------------
428,398 231,795
Allowance for loan and lease losses (3,593) (1,991)
Unamortized fees and costs (517) 602
------------ ------------
Total loans, net of unamortized fees and costs $ 424,288 $ 230,406
============ ============
Loan balances past due 90 days or more and still accruing interest, but
which management expects will eventually be paid in full, amounted to $23,000,
$44,000 and $40,000 at
62
December 31, 2004, 2003 and 2002, respectively. The Company had $205,000 in
non-accrual loans at December 31, 2004. The interest that would have been
accrued on non-accrual loans during 2004 was $4,000. The Company did not have
any non-accrual or impaired loans at December 31, 2003 or 2002.
Changes in the allowance for loan and lease losses are as follows:
December 31,
------------------------------------------
2004 2003 2002
------------ ------------ ------------
Balance at beginning of the year $ 1,991 $ 1,379 $ 780
Charge-offs (30) (74) (1)
Recoveries - 1 -
Provision charged to operations 1,632 685 600
------------ ------------ ------------
Balance at end of year $ 3,593 $ 1,991 $ 1,379
============ ============ ============
NOTE E - PREMISES AND EQUIPMENT
Premises and equipment are as follows:
December 31,
---------------------------
Estimated
useful lives 2004 2003
------------- ------------ ------------
(in thousands)
Furniture, fixtures and equipment 3 to 12 years $ 5,723 $ 4,450
Leasehold improvements 4 to 20 years 835 706
------------ ------------
6,558 5,156
Accumulated depreciation (3,600) (2,779)
------------ ------------
$ 2,958 $ 2,377
============ ============
NOTE F - DEPOSITS
At December 31, 2004, the scheduled maturities of certificates of
deposit are as follows (in thousands):
2005 $ 136,300
2006 46,431
2007 -
2008 -
2009 101
Thereafter -
-------------
$ 182,832
=============
63
NOTE G - DEBT
1. Line of Credit
The Bank entered into a $5,000,000 unsecured line of credit during 2002
that bears interest at a variable rate and is renewed annually. As of December
31, 2004, no funds were outstanding under this line.
2. Short term borrowings
Federal funds purchased and securities sold under agreements to
repurchase generally mature within 30 days from the date of the transactions.
Federal Home Loan Bank advances generally have maturities of less than one year.
The details of these categories are presented below:
As of or for the year ended December 31,
------------------------------------------
2004 2003 2002
------------ ------------ ------------
(dollars in thousands)
Securities sold under repurchase agreements
and federal funds purchased
Balance at year-end $ 5,052 $ 3 $ 1,008
Average during the year 1,507 660 1,556
Maximum month-end balance 5,052 1,021 6,561
Weighted average rate during the year 1.79% 2.27% 2.83%
Rate at December 31 1.76% 1.05% 2.30%
Federal Home Loan Bank advances
Balance at year-end $ 55,000 $ - $ -
Average during the year 29,057 - -
Maximum month-end balance 55,000 - -
Weighted average rate during the year 1.78% - -
Rate at December 31 2.24% - -
3. Guaranteed Preferred Beneficiary Interest in Company's Subordinated
Debt
In June 2002, the Company issued $5.25 million of 10.5% fixed rate
subordinated debentures (the Debentures) due June 12, 2007 to The Bancorp
Capital Trust (the Trust), a Delaware business trust, which is a wholly-owned
subsidiary of the Company. The Debentures are the sole asset of the Trust. The
Trust issued 5,250,000 shares of trust preferred securities, $10 face value, for
total proceeds of $5,250,000. The Company's obligations under the debentures and
related documents, taken together, constitute a full, irrevocable and
unconditional guarantee on a subordinated basis by the Company of the Trust's
obligations under the preferred securities. The preferred securities are
redeemable by the Company on or after June 12, 2007, or earlier if the deduction
of related interest for federal income taxes is prohibited, treatment as Tier I
capital is no longer permitted, or certain other contingencies arise. The
preferred securities must be redeemed upon maturity of the debentures in 2032.
The ability of the Company's banking subsidiary to pay dividends or extend
credit to the Company, the principal source of funds for the payment of the
debentures, is subject to legal and regulatory limitations.
64
NOTE H - SHAREHOLDERS' EQUITY
On December 22, 2004, the Company and the Bank completed its
reorganization, where by the Bank became a wholly-owned subsidiary of the
Company. The Company issued 1.15 shares of the Company's common stock for each
share of Bank stock outstanding. The Company issued 8,265,625 shares of common
stock in conjunction with this reorganization. The assets and liabilities of the
Bank were recorded at net book value.
In February 2004, the Bank completed a public offering for 7,187,500
shares of Bank common stock at $12.50 per share. Proceeds from the offering were
approximately $82.9 million, net of offering costs of $6.9 million. As a result
of this offering, and before the reorganization discussed above, the ownership
of the Company's ownership of the Bank was reduced to 32.7%.
During 2004, shareholders exercised warrants issued in connection with
the Company's offering of Series A Preferred Stock in 2002. The warrant exercise
resulted in the issuance of 1,337,486 shares of common stock. The Company
received proceeds of $13.4 million from the warrant exercises.
In August 2003, the Company sold 389,242 shares of common stock at a
price of $11.00 per share in a private placement. The proceeds of the offering
were approximately $3,980,000, net of offering costs of approximately $302,000,
which included $214,000 paid to an affiliate.
NOTE I - SERIES A PREFERRED STOCK
In 2004, the Company paid the 6% annual dividend on its Series A
Preferred Stock for 2004 in the form of stock dividends for each of the first
three quarters of the year totaling 49,408 shares of Series A Preferred Stock.
The cash dividend in the fourth quarter amounted to $169,000 or $0.15 per share.
In 2003, the Company paid the 6% annual dividend on its Series A
Preferred Stock for 2003 in the form of stock dividends. These stock dividends
were paid quarterly and resulted in the issuance of 62,232 shares of Series A
Preferred Stock.
In July 2002, the Company sold 225,000, units at a price of $10.00 per
unit in a private placement. A unit consisted of one share of Series A Preferred
Stock (2002 Preferred Stock) and two detachable warrants. The proceeds of the
offering were approximately $2,155,000 net of offering costs of approximately
$135,000.
In connection with the issuance of the 2002 Preferred Stock, the Company
also issued 493,521 detachable warrants to purchase shares of common stock at
$10.00 per share. The fair value of the warrants at the date of issuance
approximated $592,000 and is reflected as a discount to the 2002 Preferred
Stock. The discount is being amortized over the life of the warrants. 93,521 of
these warrants expire on June 12, 2006 and the remaining 400,000 warrants expire
on July 19, 2005.
In September 2002, the Company declared a 1% stock dividend on the 2002
Preferred Stock which was paid on October 15, 2002 to 2002 Preferred
Stockholders of record on September 30, 2002. In December 2002, the Company
declared a 1.5% stock dividend on the 2002 Preferred Stock which was paid on
January 15, 2003 to stockholders of record on December 31, 2002. A total of
5,675 shares of Series A Preferred Stock were issued in connection with these
stock dividends.
65
Holders of the Series A Preferred Stock are entitled to one vote for
each share, a liquidation preference at $10.00 per share, a noncumulative
preferred dividend of $0.60 per share in either cash or additional shares of
Series A Preferred Stock and a right to convert to common stock on a one-for-one
basis at any time at the option of the holder. Each share of Series A Preferred
Stock has the number of votes equal to the number of shares of common stock into
which it may be converted.
NOTE J - BENEFIT PLANS
The Company maintains a 401(k) savings plan covering substantially all
employees of the Company and the Bank. Under the plan, the Company matches 50%
of the employee contributions for all participants, not to exceed 6% of their
salary. Contributions made by the Company were approximately $145,000, $106,000
and $90,000 for the years ended December 31, 2004, 2003 and 2002, respectively.
NOTE K - INCOME TAXES
The components of the income tax benefit included in the statements of
operations are as follows:
For the year ended December 31,
------------------------------------------
2004 2003 2002
------------ ------------ ------------
Income tax benefit
Current $ 1,372,000 $ - $ -
Deferred benefit (2,415,000) (250,000) (500,000)
------------ ------------ ------------
Applicable income tax benefit $ (1,043,000) $ (250,000) $ (500,000)
============ ============ ============
The differences between applicable income tax expense and the amounts
computed by applying the statutory federal income tax rate of 34% are as
follows:
For the year ended December 31,
------------------------------------------
2004 2003 2002
------------ ------------ ------------
Computed tax expense (benefit) at statutory rate $ 956,000 $ 279,000 $ (167,000)
Change in valuation allowance (1,598,000) (250,000) (500,000)
Previously unrecognized NOL (408,000) (295,000) -
Unrecognized benefit of net operating loss
carryovers - - 161,000
Other 7,000 16,000 6,000
------------ ------------ ------------
Applicable tax benefit $ (1,043,000) $ (250,000) $ -
============ ============ ============
Deferred income taxes are provided for the temporary difference between
the financial reporting basis and the tax basis of the Company's assets and
liabilities. Cumulative temporary differences are as follows:
66
December 31,
---------------------------
2004 2003
------------ ------------
Allowance for loan and lease losses $ 492,000 $ (63,000)
Capitalized costs - 4,000
Depreciation and amortization (160,000) (160,000)
Net operating loss carryforwards 2,833,000 2,302,000
Unrealized losses on investment
securities available for sale 119,000 80,000
------------ ------------
3,284,000 2,164,000
Less valuation allowance - (1,333,000)
------------ ------------
Net deferred tax asset (included in other
assets) $ 3,284,000 $ 831,000
============ ============
NOTE L - STOCK-BASED COMPENSATION
In December 2003, the Bank adopted a stock option plan (the 2003 plan).
Employees and directors of the Bank were eligible to receive options under the
2003 plan. An aggregate of 760,000 shares of common stock for the Bank had been
reserved. Options expire on the tenth anniversary of their grant. Under the
plan, 501,000 options were granted. As a result of the reorganization of the
Company and the Bank, the Bank's plan terminated and the options granted under
the Bank's plan were converted into options to purchase 576,101 shares of the
Company's common stock.
In October 1999, the Company adopted a stock option plan (the 1999
Plan). Employees and directors of the Company and the Bank are eligible to
receive options under the 1999 Plan. An aggregate of 1,000,000 shares of common
stock have been reserved under the 1999 Plan, with no more than 75,000 shares
being issued to non-employee directors. Options vest over four years and expire
on the tenth anniversary of the grant.
A summary of the status of the Company's stock option plan and the
options assumed in the reorganization with the Bank, together with the change
during the year, is presented below.
2004 2003 2002
--------------------------- --------------------------- ---------------------------
Weighted Weighted Weighted
average average average
exercise exercise exercise
Shares price Shares price Shares price
------------ ------------ ------------ ------------ ------------ ------------
Outstanding, beginning of year 525,750 $ 10.13 464,750 $ 10.13 428,500 $ 10.00
Assumed in the reorganization 576,101 10.87
Granted 70,000 10.99 46,000 10.00
Exercised 750 10.00 - - - -
Cancelled/forfeited 4,624 10.54 9,000 10.00 9,750 10.00
------------ ------------ ------------
Outstanding, end of year 1,096,477 10.52 525,750 10.13 464,750 10.00
============ ============ ============
Options exercisable at year end 1,024,561 380,188 269,000
============ ============ ============
Weighted average fair value
of options granted during the year $ 6.08 $ 3.72 $ 4.43
============ ============ ============
67
The following table summarizes information about options outstanding at
December 31, 2004:
Options outstanding Options exercisable
------------------------------------------------ -------------------------------
Weighted
Number average Weighted Number Weighted
outstanding at remaining average outstanding at average
Range of December 31, contractual exercise December 31, exercise
exercise prices 2004 life price 2004 price
- ----------------------------------- -------------- -------------- -------------- -------------- --------------
$10.00 - $11.00 1,096,477 7.56 years $ 10.52 1,024,561 $ 10.51
In May 2001, the Company's shareholder approved an Employee and
Non-Employee Director Non-Cash Compensation Plan (2001 Non-Cash Compensation
Plan). The 2001 Non-Cash Compensation Plan allows the Company to grant up to
50,000 shares of Series A preferred stock to employees, directors or consultants
who provide services to the Company or its subsidiaries. Grants must be approved
by the board of directors and based upon terms designated by the board. As of
December 31, 2004 and 2003, no shares had been granted under the 2001 Non-Cash
Compensation Plan.
NOTE M - TRANSACTIONS WITH AFFILIATES
In fiscal 2002 and 2003, the Company purchased $2,000,000 of
collateralized debt obligations of Trapeza Funding CDO I LLC (Trapeza CDO I), an
issuer of collateralized debt obligations. The Company purchased the
collateralized debt obligations through Cohen Bros. & Company. The equity owner
of Trapeza CDO I is Trapeza Partners, L.P. (Trapeza Partners), a limited
partnership whose general partner is Trapeza Funding LLC (Trapeza Funding), a
limited liability company owned by Financial Stocks, Inc. and Resource America,
Inc. Financial Stocks and Resource America also own 20% of the limited
partnership interest in Trapeza Partners. The Chairman and the Chief Executive
Officer of the Company are the brother and parent, respectively, of the Chief
Executive Officer of Resource America and the son and spouse, respectively, of
Resource America's Chairman. The Chairman and Chief Executive Officer of
Financial Stocks, Inc. is a director of the Company. This security was sold in
2003 with no realized gain.
In October 2003, the Bank purchased an aggregate of $3.0 million of
collateralized debt obligations of Alesco Preferred Funding I, Ltd. through
Cohen Bros. & Company. Cohen Bros. received $41,000 of underwriting compensation
in connection with the purchase. Alesco Funding I is managed by a limited
liability company which is an affiliate of the Company's Chairman, and pays
management fees to such company. This security was sold in 2003 with no realized
gain.
The Bank purchased a total of $2,654,000 in loans from Resource America
in 2001. The outstanding balance of the loans purchased from Resource America
was $1,969,000, at December 31, 2004 and 2003, respectively.
The Bank paid $9,200, $429,000 and $188,000 to Cohen Bros. & Company
(Cohen Bros.) for investment securities brokerage services performed for the
years ended December 31, 2004, 2003 and 2002, respectively. The Chairman of the
Company is the principal owner of Cohen Bros. Financial
68
LLC which owns 100% of Cohen Bros. & Company. A member of the Company's Board of
Directors is an executive of Cohen Bros.
The Company paid Cohen Bros. $214,000 for investment advisory services
related to the 2003 Common Stock offering and $345,000 for investment advisory
services related to the 2002 Preferred Stock and Trust Preferred securities
offerings.
The Company entered into a sublease for office space in Philadelphia,
Pennsylvania and a technical support agreement with RAIT Investment Trust (RAIT)
commencing in October 2000. The Chief Executive Officer of RAIT is the Chairman
and Chief Executive Officer of the Bank and the Chief Executive Officer of the
Company. Under the sublease, RAIT pays the Bank rent equal to 45% of the rent
paid by the Bank and an allocation of common area expenses. Under the computer
and telecommunications systems technical support agreements, which commenced in
January 2001, the Bank also provides technical support for RAIT for a fee of
$5,000 a month. RAIT paid $60,000 for the years ended December 31, 2004, 2003
and 2002. In addition, RAIT reimbursed the Bank for assistance in other
technical support totaling $49,000, $34,000 and $0 for the years ended
December 31, 2004, 2003 and 2002, respectively.
The Company also has subleased office space to Cohen Bros. commencing in
July 2002 at a rate of $6,761 per month. Prior to 2002, the Bank subleased the
office space for $1,000 per month.
In July 2002, Cohen Bros. also entered into an agreement with the
Company for fees of $1,000 per month for technical support and $3,600 per month
for telephone system support services. Technical and telephone support fees paid
by Cohen Bros. were $55,000 for each of the years ended December 31, 2004 and
2003.
The Bank maintains deposits for various affiliated companies totaling
approximately $41,793,000 and $34,708,000 as of December 31, 2004 and, 2003,
respectively. The majority of these deposits are short-term in nature and rates
are consistent with market rates.
The Bank has entered into lending transactions in the ordinary course of
business with directors, executive officers, principal stockholders and
affiliates of such persons on the same terms as those prevailing for comparable
transactions with other borrowers. At December 31, 2004, these loans were
current as to principal and interest payments, and did not involve more than
normal risk of collectibility. At December 31, 2004, loans to these related
parties amounted to $1,254,000. During the year ended December 31, 2004, the
Bank made new loans to related parties of $196,000 and received repayments of
$2,026,000.
The Bank entered into an ATM Agreement with TRM ATM Corporation in
September 2000. Under this agreement, TRM ATM installs, operates and services
automated teller machines at various locations of the Bank's choosing. The Bank
pays TRM a monthly rental fee of $195 for each machine. The Bank retains all
fees and charges derived from the transactions conducted at the ATM (except for
one ATM situated with one of our affinity groups in which we share such fees and
charges). The Bank currently leases seven machines under its agreement with TRM.
TRM ATM Corporation is a wholly-owned subsidiary of TRM Corporation. The
Chairman of TRM ATM is the Company's Chairman. A director of TRM ATM is the
spouse of the Company's Chief Executive Officer and the father of the Chairman.
Fees paid to TRM ATM were $16,000, $15,000 and $17,000 for the years ended
December 31, 2004, 2003 and 2002, respectively.
69
In February 2003, the Company entered into a lending relationship with
The Richardson Group Inc., which is owned by entities with whom the Company's
Chief Executive Officer and her spouse have controlling interests. The
outstanding balance of the loan was $463,000 at December 31, 2004.
NOTE N - COMMITMENTS AND CONTINGENCIES
1. Operating leases
The Company entered into a lease for its operations facility, which
expires on March 31, 2010, and entered into a lease for its executive offices,
which expires in 2014. These leases require payment by the Company of the real
estate taxes and insurance on the leased properties. Approximate future minimum
annual rental payments required by these leases are as follows (in thousands):
Year ending December 31,
2005 $ 1,251
2006 1,237
2007 1,234
2008 1,205
Thereafter 4,244
----------
$ 9,171
==========
The Company has provided letters of credit on these two leases that
totaled $497,000 at December 31, 2004. These letters of credit reduce annually
based upon rental payments made.
Rent expense for the years ended December 31, 2004, 2003 and 2002 was
approximately $651,000, $520,000 and $569,000 net of rental payments from RAIT
and Cohen Bros., of approximately $354,000, $325,000 and $183,000, respectively.
2. Litigation Settlement
In September 2002, the Company paid a settlement of $800,000 in
connection with an action brought by a shareholder of a financial institution
with which certain members of the Company's management had previously been
associated. The plaintiff alleged that the Company has misappropriated an
opportunity properly belonging to the other financial institution. The Company
did not record an expense at the time of settlement since, based upon the advice
of its legal counsel and insurance advisors, it expected a favorable outcome of
its claim under its directors' and officers' insurance policy. Management
evaluated its claim in each succeeding period and, based upon advice of legal
counsel, determined that it was probable that the claim would have a favorable
outcome. In October 2002, counsel advised the Company that significant further
litigation would be required to pursue the Company's claim and, to avoid further
expense, the Company settled its claim for $250,000 and recorded an expense of
$691,000, representing the difference between the settlement amount plus related
expenses and the settlement payment received.
70
NOTE O - FINANCIAL INSTRUMENTS WITH OFF-BALANCE-SHEET RISK AND CONCENTRATIONS OF
CREDIT RISK
The Company is party to financial instruments with off-balance-sheet
risk in the normal course of business to meet the financing needs of its
customers. These financial instruments include commitments to extend credit and
standby letters of credit. Such financial instruments are recorded in the
financial statements when they become payable. Those instruments involve, to
varying degrees, elements of credit and interest rate risk in excess of the
amount recognized in the consolidated balance sheets. The contractual, or
notional, amounts of those instruments reflect the extent of involvement the
Company has in particular classes of financial instruments.
The Company's exposure to credit loss in the event of non-performance
by the other party to the financial instrument for commitments to extend credit
and standby letters of credit is represented by the contractual or notional
amount of those instruments. The Company uses the same credit policies in making
commitments and conditional obligations as it does for on-balance-sheet
instruments.
Unless noted otherwise, the Company does not require collateral or other
security to support financial instruments with credit risk. The approximate
contract amounts are as follows:
December 31,
-----------------------
2004 2003
---------- ----------
(in thousands)
Financial instruments whose contract amounts
represent credit risk
Commitments to extend credit $ 134,902 $ 65,627
Standby letters of credit 5,879 4,117
Commitments to extend credit are agreements to lend to a customer as
long as there is no violation of any condition established in the contract.
Commitments generally have fixed expiration dates or other termination clauses
and may require payment of a fee. Since many of the commitments are expected to
expire without being drawn upon, the total commitment amounts do not necessarily
represent future cash requirements. The Company evaluates each customer's
creditworthiness on a case-by-case basis. The amount of collateral obtained, if
deemed necessary by the Company upon extension of credit, is based on
management's credit evaluation.
Standby letters of credit are conditional commitments issued by the
Company to guarantee the performance of a customer to a third party. Those
guarantees are primarily issued to support public and private borrowing
arrangements, including commercial paper, bond financing and similar
transactions. The credit risk involved in issuing letters of credit is
essentially the same as that involved in extending loan facilities to customers.
The Company holds residential or commercial real estate, accounts receivable,
inventory and equipment as collateral supporting those commitments for which
collateral is deemed necessary. Based upon periodic analysis of the Company's
standby letters of credit, management has determined that a SFAS 5 reserve is
not necessary at December 31, 2004. The Company also obtains collateral, such as
real estate, cash or liens on its customer's assets, depending on the customer,
for any standby commitment. The Company reduces any potential liability on its
standby letters of credit based upon its estimate of the proceeds obtainable
upon the liquidation of the collateral held. Fair values of unrecognized
financial instruments, including commitments to extend credit and the fair value
of letters of credit, are considered immaterial.
The Company grants loans primarily to customers in Philadelphia and its
immediately adjacent suburban Pennsylvania counties which include Chester,
Delaware and Montgomery and northern Delaware.
71
NOTE P - FAIR VALUE OF FINANCIAL INSTRUMENTS
SFAS 107 requires disclosure of the estimated fair value of an entity's
assets and liabilities considered to be financial instruments. For the Company,
as for most financial institutions, the majority of its assets and liabilities
are considered financial instruments. However, many such instruments lack an
available trading market, as characterized by a willing buyer and seller
engaging in an exchange transaction. Also, it is the Company's general practice
and intent to hold its financial instruments to maturity whether or not
categorized as "available-for-sale" and not to engage in trading or sales
activities, except for certain loans. Therefore, the Company has used
significant estimates and present value calculations in determining the fair
value of its financial instruments.
Changes in the assumptions or methodologies used to estimate fair values
may materially affect the estimated amounts. Also, there may not be reasonable
comparability between institutions due to the wide range of permitted
assumptions and methodologies in the absence of active markets. This lack of
uniformity gives rise to a high degree of subjectivity in estimating financial
instrument fair values.
Estimated fair values have been determined by the Company using the best
available data and an estimation methodology suitable for each category of
financial instruments. The estimation methodologies used, the estimated fair
values, and recorded book balances at December 31, 2004 and 2003, are outlined
below.
For cash and cash equivalents, including cash and due from banks and
federal funds sold the recorded book values of $19,503,000 and $42,183,000 as of
December 31, 2004 and 2003, respectively, approximate fair values. The estimated
fair values of investment securities are based on quoted market prices, if
available. Estimated fair values are based on quoted market prices of comparable
instruments if quoted market prices are not available.
The net loan portfolio at December 31, 2004 and 2003, has been valued
using the present value of discounted cash flow where market prices were not
available. The discount rate used in these calculations is the estimated current
market rate adjusted for credit risk. The carrying value of accrued interest
approximates fair value.
The estimated fair values of demand deposits (i.e., interest- and
noninterest-bearing checking accounts, savings, and certain types of money
market accounts) are, by definition, equal to the amount payable on demand at
the reporting date (i.e., their carrying amounts). The fair values of
certificates of deposit are estimated using a discounted cash flow calculation
that applies interest rates currently being offered to a schedule of aggregated
expected monthly time deposit maturities. Based upon time deposit maturities at
December 31, 2004, the carrying value approximates their fair value. The
carrying amount of accrued interest payable approximates its fair value.
72
2004 2003
--------------------------- ---------------------------
Carrying Estimated Carrying Estimated
amount fair value amount fair value
------------ ------------ ------------ ------------
(in thousands)
Investment securities available-for-sale $ 120,252 $ 120,252 $ 24,387 $ 24,387
Loans receivable, net 424,288 423,938 230,406 229,883
Certificates of deposit 182,832 183,882 117,321 117,737
Securities sold under agreements to repurchase 5,052 5,052 3 3
Subordinated debt 5,413 4,177
FHLB advances 55,000 55,000
Guaranteed preferred beneficial interests in the
Company's subordinated debentures - - 5,250 3,811
The fair value of commitments to extend credit is estimated based on the
amount of unamortized deferred loan commitment fees. The fair value of letters
of credit is based on the amount of unearned fees plus the estimated cost to
terminate the letters of credit. Fair values of unrecognized financial
instruments including commitments to extend credit and the fair value of letters
of credit are considered immaterial.
NOTE Q - REGULATORY MATTERS
It is the policy of the Federal Reserve that bank holding companies
should pay cash dividends on common stock only out of income available over the
past year and only if prospective earnings retention is consistent with the
organization's expected future needs and financial condition. The policy
provides that bank holding companies should not maintain a level of cash
dividends that undermines the bank holding company's ability to serve as a
source of strength to its banking subsidiaries.
Various federal and state statutory provisions limit the amount of
dividends that subsidiary banks can pay to their holding companies without
regulatory approval. Under Delaware banking law, the Bank's directors may
declare dividends on common or preferred stock of so much of its net profits as
they judge expedient, but the Bank must, before the declaration of a dividend on
common stock from net profits, carry 50% of its net profits of the preceding
period for which the dividend is paid to its surplus fund until its surplus fund
amounts to 50% of its capital stock and thereafter must carry 25% of its net
profits for the preceding period for which the dividend is paid to its surplus
fund until its surplus fund amounts to 100% of its capital stock.
In addition to these explicit limitations, federal and state regulatory
agencies are authorized to prohibit a banking subsidiary or bank holding company
from engaging in an unsafe or unsound practice. Depending upon the
circumstances, the agencies could take the position that paying a dividend would
constitute an unsafe or unsound banking practice.
The Bank and Company are subject to various regulatory capital
requirements administered by the federal banking agencies. Failure to meet
minimum capital requirements can initiate certain mandatory and possible
additional discretionary actions by regulators that, if undertaken, could have a
direct material effect on the Company's consolidated financial statements. Under
capital adequacy guidelines and the regulatory framework for prompt corrective
action, the Company and the Bank must meet specific capital guidelines that
involve quantitative measures of their assets, liabilities and certain
off-balance-sheet items as calculated under regulatory accounting practices. The
capital amounts and classification of the Company and the Bank are also subject
to qualitative judgments by the regulators about components, risk weightings and
other factors.
Quantitative measures established by regulations to ensure capital
adequacy require the Company and 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, and of Tier I capital to average assets.
73
As of December 31, 2004, the Company and the Bank met all regulatory
requirements for classification as well capitalized under the regulatory
framework for prompt corrective action.
To be well
capitalized under
For capital prompt corrective
Actual adequacy purposes action provisions
--------------------------- --------------------------- ---------------------------
Amount Ratio Amount Ratio Amount Ratio
------------ ------------ ------------ ------------ ------------ ------------
(dollars in thousands)
As of December 31, 2004
Total capital
(to risk-weighted assets)
Company $ 130,243 27.04% $ 38,539 >= 8.00% N/A N/A
Bank 117,167 24.49% 38,278 8.00 25,244 >= 10.00%
Tier I capital
(to risk-weighted assets)
Company 126,651 26.29% 19,269 >= 4.00 N/A N/A
Bank 113,575 23.74% 19,139 4.00 15,146 >= 6.00%
Tier I capital
(to average assets)
Company 126,651 22.88% 22,142 >= 4.00 N/A N/A
Bank 113,575 20.54% 22,122 4.00 15,303 >= 5.00%
As of December 31, 2003
Total capital
(to risk-weighted assets)
Company $ 23,820 9.44% $ 12,242 >= 8.00% N/A N/A
Bank 27,895 11.05% 20,207 8.00 25,244 >= 10.00%
Tier I capital
(to risk-weighted assets)
Company 21,829 8.65% 10,092 >= 4.00 N/A N/A
Bank 25,904 10.26% 10,098 4.00 15,146 >= 6.00%
Tier I capital
(to average assets)
Company 21,829 7.13% 20,184 >= 4.00 N/A N/A
Bank 25,904 8.46% 12,242 4.00 15,303 >= 5.00%
NOTE R - BUSINESS SEGMENTS
The Company only has one reportable segment in 2004, 2003 and 2002,
Community Banking. SFAS 131 Disclosures about Segments of an Enterprise and
Related Information, establishes standards for the way business enterprises
report information about operating segments in annual financial statements. The
Company has one operating segment, and accordingly, one reportable segment,
"Community Banking". All of the Company's activities are interrelated, and each
activity is dependent and assessed based on how each of the activities of the
Company supports the other. For example, commercial lending is dependent upon
the ability of the Company to fund itself with retail deposits and other
borrowings and to manage interest rate and credit risk. The situation is also
similar for consumer and residential and residential and commercial mortgage
lending. All significant operating decisions are based upon analysis of the
Company as one operating segment or unit.
74
NOTE S - QUARTERLY FINANCIAL DATA (UNAUDITED)
Three months ended
---------------------------------------------------------
2004 March 31, June 30, September 30, December 31,
- -------------------------------------------------- ------------ ------------ ------------ ------------
(in thousands, except per share data)
Interest income $ 4,683 $ 5,726 $ 6,611 $ 7,653
Net interest income 3,290 4,094 4,766 5,446
Provision for loan and lease losses 332 400 250 650
Non-interest income 1,884 2,251 2,374 2,395
Non-interest expense 4,584 5,256 6,061 6,292
Income tax benefit - - - 1,043
Net income available to common shareholders 11 404 609 1,554
Net income per share - basic 0.01 0.04 0.06 0.13
Net income per share - diluted 0.01 0.04 0.06 0.13
Three months ended
---------------------------------------------------------
2003 March 31, June 30, September 30, December 31,
- -------------------------------------------------- ------------ ------------ ------------ ------------
(in thousands, except per share data)
Interest income $ 3,406 $ 3,482 $ 3,724 $ 4,185
Net interest income 2,106 2,153 2,384 2,731
Provision for loan and lease losses 150 150 150 235
Non-interest income 2,235 2,379 2,709 3,164
Non-interest expense 3,821 4,264 4,605 5,665
Income tax benefit - - 125 125
Net income (loss) available to common
shareholders 151 (102) 150 (70)
Net income (loss) per share - basic 0.08 (0.05) 0.07 (0.04)
Net income (loss) per share - diluted 0.08 (0.05) 0.07 (0.04)
NOTE T- SUBSEQUENT EVENT
On December 31, 2004, the Company and the Bank entered into an agreement
to acquire Mears Motor Livery Corporation ("Mears"). The acquisition was
completed on January 3, 2005. Consideration for the acquisition was 253,126
shares of the Company's common stock and $1.0 million in cash for total
consideration of $4,969,000. As part of the transaction, the Company agreed to
file a registration statement under the Securities Act of 1933, as amended,
registering the common stock for resale. By letter dated February 7, 2005,
counsel for the former Mears shareholders alleged that the registration
statement had not been timely filed and demanded indemnification for purported
damages sustained by the former Mears shareholders. By letter dated March 9,
2005, the Company disputed the claim. In a letter dated March 21, 2005, counsel
for the former Mears shareholders reiterated their claim and, alternatively,
demanded rescission of the transaction. The parties are currently in the dispute
resolution phase provided under the agreement, which expires April 8, 2005. The
Company cannot predict the outcome of this dispute, but believes that its
resolution will not materially adversely affect its financial condition or
results of operation.
75
NOTE U - CONDENSED FINANCIAL INFORMATION - PARENT ONLY
CONDENSED BALANCE SHEETS
December 31,
--------------------
2004 2003
-------- --------
(in thousands)
Assets
Cash and due from banks $ 13,083 $ 1,355
Investment in bank subsidiaries 113,343 25,724
Other assets 592 510
-------- --------
Total assets $127,018 $ 27,589
======== ========
Liabilities and stockholders' equity
Other liabilities $ 203 $ 666
Guaranteed preferred beneficial interest in the
Company's subordinated debentures 5,413 5,250
Stockholders' equity 121,402 21,673
-------- --------
Total liabilities and stockholders' equity $127,018 $ 27,589
======== ========
CONDENSED STATEMENTS OF OPERATIONS
December 31,
--------------------------------
2004 2003 2002
-------- -------- --------
(in thousands)
Income
Other income $ 144 $ 184 $ 144
-------- -------- --------
Total income 144 184 144
Expense
Interest on subordinated debentures 551 551 305
Non-interest expense 669 413 796
-------- -------- --------
Total expense 1,220 964 1,101
-------- -------- --------
Equity in undistributed income of subsidiaries 4,794 1,851 966
-------- -------- --------
Net income 3,718 1,071 9
Less preferred stock dividends and accretion (817) (881) (750)
Income allocated to Series A preferred
shareholders (323) (61) -
-------- -------- --------
Net income (loss) available to common
shareholders $ 2,578 $ 129 $ (741)
======== ======== ========
CONDENSED STATEMENTS OF CASH FLOWS
December 31,
--------------------------------
2004 2003 2002
-------- -------- --------
(in thousands)
Operating activities
Net income $ 3,718 $ 1,071 $ 9
Increase in other assets (82) - -
Decrease in other liabilities (322) (523) (575)
Equity in undistributed income of subsidiaries (4,794) (1,851) (966)
-------- -------- --------
Net cash used in operating activities (1,480) (1,303) (1,532)
-------- -------- --------
Investing activities
Contribution to subsidiary (82,878) (3,980) (4,000)
-------- -------- --------
Net cash used in investing activities (82,878) (3,980) (4,000)
-------- -------- --------
Financing activities
Dividends on Series A preferred stock (169) - -
Proceeds from the issuance of preferred stock 82,878 4,104 -
Proceeds from the exercise of common
stock warrants 13,368 - -
Proceeds from the exercise of common
stock options 9 - -
Proceeds from the issuance of Series A
preferred stock, net - - 2,115
Proceeds from the issuance of beneficial
interest in the Company's subordinated
debentures - - 5,250
-------- -------- --------
Net cash provided by financing activities 96,086 4,104 7,365
-------- -------- --------
Net increase (decrease) in cash and cash equivalents 11,728 (1,179) 1,833
Cash and cash equivalents, beginning of year 1,355 2,534 701
-------- -------- --------
Cash and cash equivalents, end of year $ 13,083 $ 1,355 $ 2,534
======== ======== ========
76
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
None.
ITEM 9A. CONTROLS AND PROCEDURES
We maintain disclosure controls and procedures that are designed to ensure that
information required to be disclosed in our Securities Exchange Act of 1934
reports is recorded, processed, summarized and reported within the time periods
specified in the Securities and Exchange Commission's rules and forms, and that
such information is accumulated and communicated to our management, including
our Chief Executive Officer and our Chief Financial Officer, as appropriate, to
allow timely decisions regarding required disclosure. In designing and
evaluating the disclosure controls and procedures, our management recognized
that any controls and procedures, no matter how well designed and operated, can
provide only reasonable assurance of achieving the desired control objectives,
and our management necessarily was required to apply judgment in evaluating the
cost-benefit relationship of possible controls and procedures.
Under the supervision of our Chief Executive Officer and Chief Financial Officer
and with the participation of our disclosure committee, we have carried out an
evaluation of the effectiveness of our disclosure controls and procedures as of
the end of the period covered by this report. Based upon that evaluation, our
Chief Executive Officer and Chief Financial Officer concluded that our
disclosure controls and procedures are effective at the reasonable assurance
level.
There have been no significant changes in our internal controls over the
financial reporting that has partially affected, or are reasonably likely to
materially affect, our internal control over financial reporting during our most
recent fiscal year.
ITEM 9B. OTHER INFORMATION
None.
77
PART III
ITEM 10. TRUSTEES AND EXECUTIVE OFFICERS OF THE REGISTRANT
Information included in the 2005 Proxy Statement to be filed is incorporated
herein by reference.
ITEM 11. EXECUTIVE COMPENSATION
Information included in the 2005 Proxy Statement to be filed is incorporated
herein by reference.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
Information included in the 2005 Proxy Statement to be filed is incorporated
herein by reference.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
Information included in the 2005 Proxy Statement to be filed is incorporated
herein by reference.
ITEM 14. PRINCIPAL ACCOUNTING FEES AND SERVICES
Information included in the 2005 Proxy Statement to be filed is incorporated
herein by reference.
PART IV
ITEM 15. EXHIBITS AND FINANCIAL STATEMENT SCHEDULES
(a) Listed below are all financial statements, financial statement
schedules, and exhibits filed as part of this report.
1. FINANCIAL STATEMENTS
Report of Independent Registered Public Accounting Firm
Balance Sheets
Statements of Operations
Statements of Changes in Shareholders' Equity
Statements of Cash Flows
Notes to Financial Statements
2. FINANCIAL STATEMENT SCHEDULES
None
78
3. EXHIBITS
Exhibit No. Description
----------- -----------------------------------------------------
2.1 Form of Agreement and Plan of Merger between the
Bancorp, Inc. and the Bancorp Bank (1)
2.2 Acquisition Agreement and Plan of Merger (Mears Motor
Livery Corporation) (2)
3.1 Certificate of Incorporation (1)
3.2 Bylaws (1)
4.1 Specimen stock certificate (1)
4.2 Investor Rights Agreement (1999) (1)
4.3 Investor Rights Agreement (2002) (1)
10.1 1999 Stock Option Plan (1)
10.2 Employee and Non-employee Director Non-cash
Compensation Plan (1)
10.3 Sublease and Technical Support Agreement with RAIT
Investment Trust (1)
10.4 Sublease and Technical Support Agreement with Cohen
Bros. (1)
21.1 Subsidiaries of Registrant (1)
31.1 Rule 13a-14(a)/15d-14(a) Certifications
32.2 Rule 13a-14(a)/15d-14(a) Certifications
32.1 Section 1350 Certifications
32.2 Section 1350 Certifications
(1) Filed previously as an exhibit to our Registration
Statement on Form S-4, registration number 333-117385,
and by this reference incorporated herein.
(2) Filed previously as an exhibit to our current report on
Form 8-K for December 22, 2004, and by this reference
incorporated herein.
79
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.
THE BANCORP BANK
By: /s/ Betsy Z. Cohen
-------------------------------------
Betsy Z. Cohen
Chief Executive Officer
March 30, 2005
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.
By: /s/ Betsy Z. Cohen Chief Executive Officer March 30, 2005
-----------------------
Betsy Z. Cohen
By: /s/ D. Gideon Cohen Chairman of the Board March 30, 2005
----------------------- of Directors
D. Gideon Cohen
By: /s/Walter T. Beach Director March 30, 2005
-----------------------
Walter T. Beach
By: /s/Arthur M. Birenbaum Executive Vice President March 30, 2005
-----------------------
Arthur M. Birenbaum
By: /s/Matthew Cohn Director March 30, 2005
-----------------------
Matthew Cohn
By: /s/Martin F. Egan Senior Vice President, Chief March 30, 2005
----------------------- Financial Officer and Secretary
Martin F. Egan
By: /s/Leon A. Huff Director March 30, 2005
-----------------------
Leon A. Huff
By: /s/William H. Lamb Director March 30, 2005
-----------------------
William H. Lamb
By: /s/Frank M. Mastrangelo President, Chief Operating March 30, 2005
----------------------- Officer and Director
Frank M. Mastrangelo
80
By: /s/James J. McEntee III Director March 30, 2005
-----------------------
James J. McEntee III
By: /s/Donald F. McGraw, Jr Executive Vice President and March 30, 2005
----------------------- Chief Credit Officer
Donald F. McGraw, Jr.
By: /s/Scott R. Megargee Executive Vice President and March 30, 2005
----------------------- Chief Lending Officer
Scott R. Megargee
By: /s/Linda Schaeffer Director March 30, 2005
-----------------------
Linda Schaeffer
By: /s/Joan Specter Director March 30, 2005
-----------------------
Joan Specter
By: /s/Steven Stein Director March 30, 2005
-----------------------
Steven Stein
81
EXHIBIT INDEX
Exhibit No. Description
----------- -----------------------------------------------------
31.1 Rule 13a-14(a)/15d-14(a) Certifications
32.2 Rule 13a-14(a)/15d-14(a) Certifications
32.1 Section 1350 Certifications
32.2 Section 1350 Certifications