.
.
.
Exhibit 13
SELECTED FINANCIAL DATA
YEAR ENDED DECEMBER 31,
-------------------------------------------------------------------------------
(DOLLARS IN THOUSANDS EXCEPT PER SHARE DATA)
2004 2003 2002 2001 2000
----------- ----------- ----------- ----------- -----------
OPERATIONS DATA:
Net Interest Income $ 13,800 $ 10,469 $ 10,745 $ 9,757 $ 8,862
Provision for Loan Losses 453 317 160 360 360
Noninterest Income 1,582 1,755 1,847 1,402 1,373
Noninterest Expense 9,768 8,428 9,398 6,995 6,332
Net Income 3,720 2,446 1,968 2,486 2,336
SHARE DATA:
Basic Net Income Per Common Share $ 3.24 $ 2.16 $ 1.72 $ 2.16 $ 1.99
Diluted Net Income Per Common Share $ 3.10 $ 2.05 $ 1.63 $ 2.07 $ 1.90
Cash Dividends Paid Per Common Share $ 0.47 $ 0.37 $ 0.33 $ 0.27 $ 0.20
Weighted Average Common
Shares Outstanding:
Basic 1,146,339 1,131,066 1,142,126 1,150,391 1,176,908
Diluted 1,198,680 1,194,032 1,206,183 1,198,181 1,231,709
FINANCIAL CONDITION DATA:
Total Assets $ 505,767 $ 351,730 $ 282,128 $ 261,957 $ 248,339
Loans Receivable, Net 289,325 217,740 197,449 193,450 172,090
Total Investment Securities 175,690 99,895 44,667 43,963 58,575
Total Deposits 266,755 227,555 203,025 183,117 167,806
Long and Short-Term Debt 198,235 94,242 48,922 50,463 54,951
Total Stockholders' Equity 31,124 27,912 26,873 25,586 23,430
PERFORMANCE RATIOS:
Return on Average Assets 0.88% 0.78% 0.72% 0.97% 1.00%
Return on Average Equity 12.89% 8.99% 7.50% 10.09% 10.65%
Net Interest Margin 3.43% 3.55% 4.20% 4.00% 3.98%
Efficiency Ratio 70.80% 68.95% 74.73% 62.68% 61.86%
Dividend Payout Ratio 14.56% 17.27% 20.04% 12.44% 10.13%
CAPITAL RATIOS:
Average Equity to Average
Assets 9.29% 8.04% 9.53% 9.64% 9.37%
Leverage Ratio 9.29% 8.04% 9.53% 9.64% 9.61%
Total Risk-Based Capital Ratio 11.89% 12.20% 13.77% 14.08% 13.53%
Tier 1 Risk-Based Capital Ratio 11.01% 11.17% 12.63% 12.81% 12.50%
ASSET QUALITY RATIOS:
Allowance for Loan Losses to
Total Loans 1.04% 1.16% 1.15% 1.16% 1.10%
Nonperforming Loans to Total Loans 0.23% 0.17% 0.30% 0.12% 0.06%
Allowance for Loan Losses to
Nonperforming Loans 452.97% 678.30% 387.60% 996.07% 1,770.55%
Net Charge-offs to Average Loans (0.01%) 0.03% 0.06% 0.01% 0.05%
All per share amounts have been adjusted for the 3 for 2 stock split which was
declared in December 2004.
1
FORWARD-LOOKING STATEMENTS
When used in this discussion and elsewhere in this Annual Report, the words or
phrases "will likely result," "are expected to," "will continue," "is
anticipated," "estimate," "project" or similar expressions are intended to
identify "forward-looking statements" within the meaning of the Private
Securities Litigation Reform Act of 1995. Tri County Financial Corporation (the
"Company") cautions readers not to place undue reliance on any such
forward-looking statements, which speak only as of the date made, and to advise
readers that various factors, including regional and national economic
conditions, unfavorable judicial decisions, substantial changes in levels of
market interest rates, credit and other risks of lending and investment
activities and competitive and regulatory factors could affect the Company's
financial performance and could cause the Company's actual results for future
periods to differ materially from those anticipated or projected.
The Company does not undertake and specifically disclaims any obligation to
update any forward-looking statements to reflect occurrence of anticipated or
unanticipated events or circumstances after the date of such statements.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS
OVERVIEW
Since its conversion to a commercial bank charter in 1997, the Community Bank of
Tri County (the "Bank") has sought to increase total assets as well as certain
targeted loan types. The Bank feels that its ability to offer fast, flexible and
local decision-making in the commercial, commercial real estate, and consumer
loan areas will continue to attract significant new loans and enhance asset
growth. The Bank's local focus and targeted marketing is also directed towards
increasing its balances of consumer and business transaction deposit accounts.
The Bank believes that increases in these account types will lessen the Bank's
dependence on time deposits such as certificates of deposit to fund loan growth.
Although management believes that the strategy outlined above will increase
financial performance over time, we recognize that products such as commercial
lending and transaction accounts will also increase the Bank's noninterest
expense. We also recognize that certain lending and deposit products also
increase the possibility of losses from credit and other risks.
CRITICAL ACCOUNTING POLICIES
The Company's consolidated financial statements are prepared in accordance with
accounting principles generally accepted in the United States of America and the
general practices of the United States banking industry. Application of these
principles requires management to make estimates, assumptions, and judgments
that affect the amounts reported in the financial statements and accompanying
notes. These estimates assumptions and judgments are based on information
available as of the date of the financial statements; accordingly, as this
information changes, the financial statements could reflect different estimates,
assumptions, and judgments. Certain policies inherently have a greater reliance
on the use of estimates, assumptions and judgments and as such have a greater
possibility of producing results that could be materially different than
originally reported. The Company considers its determination of the allowance
for loan losses and the valuation allowance on its foreclosed real estate to be
critical accounting policies. Estimates, assumptions, and judgments are
necessary when assets and liabilities are required to be recorded at fair value,
when a decline in the value of an asset not carried on the financial statements
at fair value warrants an impairment write-down or valuation reserve to be
established, or when an asset or liability needs to be recorded contingent upon
a future event. Carrying assets and liabilities at fair value inherently results
in more financial statement volatility. The fair values and the information used
to record valuation adjustments for certain assets and liabilities are based
either on quoted market prices or are provided by other third-party sources,
when available. When these sources are not available, management makes estimates
based upon what it considers to be the best available information.
The allowance for loan losses is an estimate of the losses that may be sustained
in the loan portfolio. The allowance is based on two principles of accounting:
(a) Statement on Financial Accounting Standards ("SFAS") No. 5, "Accounting for
Contingencies", which requires that losses be accrued when they are
2
probable of occurring and are estimable and (b) SFAS No. 114, "Accounting by
Creditors for Impairment of a Loan", which requires that losses be accrued when
it is probable that the Company will not collect all principal and interest
payments according to the contractual terms of the loan. The loss, if any, is
determined by the difference between the loan balance and the value of
collateral, the present value of expected future cash flows, or values
observable in the secondary markets.
The loan loss allowance balance is an estimate based upon management's
evaluation of the loan portfolio. Generally the allowance is comprised of a
specific and a general component. The specific component consists of
management's evaluation of certain loans and their underlying collateral. Loans
are examined to determine the specific allowance based upon the borrower's
payment history, economic conditions specific to the loan or borrower, or other
factors that would impact the borrower's ability to repay the loan on its
contractual basis. Management assesses the ability of the borrower to repay the
loan based upon any information available. Depending on the assessment of the
borrower's ability to pay the loan as well as the type, condition, and amount of
collateral, management will establish an allowance amount specific to the loan.
In establishing the general component of the allowance, management analyzes
non-classified and non-impaired loans in the portfolio including changes in the
amount and type of loans. Management also examines the Bank's history of
write-offs and recoveries within each loan category. The state of the local and
national economy is also considered. Based upon these factors the Bank's loan
portfolio is categorized and a loss factor is applied to each category. These
loss factors may be higher or lower than the Bank's actual recent average losses
in any particular loan category, particularly in loan categories where the Bank
is rapidly increasing the size of its portfolio. Based upon these factors, the
Bank will adjust the loan loss allowance by increasing or decreasing the
provision for loan losses.
Management has significant discretion in making the judgments inherent in the
determination of the provision and allowance for loan losses, including in
connection with the valuation of collateral, a borrower's prospects of
repayment, and in establishing allowance factors on the general component of the
allowance. Changes in allowance factors will have a direct impact on the amount
of the provision, and a corresponding effect on net income. Errors in
management's perception and assessment of the global factors and their impact on
the portfolio could result in the allowance not being adequate to cover losses
in the portfolio, and may result in additional provisions or charge-offs. For
additional information regarding the allowance for loan losses, refer to Notes 1
and 4 to the Consolidated Financial Statements and the discussion under the
caption "Provision for Loan Losses" below.
In addition to the loan loss allowance, the Company also maintains a valuation
allowance on its foreclosed real estate. As with the allowance for loan losses
the valuation allowance on foreclosed real estate is based on SFAS No. 5,
"Accounting for Contingencies," as well as SFAS No. 144 "Accounting for the
Impairment or Disposal of Long-Lived Assets." These statements require that the
Company establish a valuation allowance when it has determined that the carrying
amount of a foreclosed asset exceeds its fair value. Fair value of a foreclosed
asset is measured by the cash flows expected to be realized from its subsequent
disposition. These cash flows should be reduced for the costs of selling or
otherwise disposing of the asset.
In estimating the cash flow from the sale of foreclosed real estate, management
must make significant assumptions regarding the timing and amount of cash flows.
In cases where the real estate acquired is undeveloped land, management must
gather the best available evidence regarding the market value of the property,
including appraisals, cost estimates of development, and broker opinions. Due to
the highly subjective nature of this evidence, as well as the limited market,
long time periods involved, and substantial risks, cash flow estimates are
highly subjective and subject to change. Errors regarding any aspect of the
costs or proceeds of developing, selling, or otherwise disposing of foreclosed
real estate could result in the allowance being inadequate to reduce carrying
costs to fair value and may require an additional provision for valuation
allowances.
In December 2004, the Company declared a 3 for 2 stock split in the form of a
stock dividend. All per share numbers in the following discussion reflect
retroactive application of this stock split.
3
COMPARISON OF RESULTS OF OPERATIONS FOR THE YEARS ENDED DECEMBER 31, 2004, 2003
AND 2002
GENERAL. For the year ended December 31, 2004, the Company reported consolidated
net income of $3,719,834 ($3.24 basic and $3.10 diluted earnings per share)
compared to consolidated net income of $2,445,898 ($2.16 basic and $2.05 diluted
earnings per share) for the year ended December 31, 2003, and consolidated net
income of $1,967,821 ($1.72 basic and $1.63 diluted earnings per share) for the
year ended December 31, 2002. The increase in net income for 2004 was primarily
attributable to an increase in net interest income which was partially offset by
increases in the provision for loan loss and noninterest expenses and a decline
in noninterest income in 2004. In 2004, the Bank used funds from the issuance of
$7 million of trust preferred securities and wholesale borrowing to purchase
certain securities. The Bank also substantially increased its loan portfolio and
lower cost deposit balances. These changes led to the large increases in net
interest income for the year ended December 31, 2004. Noninterest income
declined mainly through a decline in the amount of sales of loans to third
parties. These declines were partially offset by increases in service charges.
Provision for loan losses increased in 2004 due to increases in the loan
portfolio. Noninterest expenses increased primarily due to increases in
personnel, occupancy, data processing, and advertising. Income tax expenses
increased by $408,562 or 39.57% in 2004.
For the year ended December 31, 2003, net interest income was $10,468,526
compared to $10,745,360 for the year ended December 31, 2002, a decrease of
$276,834 or 2.58%. Noninterest income also declined to $1,754,538 from
$1,847,061 in 2002. a decline of $92,523 or 5.01%. Noninterest expenses declined
to $8,427, 771 in 2003 from a total of $9,397,600 in 2002. This decline of
$969,829 or 10.32% was caused by a decline in the provision for a valuation
allowance on foreclosed real estate as well as declines in certain other
noninterest expenses relating to the systems conversion in 2002. Income tax
expense decreased by 3.24% to $1,032,432 in 2003.
NET INTEREST INCOME. The primary component of the Company's net income is its
net interest income which is the difference between income earned on assets and
interest paid on the deposits and borrowings used to fund them. Net interest
income is determined by the spread between the yields earned on the Company's
interest-earning assets and the rates paid on interest-bearing liabilities as
well as the relative amounts of such assets and liabilities. Net interest
income, divided by average interest-earning assets, represents the Company's net
interest margin.
Consolidated net interest income for the year ended December 31, 2004 was
$13,799,929 compared to $10,468,526 for the year ended December 31, 2003 and
$10,745,360 for the year ended December 31, 2002. The $3,331,403 increase in the
most recent year was due an increase in interest income of $5,448,414, partially
offset by the increase in interest expense of $2,117,011. For the year ended
December 31, 2003, the $276,834 decrease was due to a decrease of $549,063 in
interest income offset by a decrease of $272,229 in interest expense for the
same period. Changes in the components of net interest income due to changes in
average balances of assets and liabilities and to changes caused by changes in
interest rates are presented in the rate volume analysis below.
During 2004, the Company's interest rate spread declined because the Bank's
yield on interest earning assets fell while its cost for interest bearing
liabilities was the same. The Bank's yield on loans declined due to the
continued pay off of higher interest rate loans in its portfolio. These loans
were generally replaced by lower rate loans. The Bank's investment yield
increased during 2004 as the Bank's average maturity on its investments
increased. While the cost of both deposits and borrowings fell, the proportion
of total interest bearing liabilities that were represented by higher cost
borrowings increased, leading to a stable average cost in 2004 compared to 2003.
During 2003, the Company's interest rate spread decreased because the Bank was
unable to lower the interest rates paid on deposits and borrowings as quickly
and as much as the interest rates earned on loans and investments fell. Rates on
deposits, particularly interest bearing transaction and money market accounts
had already been very low in 2002, as interest rates fell in 2003, the rates
paid on these deposits decreased slightly while the rates on investments and
loans decreased by a greater amount. In addition, the percentage of funding
contributed by relatively higher cost borrowings compared to deposits increased.
4
The effects of these changes can be seen in the fact that in 2003 interest
income declined by $549,063 or 3.29% to $16,164,925, while interest expense
declined to $5,696,399 a decrease of $272,229 or by 4.56%. These declines, in
turn led to a decline in net interest income of $276,834, or 2.58%, to
$10,468,526.
The following table presents information on the average balances of the
Company's interest-earning assets and interest-bearing liabilities and interest
earned or paid thereon for the past three fiscal years.
5
(DOLLARS IN THOUSANDS)
---------------------------------------------------------------------------------------
FOR THE YEAR ENDED DECEMBER 31,
---------------------------------------------------------------------------------------
2004 2003 2002
---------------------------- ---------------------------- --------------------------
AVERAGE AVERAGE AVERAGE
AVERAGE YIELD/ AVERAGE YIELD/ AVERAGE YIELD/
BALANCE INTEREST COST BALANCE INTEREST COST BALANCE INTEREST COST
--------- -------- ------- --------- -------- ------- -------- -------- -------
Interest-earning assets:
Loan portfolio (1) $ 254,605 $ 16,033 6.30% $ 201,440 $ 13,412 6.66% $195,280 $ 14,221 7.28%
Investment securities, federal
funds sold and interest bearing
deposits 147,274 5,580 3.79% 93,261 2,753 2.95% 60,637 2,493 4.11%
--------- -------- --------- -------- -------- --------
Total interest-earning assets 401,879 21,613 5.38% 294,702 16,165 5.49% 255,917 16,714 6.53%
--------- -------- --------- -------- -------- --------
Interest-bearing liabilities:
Interest bearing deposits and
escrow 249,164 3,230 1.30% 212,643 2,869 1.35% 189,518 3,453 1.82%
Borrowings 138,031 4,584 3.32% 68,679 2,828 4.12% 48,487 2,515 5.19%
--------- -------- --------- -------- -------- --------
Total interest bearing liabilities 387,195 7,813 2.02% 281,322 5,696 2.02% 238,005 5,969 2.51%
========= ======== ========= ======== ======== ========
Net interest income $ 13,800 $ 10,469 $ 10,745
======== ======== ========
Interest rate spread 3.36% 3.46% 4.02%
====== ====== ======
Net yield on interest-earning
assets 3.43% 3.55% 4.20%
====== ====== ======
Ratio of average interest-earning
assets to average interest
bearing liabilities 103.79% 104.76% 107.53%
====== ====== ======
- ---------
(1) Average balance includes non-accrual loans.
6
The table below sets forth certain information regarding changes in interest
income and interest expense of the Bank for the periods indicated. For each
category of interest-earning asset and interest-bearing liability, information
is provided on changes attributable to: (1) changes in volume (changes in volume
multiplied by old rate); and (2) changes in rate (changes in rate multiplied by
old volume). Changes in rate-volume (changes in rate multiplied by the change in
volume) have been allocated to changes due to volume.
2004 2003
DUE TO DUE TO
------- -------
VOLUME RATE TOTAL VOLUME RATE TOTAL
------ ------- ------ ------ ------- -----
Interest income:
Loan portfolio $3,541 $ (920) $2,621 $ 410 $(1,220) $(809)
Interest-earning cash and
investment portfolio 1,593 1,234 2,827 963 (703) 260
------ ------- ------ ------ ------- -----
Total interest-earning assets $5,134 $ 314 $5,448 $1,373 $(1,922) $(549)
====== ======= ====== ====== ======= =====
Interest expense:
Savings deposits and escrows $ 493 $ (132) $ 361 $ 312 $ (897) $(585)
FHLB advances and other
borrowings 2,857 (1,101) 1,756 831 (519) 313
------ ------- ------ ------ ------- -----
Total interest bearing liabilities $3,350 $(1,233) $2,117 $1,143 $(1,416) $(272)
====== ======= ====== ====== ======= =====
Net change in net interest income $1,784 $ 1,547 $3,331 $ 230 $ (506) $(277)
====== ======= ====== ====== ======= =====
PROVISION FOR LOAN LOSSES. Provision for loan losses for the year ended December
31, 2004 was $452,998 compared to $316,963 and $160,000 for December 31, 2003
and 2002, respectively. The higher provision for loan losses in 2004 was due to
the increase in the size of the loan portfolio as well as the higher
concentration of loans in types with higher credit risk. These factors were
partially offset by the Bank's continued low levels of delinquency and
charge-offs. The loan loss allowance and the provision for loan losses is
determined based upon an analysis of individual loans and the application of
certain loss factors to different loan categories. Individual loans are analyzed
for impairment as the facts and circumstances warrant. In addition, a general
component of the loan loss allowance is added based on a review of the
portfolio's size and composition. At December 31, 2004, the allowance for loan
loss equaled 453% of non-accrual and past due loans compared to 678% and 388% at
December 31, 2003 and 2002, respectively. For the year ended December 31, 2004,
the Company recorded net recoveries of $32,000 (.001% of average loans) compared
to net charge offs of $58,000 (0.03% of average loans) in 2003 and $128,000
(0.06% of average loans) in net charge-offs for 2002.
NONINTEREST INCOME. Noninterest income declined to $1,582,316 in 2004, from
$1,754,538 in 2003, a decline of $172,222 or 9.82%. Noninterest income decreased
to $1,754,538 for the year ended December 31, 2003 compared to $1,847,061, for
the prior year, a decrease of 5.01%. Changes in noninterest income over the past
three years have been the result of wide fluctuations in certain noninterest
income categories, (gain on sale of loans, other income, service charges, and
loan fees) and an increase in income from Bank Owned Life Insurance ("BOLI") in
the past 2 years.
Loan appraisal, credit and miscellaneous charges are highly variable; from 2003
to 2004 these charges decreased by $32,262 or 12.34% to $229,125. From 2002 to
2003, these charges increased to $261,387 an increase of 46.02%. Increases and
decreases in this category reflect changes in lending volumes and patterns as
well as competitive pressures. Gain on sale of loans held-for-sale has been
highly variable reflecting the overall interest rate environment and the Bank's
desire to keep certain loans in its portfolio. Gain on the sale of loans
decreased to $21,404 from $505,435, a decline of $484,031 or 95.77%. This change
was caused by the Bank's declining sales volume of these loans to third party
investors. From 2002 to 2003, this income item increased to $505,435 from
$499,304 an increase of $6,131 or 1.23%.
7
Income from BOLI increased to $261,411 from $230,607 in 2003 and none in 2002.
The income from BOLI in 2003 and 2004 was the result of the purchase of BOLI in
2003. The income for 2004 reflects a full year of ownership as well as higher
earning balances. Service charges and fees are primarily generated by the Bank's
ability to attract and retain transaction-based deposit accounts and by loan
servicing fees net of amortization of and valuation allowances on mortgage
servicing rights. In 2004, service charges increased by $493,873 to $1,189,001
reflecting higher deposit volumes and lower total amortization of mortgage
servicing rights. In 2003, service charges and fees declined to $695,128 from
2002's level of $1,041,662, a decline of $346,534 or 33.27%. This decline was
primarily caused by an increase in the amortization of mortgage servicing rights
and valuation allowances. The Bank hopes to increase its service charge and fee
revenues in the future by increasing the level of transaction-based accounts. In
2004, the Bank recorded a loss of $61,875 on the sale of available for sale
securities and recognized a loss of $65,000 on other than temporary decline in
the value of certain available for sale securities. In 2004, other noninterest
income declined to nothing from $61,981 and $17,945 in 2003 and 2002
respectively.
NONINTEREST EXPENSES. Noninterest expenses for the year ended December 31, 2004
totaled $9,768,419 an increase of $1,340,648 or 15.91% from the prior year.
Noninterest expenses for the year ended December 31, 2003 totaled $8,427,771, a
decrease of $969,829 or 10.32% from 2002. Salary and employee benefits expenses
increased by $730,717 or 15.54% to $5,432,898 in 2004. In 2003, they increased
by 11.21% to $4,702,181 compared to $4,228,050 for the prior year. The increase
reflects growth in the Bank's workforce to fully staff branches, an increasing
need for highly skilled employees due to the higher complexity level of the
Bank's business, and continued increases in the Bank's benefit and incentive
costs. Expenses also included certain supplemental retirement benefits which
were funded by the BOLI income. Occupancy expense increased to $858,891 in 2004
compared to $750,567 in 2003 an increase of $108,324 or 14.43%. In 2003,
occupancy expense decreased to $750,567 compared to $831,148 in 2002. In 2003,
occupancy expenses decreased from 2002 due to a decrease in certain nonrecurring
expenses such as the costs of a temporary branch in Charlotte Hall and certain
major repairs in other branches. In 2004, these expenses reflected the
refurbishment of certain offices and other renovation costs. In 2004,
advertising expenses increased from $308,951 to $539,715 an increase of $230,764
or 74.69%. These advertising costs reflected several major advertising campaigns
and marketing efforts. Advertising decreased to $308,951 for the year ended
December 31, 2003 from $338,216 in 2002. In 2002, the bank introduced several
new products which increased costs. Data processing expenses increased to
$550,781 an increase of $146,814 or 36.34% from the prior year total of
$403,967. The increase is reflective of the Bank's increased size in loans and
deposits as well as increases in certain third party processing costs related to
data processing. From 2003 to 2002 data processing expenses fell to $403,967
from the prior year total of $568,095 a decrease of 28.89%. The Bank incurred
significant data processing costs related to its conversion in 2002. These costs
included training, consulting, and transition fees related to the conversion
process. The successful conversion in 2002 led to a decline in these expenses in
2003. Loss on disposal of obsolete equipment totaled $65,104 in 2002. These
expenses related to the write-off of certain equipment that could not support
the new core data system.
Depreciation of furniture, fixtures, and equipment decreased to $372,237 in 2004
from $507,236 in 2003, a decline of $134,999 or 26.61%. Depreciation declined as
certain assets purchased in 2001 and 2002 in anticipation of the 2002 systems
conversion were fully depreciated in early 2004. In 2003, depreciation of
furniture, fixtures, and equipment increased by $168,052 or 49.55% due to the
large amount of equipment purchased in 2002. Telephone communications expenses
decreased to $103,421 in 2004 from 166,553 in 2003, a decrease of $63,132 or
37.91%. In 2003, these expenses declined by $179,006 or 51.80%. In 2004,
telephone communications decreased due to changes in vendors and renegotiation
of vendor contracts. Telephone communications expenses decreased in 2003 because
2002 expenses included certain data processing conversion costs. In 2002 and
2004, the Bank recorded valuation allowances of $972,889 and $114,606,
respectively on its foreclosed real estate. No valuation allowances on
foreclosed assets were recorded in 2003. ATM expenses increased in 2004 by
$71,266 or 25.99% from $274,188 in 2003. ATM expenses were $312,200 in 2002. In
2002, ATM expenses included costs relating to the systems conversion which were
nonrecurring. The increase in expenses in this area in 2004 included increases
in volumes and rates charged by third party vendors. Office supplies expense
increased in 2004 from 2003 by $20,634 to $151,862, an increase of 15.72%. In
2003, office supplies expense decreased by $159,408 or 54.85% from 2002. The
increase in 2004 was related to higher amounts of deposit and loan activity.
Office equipment
8
expenses decreased in 2004 to $90,520 from $129,849 in 2003 and $247,171 in
2002. These decreases are the result of declining needs for certain specialized
equipment which is no longer needed after our systems conversion. Other
noninterest expense increased by $154,983 or 14.72% to $1,208,034 in 2004, from
$1,053,051 in 2003. In 2003, noninterest expenses increased by $193,703 or
22.54% from 2002. These increases reflect the growing size of the Bank.
INCOME TAX EXPENSE. During the year ended December 31, 2004, the Company
recorded income tax expense of $1,440,994 compared to expenses of $1,032,432 and
$1,067,000 in the two prior years. The Company's effective tax rates for the
years ended December 31, 2004, 2003, and 2002 were 27.9%, 29.7% and 35.20%,
respectively. The 2004 effective tax rate declined due to a large donation of
property made in 2004 which offset slightly lower nontaxable income. The decline
in the effective tax rate from 2002 to 2003 was due to an increase in
non-taxable income and a slight decrease in state taxes.
COMPARISON OF FINANCIAL CONDITION AT DECEMBER 31, 2004 AND 2003
In 2004, the Company increased in size through the implementation of a
leveraging strategy. This strategy included the sale of a trust preferred issue
of $7,000,000 which was subsequently invested in the Bank. The Bank used the
proceeds to purchase securities and make loans. These increases in interest
earning assets were also funded by increases in short and long term borrowings
as well as by increases in retail deposits. In 2004, total assets increased by
$153,820,131 or 43.73%. Cash and due from banks increased by $3,698,796 or
159.48%. Fed funds sold decreased by $160,647 or 17.12% to $777,519.
Interest-bearing deposits with banks increased by 22.53% or $2,007,832. These
increases all reflect higher cash and liquidity needs due to higher asset size.
While securities available for sale fell by $25,341,103 or 66.18%, securities
held to maturity increased by $101,135,980 or 164.17% to $162,741,155. Generally
the proceeds of securities in the available for sale portfolio were used to buy
new securities in the held to maturity portfolio. The Company purchased
$171,294,471 of securities during 2004. Total securities balances increased by
$75,794,877 or 75.87%. These increases in total securities portfolios resulted
in an increase interest income. Stock in the Federal Home Loan Bank increased
due to stock purchases made necessary by increased Federal Home Loan Bank
borrowing levels. Loans held for sale declined by $474,880 or 100%, as current
loan production is increasingly held in the Bank's portfolio. Loans receivable
increased by $71,584,898 or 32.88%, as the Bank continued to build assets in
2004 to increase net interest income.
Premises and equipment increased to $6,011,913 from $5,580,189 an increase of
7.74% or $431,724. This increase was due to construction costs of a planned new
branch and some renovations at our home office. Foreclosed real estate declined
by $231,203 due to sales and donations of various foreclosed properties. BOLI
increased due to the continued growth of the policies in 2004. Accrued interest
receivable increased due to higher interest earning asset balances. Other assets
decreased to $2,134,303 due to a decrease in certain prepaid tax accounts.
In 2004, total liabilities increased by $150,608,466 or 46.51%. Deposits
increased to $266,754,504 at December 31, 2004 compared to $227,554,568 for the
prior year. Both noninterest and interest bearing deposit totals increased due
to the Bank's continued marketing efforts. Short and long term debt increased as
the Company sought to add assets to increase net interest income offsetting a
decline in interest spread. The increases in short term debt were $84,112,925 or
269.67%, these funds were used to buy securities and increase loan balances.
Long term debt increased by $19,879,937 or 31.53%, these funds were used to buy
securities. The Company completed a Trust Preferred issue of $7,000,000 in 2004
which was used to increase the Bank's equity and support a larger asset base.
The Company experienced a $3,211,665, or 11.51%, increase in stockholders'
equity for the year ended December 31, 2004. The increase in stockholders'
equity was attributable to the retention of earnings from the period of
$3,719,834, less cash dividends of $541,633. Equity was also increased by the
exercise of stock options totaling $241,475, an increase in accumulated other
comprehensive income of $189,270, the tax effect of non-employee stock option
exercise, and activity in the ESOP shares resulting in a gain of $8,507. These
increases were partially offset by the repurchase of common stock in the amount
of $412,973.
9
ASSET/LIABILITY MANAGEMENT
Net interest income, the primary component of the Company's net income, arises
from the difference between the yield on interest-earning assets and the cost of
interest-bearing liabilities and the relative amounts of such assets and
liabilities. The Company manages its assets and liabilities by coordinating the
levels of and gap between interest-rate sensitive assets and liabilities to
control changes in net interest income and in the economic value of its equity
despite changes in market interest rates.
Among the tools used to monitor interest rate risk is a "gap" report which
measures the dollar difference between the amount of interest-earning assets and
interest-bearing liabilities subject to repricing within a given time period. A
gap is considered negative when the amount of interest rate sensitive
liabilities exceeds the amount of interest rate sensitive assets. Generally,
during a period of rising interest rates, an institution with a negative gap
position would be in a worse position to invest in higher-yielding assets which,
consequently may result in the yield on interest earning assets increasing at a
slower rate than its cost of interest bearing liabilities than if it had a
positive gap. While, conversely, during a period of falling interest rates, an
institution with a negative gap would tend to have its interest-earning assets
repricing downward at a slower rate than its interest-rate liabilities as
compared to an institution with a positive gap which, consequently, may tend to
adversely affect net interest income. The following sets forth the amounts of
interest-earning assets and interest-bearing liabilities outstanding at December
31, 2004, which are anticipated by the Company, based on certain assumptions, to
reprice or mature in each of the future time periods shown:
OVER 1
OVER 3 TO THROUGH OVER
0-3 MONTHS 12 MONTHS 5 YEARS 5 YEARS
---------- ---------- --------- ---------
(DOLLARS IN THOUSANDS)
Assets:
Cash and due from banks $ 6,018 $ - $ - $ -
Interest-bearing deposits 10,920 - - -
Fed Funds sold 778 - - -
Securities 68,127 16,104 68,008 29,595
Loans 82,248 22,727 118,103 70,069
---------- ---------- --------- ---------
Total Assets $ 168,091 $ 38,831 $ 186,111 $ 99,664
========== ========== ========= =========
Liabilities
Noninterest-bearing deposits $ 35,553 $ - $ - $ -
Interest-bearing demand deposits 57,856 - - -
Money market deposits 34,692 - - -
Savings 36,852 - - -
Certificates of deposit 17,625 40,132 44,041 3
Short-term debt 115,304 - - -
Long-term debt - 5,074 32,000 45,857
---------- ---------- --------- ---------
Total Liabilities $ 297,882 $ 45,206 $ 76,041 $ 45,860
========== ========== ========= =========
Gap $ (129,791) $ (6,375) $ 110,070 $ 53,804
Cumulative Gap $ (129,791) $ (136,166) $ (26,096) $ 27,708
Cumulative Gap as a percentage
of total assets (26.34%) (27.64%) (5.30%) 5.62%
The foregoing analysis assumes that the Bank's assets and liabilities move with
rates at their earliest repricing opportunities based on final maturity.
Mortgage-backed securities are assumed to mature during
10
the period in which they are estimated to prepay and it is assumed that loans
and other securities are not called nor do they prepay prior to maturity.
Certificates of deposit and IRA accounts are presumed to reprice at maturity.
NOW and savings accounts are assumed to reprice within three months although it
is the Company's experience that such accounts may be less sensitive to changes
in market rates.
As noted above, the Bank has a substantial excess of liabilities over assets
repricing or maturing within one year. This would indicate that the Bank's net
interest income would decline if interest rates were to increase. A decrease in
net interest income as a result of a general increase in rates is likely, but
the Bank has the ability to moderate the effect of a general increase in
interest rates by controlling increases in rates on transaction accounts, using
available cash to reduce the amounts in particularly rate sensitive liability
accounts, and increasing total assets through increased leverage. In addition,
the analysis above substantially understates the amount of loan prepayments the
Bank has historically experienced even in periods of rising interest rates.
LIQUIDITY AND CAPITAL RESOURCES
The Company currently has no business other than that of the Bank and does not
currently have any material funding requirements, except for the payment of
dividends and the repurchase of stock. The Company's principal sources of
liquidity are cash on hand and dividends received from the Bank. The Bank is
subject to various regulatory restrictions on the payment of dividends.
The Bank's principal sources of funds for investments and operations are net
income, deposits from its primary market area, principal and interest payments
on loans, interest received on investment securities and proceeds from maturing
investment securities. Its principal funding commitments are for the origination
or purchase of loans and the payment of maturing deposits. Deposits are
considered the primary source of funds supporting the Bank's lending and
investment activities. The Bank also uses borrowings from the FHLB of Atlanta to
supplement deposits. The amount of FHLB advances available to the Bank is
limited to the lower of 40% of Bank assets or the amount supportable by eligible
collateral including FHLB stock, current residential first mortgage loans, and
certain securities.
The Bank's most liquid assets are cash, cash equivalents, and federal funds
sold. The levels of such assets are dependent on the Bank's operating financing
and investment activities at any given time. The variations in levels of cash
and cash equivalents are influenced by deposit flows and anticipated future
deposit flows.
Cash, cash equivalents, and interest-bearing deposits as of December 31, 2004
totaled $17,715,779, an increase of $5,545,981, or 45.57%, from the December 31,
2003 total of $12,169,798. This increase was due to the Bank's increase in
deposits and long and short-term borrowings.
The Bank's principal sources of cash flows are its financing activities
including deposits and borrowings. During the year 2004, all financing
activities provided $149,495,359 in cash compared to $68,939,687 during 2003 and
$17,747,865 during 2002. The increase in cash flows from financing activities
during the most recent period was principally due to an increase in borrowing
activity in 2004. The proceeds of long term borrowing increased to $30,000,000
in 2004 compared to $15,000,000 in 2003, and $920,000 in 2002. Short-term
borrowing provided a net increase in cash of $84,112,925 in 2004, compared to
$30,438,987 in 2003 and a use of cash in 2002 of $1,061,019. During 2004, net
deposit growth was $39,199,936 compared to $24,529,456 in 2003, and $19,908,578
in 2002. In 2004, the Company also completed a Trust Preferred offering in the
amount of $7,000,000, the proceeds of which were invested in the Bank. The Bank
also receives cash from its operating activities which provided $6,713,541 in
2004 compared to cash flows of $2,399,051 and $4,159,722 during 2003 and 2002,
respectively. The increase in operating cash flows during 2004 was primarily due
to an increase in net income combined with a decrease in other assets.
The Bank's principal use of cash has been in investing activities including its
investments in loans for portfolio, investment securities and other assets.
During the year ended December 31, 2004, the Bank invested a total of
$152,510,104 compared to $79,012,894 in 2003 and $18,364,135 in 2002. The
principal reason for the increase in cash used in investing activities was an
increase in the purchase of investments.
11
Federal banking regulations require the Company and the Bank to maintain
specified levels of capital. At December 31, 2004, the Company was in compliance
with these requirements with a leverage ratio of 9.29%, a Tier 1 risk-based
capital ratio of 11.01% and total risk-based capital ratio of 11.89%. At
December 31, 2004, the Bank met the criteria for designation as a
well-capitalized depository institution under FRB regulations. See Note 14 of
the consolidated financial statements.
OFF BALANCE SHEET ARRANGEMENTS
In the normal course of its business the Bank has committed to make credit
available to its borrowers under various loan and other agreements provided that
certain terms and conditions are met. For a discussion of these agreements
including collateral and other arrangements see Note 11 to the consolidated
financial statements.
CONTRACTUAL OBLIGATIONS
In the normal course of its business, the Bank commits to make future payments
to others to satisfy contractual obligations. These commitments include the
following: commitments to repay short and long term borrowings, and commitments
incurred under operating lease agreements. These commitments are summarized
below:
LESS MORE THAN
THAN 1-3 3-5 5
PAYMENTS DUE BY PERIOD TOTAL 1 YEAR YEARS YEARS YEARS
(IN THOUSANDS) -------- -------- ---------- --------- ---------
Long Term Debt Obligations $ 82,931 $ 5,074 $ 17,000 $ 15,000 $ 45,857
Short Term Debt Obligations 115,304 115,304 - - -
Deposits 266,755 222,711 34,093 9,948 3
Data Processing Servicing Contracts 2,928 747 1,422 209 550
Operating Lease Obligations 1,708 254 487 417 550
Other Long Term Liabilities Reflected
on the Registrant's Balance Sheet
Under GAAP - - - - 7,000
--------- -------- ---------- --------- ---------
$ 469,626 $344,090 $ 53,001 $ 25,574 $ 53,960
========= ======== ========== ========= =========
IMPACT OF INFLATION AND CHANGING PRICES
The consolidated financial statements and notes thereto presented herein have
been prepared in accordance with generally accepted accounting principles, which
require the measurement of financial position and operating results in terms of
historical dollars without considering the changes in the relative purchasing
power of money over time due to inflation. Unlike most industrial companies,
nearly all of the Company's assets and liabilities are monetary in nature. As a
result, interest rates have a greater impact on the Company's performance than
do the effects of general levels of inflation. Interest rates do not necessarily
move in the same direction or to the same extent as the prices of goods and
services.
12
MARKET FOR THE REGISTRANT'S COMMON STOCK AND RELATED SECURITY HOLDER MATTERS
MARKET INFORMATION. The following table sets forth high and low bid quotations
reported on the OTC Bulletin for the Company's common stock for each quarter
during 2003 and 2004. These quotes reflect inter-dealer prices without retail
mark-up, mark-down or commission and may not necessarily reflect actual
transactions. All per share amounts have been adjusted to reflect the 3 for 2
stock dividend declared on December 1, 2004.
2003 High Low
------ ------
Fourth Quarter $28.67 $26.00
Third Quarter 26.67 26.00
Second Quarter 26.00 24.67
First Quarter 26.00 24.67
2004 High Low
------ ------
Fourth Quarter $29.00 $26.00
Third Quarter 40.00 28.00
Second Quarter 32.17 29.33
First Quarter 65.00 33.33
HOLDERS. The number of stockholders of record of the Company at March 25, 2005
was 515.
DIVIDENDS. The Company has paid annual cash dividends since 1994. During fiscal
years 2004 and 2003, the Company paid cash dividends of $0.47 and $0.37,
respectively.
The Company's ability to pay dividends is governed by the policies and
regulations of the Federal Reserve Board (the "FRB"), which prohibits the
payment of dividends under certain circumstances dependent on the Company's
financial condition and capital adequacy. The Company's ability to pay dividends
is also depending on the receipt of dividends from the Bank.
Federal regulations impose certain limitations on the payment of dividends and
other capital distributions by the Bank. The Bank's ability to pay dividends is
governed by the Maryland Financial Institutions Code and the regulations of the
FRB. Under the Maryland Financial Institution Code, a Maryland bank (1) may only
pay dividends from undivided profits or, with prior regulatory approval, its
surplus in excess of 100% of required capital stock and (2) may not declare
dividends on its common stock until its surplus funds equals the amount of
required capital stock or, if the surplus fund does not equal the amount of
capital stock, in an amount in excess of 90% of net earnings.
Without the approval of the FRB, a state member bank may not declare or pay a
dividend if the total of all dividends declared during the year exceeds its net
income during the current calendar year and retained net income for the prior
two years. The Bank is further prohibited from making a capital distribution if
it would not be adequately capitalized thereafter. In addition, the Bank may not
make a capital distribution that would reduce its net worth below the amount
required to maintain the liquidation account established for the benefit of its
depositors at the time of its conversion to stock form.
13
Report of Independent Registered Public Accounting Firm
Board of Directors and Stockholders
Tri-County Financial Corporation
We have audited the accompanying consolidated balance sheets of Tri-County
Financial Corporation as of December 31, 2004 and 2003, and the related
consolidated statements of income, changes in stockholders' equity and cash
flows for each of the three years in the period ended December 31, 2004. These
consolidated financial statements are the responsibility of the Company's
management. Our responsibility is to express an opinion on these consolidated
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. An audit includes
examining, on a test basis, evidence supporting the amounts and disclosures in
the financial statements. An audit also includes assessing the accounting
principles used and significant estimates made by management, as well as
evaluating the overall financial statement presentation. We believe that our
audits provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above
present fairly, in all material respects, the consolidated financial position of
Tri-County Financial Corporation as of December 31, 2004 and 2003, and the
results of its consolidated operations and cash flows for 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/ Stegman & Company
Baltimore, Maryland
March 21, 2005
14
TRI-COUNTY FINANCIAL CORPORATION
CONSOLIDATED BALANCE SHEETS
DECEMBER 31,
---------------------------
2004 2003
Assets
Cash and due from banks $ 6,018,096 $ 2,319,300
Fed Funds sold 777,519 938,166
Interest-bearing deposits with banks 10,920,164 8,912,332
Securities available for sale 12,948,971 38,290,074
Securities held to maturity (approximate fair value of $161,664,754 and
61,219,315, respectively) 162,741,155 61,605,175
Federal Home Loan Bank and Federal Reserve Bank stock-at cost 6,144,300 4,776,850
Loans held for sale - 474,880
Loans receivable - net of allowance for loan losses
of $3,057,558 and $2,572,799, respectively 289,325,051 217,740,153
Premises and equipment, net 6,011,913 5,580,189
Foreclosed real estate 475,561 706,764
Accrued interest receivable 1,870,135 1,318,318
Investment in bank owned life insurance 6,182,955 5,921,544
Other assets 2,351,303 3,146,247
------------ ------------
TOTAL ASSETS $505,767,123 $351,729,992
============ ============
Liabilities and Stockholders' Equity
Deposits
Noninterest-bearing $ 35,552,503 $ 29,270,007
Interest-bearing 231,202,001 198,284,561
------------ ------------
Total deposits 266,754,504 227,554,568
Short-term borrowings 115,304,210 31,191,285
Long-term debt 82,931,113 63,051,176
Guaranteed preferred beneficial interest in junior
subordinated debentures 7,000,000 -
Accrued expenses and other liabilities 2,653,721 2,021,053
------------ ------------
Total Liabilities 474,643,548 323,818,082
------------ ------------
Stockholders' equity:
Common stock - par value $.01; authorized - 15,000,000 shares;
issued 1,146,864 and 753,278 shares, respectively 11,469 7,533
Additional paid in capital 8,252,152 7,975,036
Retained earnings 22,833,112 20,071,630
Accumulated other comprehensive income (loss) 186,140 (3,130)
Unearned ESOP shares (159,298) (139,159)
------------ ------------
Total Stockholders' Equity 31,123,575 27,911,910
------------ ------------
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $505,767,123 $351,729,992
============ ============
See notes to consolidated financial statements.
15
TRI-COUNTY FINANCIAL CORPORATION
CONSOLIDATED STATEMENTS OF INCOME
YEARS ENDED DECEMBER 31,
-----------------------------------------------
2004 2003 2002
------------- ------------- -------------
Interest and dividend income
Loans, including fees $ 16,033,239 $ 13,411,904 $ 14,221,247
Taxable interest and dividends on investment securities 5,551,943 2,688,451 2,388,095
Interest on deposits with banks 28,157 64,570 104,646
------------- ------------- -------------
Total interest and dividend income 21,613,339 16,164,925 16,713,988
------------- ------------- -------------
Interest expense
Deposits 3,229,502 2,868,709 3,453,443
Short term borrowings 1,163,647 95,707 7,634
Long term debt 3,420,261 2,731,983 2,507,551
------------- ------------- -------------
Total interest expenses 7,813,410 5,696,399 5,968,628
------------- ------------- -------------
Net interest income 13,799,929 10,468,526 10,745,360
Provision for loan losses 452,998 316,963 160,000
------------- ------------- -------------
Net interest income, after provision for loan losses 13,346,931 10,151,563 10,585,360
------------- ------------- -------------
Noninterest income:
Loan appraisal, credit, and miscellaneous charges 229,125 261,387 179,006
Net gain on sale of loans held for sale 21,404 505,435 499,304
Income from bank owned life insurance 261,411 230,607 -
Service charges 1,189,001 695,128 1,041,662
Gain on sale of equipment 8,250 - 44,389
Gain on sale of foreclosed real estate - - 64,755
Loss on the sale of investment securities (61,875) - -
Recognition of other than temporary decline in value of marketable securities (65,000)
Other - 61,981 17,945
------------- ------------- -------------
Total noninterest income 1,582,316 1,754,538 1,847,061
------------- ------------- -------------
16
TRI-COUNTY FINANCIAL CORPORATION
CONSOLIDATED STATEMENTS OF INCOME
YEARS ENDED DECEMBER 31,
-----------------------------------------------
2004 2003 2002
----------- ------------- -------------
Noninterest expenses
Salary and employee benefits $ 5,432,898 $ 4,702,181 $ 4,228,050
Occupancy expense 858,891 750,567 831,148
Advertising 539,715 308,951 338,216
Data processing expense 550,781 403,967 568,095
Loss on disposal of obsolete equipment - - 65,104
Depreciation of furniture, fixtures, and equipment 372,237 507,236 339,184
Telephone communications 103,421 166,553 345,559
Valuation allowance on foreclosed real estate 114,606 - 972,889
ATM expenses 345,454 274,188 312,200
Office supplies 151,862 131,228 290,636
Office equipment expenses 90,520 129,849 247,171
Other 1,208,034 1,053,051 859,348
----------- ------------- -------------
Total noninterest expenses 9,768,419 8,427,771 9,397,600
----------- ------------- -------------
Income before income taxes 5,160,828 3,478,330 3,034,821
Income tax expense 1,440,994 1,032,432 1,067,000
----------- ------------- -------------
Net income $ 3,719,834 $ 2,445,898 $ 1,967,821
=========== ============= =============
Earnings per share*
Basic $ 3.24 $ 2.16 $ 1.72
Diluted $ 3.10 $ 2.05 $ 1.63
See notes to consolidated financial statements.
*Share and per share data have been retroactively adjusted to effect a
three-for-two common stock split paid on December 1, 2004.
17
TRI-COUNTY FINANCIAL CORPORATION
Consolidated Statements of Changes in Stockholders' Equity
Years Ended December 31, 2004, 2003, and 2002
Accumulated
Other Unearned
Common Paid-in Retained Comprehensive ESOP
Stock Capital Earnings Income (Loss) Shares Total
-------- ----------- ----------- ------------- --------- ------------
Balance at December 31, 2001 $ 7,568 $ 7,545,590 $17,678,367 $ 555,513 $(200,580) $ 25,586,458
Comprehensive income:
Net Income - - 1,967,821 - - 1,967,821
Change in unrealized gains on investment
securities net of tax of $24,455 - - - (61,822) - (61,822)
------------
Total comprehensive income 1,905,999
Cash dividend $0.33 per share - - (385,129) - - (385,129)
Excess of fair market value over cost
of leveraged ESOP shares released - 10,445 - - - 10,445
Exercise of stock options 133 160,871 - - - 161,004
Repurchase of common stock (123) - (443,444) (443,567)
Net change in unearned ESOP shares 20 - - - 37,535 37,555
-------- ----------- ----------- ------------- --------- ------------
Balance at December 31, 2002 7,598 7,716,906 18,817,615 493,691 (163,045) 26,872,765
Comprehensive income:
Net Income - - 2,445,898 - - 2,445,898
Change in unrealized gains (losses) on
investment securities net of tax of $268,756 (496,821) (496,821)
------------
Total comprehensive income 1,949,077
Cash dividend $0.37 per share (422,361) (422,361)
Excess of fair market value over cost
of leveraged ESOP shares released 39,533 39,533
Exercise of stock options 116 200,435 200,551
Repurchase of common stock (197) (769,522) (769,719)
Net change in unearned ESOP shares 16 23,886 23,902
Exercise of nonemployee stock options - 18,162 - - - 18,162
-------- ----------- ----------- ------------- --------- ------------
Balance at December 31, 2003 7,533 7,975,036 20,071,630 (3,130) (139,159) 27,911,910
Comprehensive income:
Net Income 3,719,834 3,719,834
Change in unrealized gains on investment
securities net of tax of $97,503 189,270 189,270
------------
Total comprehensive income 3,909,104
Cash dividend $0.47 per share (541,633) (541,633)
Excess of fair market value over cost
of leveraged ESOP shares released 28,670 28,670
Exercise of stock options 214 241,261 241,475
Repurchase of common stock (93) (412,880) (412,973)
Net change in unearned ESOP shares (24) (20,139) (20,163)
3 for 2 stock split in the form of a dividend 3,839 (3,839) -
Exercise of nonemployee stock options - 7,185 - - - 7,185
-------- ----------- ----------- ------------- --------- ------------
Balance at December 31, 2004 $ 11,469 $ 8,252,152 $22,833,112 $ 186,140 $(159,298) $ 31,123,575
======== =========== =========== ============= ========= ============
18
TRI-COUNTY FINANCIAL CORPORATION
CONSOLIDATED STATEMENTS OF CASH FLOWS
YEARS ENDED DECEMBER 31,
------------------------
2004 2003 2002
------------- ------------- -------------
Cash flows from operating activities:
Net income $ 3,719,834 $ 2,445,898 $ 1,967,821
Adjustments to reconcile net income to net
cash provided by operating activities:
Valuation allowance on foreclosed real estate 114,606 - 972,889
Provision for loan losses 452,998 316,963 160,000
Loss on investment security 126,875 - -
Depreciation and amortization 636,711 663,134 445,558
Net amortization of premium/discount on
mortgage backed securities and investments 116,256 447,503 48,426
Increase in cash surrender of bank owned life insurance (261,411) (221,544) -
Deferred income tax expense (benefit) 65,850 (22,219) (399,000)
Decrease (increase) in accrued interest receivable (551,817) (275,865) 6,948
Increase (decrease) in deferred loan fees 114,618 (17,849) (90,291)
Increase (decrease) in accrued expenses and other liabilities 349,818 (1,332,467) 562,539
Decrease (increase) in other assets 914,440 170,189 (319,625)
Loss (gain) on disposal of premises and equipment (8,250) 12,241 76,315
Origination of loans held for sale - (16,792,123) (23,376,262)
Proceeds from sale of loans held for sale 496,284 18,085,314 24,967,214
Gain on sales of loans held for sale (21,404) (505,434) (499,304)
------------- ------------- -------------
Net cash provided by operating activities 6,265,408 2,973,741 4,523,228
------------- ------------- -------------
Cash flows from investing activities:
Purchase of investment securities available for sale (27,944,571) (65,726,882) (30,740,615)
Proceeds from sale, redemption or principal payments
of investment securities available for sale 53,031,692 67,772,952 24,692,742
Purchase of investment securities held to maturity (143,349,900) (64,384,597) (2,375,053)
Proceeds from maturities or principal payments
of investment securities held to maturity 42,511,543 5,898,120 1,822,600
Net (purchase) redemption of FHLB and Federal Reserve stock (1,367,450) (2,040,100) 298,800
Loans originated or acquired (192,785,961) (172,289,356) (86,078,892)
Principal collected on loans 120,633,447 151,699,369 82,009,912
Purchase of premises and equipment (1,068,435) (528,169) (1,106,504)
Proceeds from disposal of premises and equipment 8,250 9,000 281,084
Purchase of Bank owned life insurance policies - (5,700,000) -
Sale of foreclosed real estate
116,597 9,250 333,484
------------- ------------- -------------
Net cash used in investing activities (150,214,788) (85,280,413) (10,862,442)
------------- ------------- -------------
See notes to consolidated financial statements.
19
TRI-COUNTY FINANCIAL CORPORATION
CONSOLIDATED STATEMENTS OF CASH FLOWS
YEARS ENDED, DECEMBER 31,
---------------------------------------------
2004 2003 2002
------------- ------------- -------------
Cash flows from financing activities
Net increase in deposits 39,199,936 24,529,456 19,908,578
Net increase (decrease) in short-term borrowings 84,112,925 30,438,987 (1,061,019)
Dividends paid (541,633) (422,361) (385,129)
Exercise of stock options 248,661 218,712 161,004
Net change in unearned ESOP shares 8,508 63,436 47,999
Repurchase of common stock (412,973) (769,719) (443,568)
Proceeds from long-term borrowings 30,000,000 15,000,000 920,000
Payments of long-term borrowings (10,120,063) (118,824) (1,400,000)
Trust Preferred Debentures 7,000,000 - -
------------- ------------- -------------
Net cash provided by financing activities 149,495,361 68,939,687 17,747,865
Increase (Decrease) in cash and cash equivalents 5,545,981 (13,366,985) 11,408,651
Cash and cash equivalents at beginning of year 12,169,798 25,536,783 14,128,132
------------- ------------- -------------
Cash and cash equivalents at end of year $ 17,715,779 $ 12,169,798 $ 25,536,783
============= ============= =============
Supplementary cash flow information:
Cash paid during the year for:
Interest $ 5,223,366 $ 5,647,280 $ 6,225,058
Income taxes 1,232,500 1,715,369 2,110,500
See notes to consolidated financial statements.
20
TRI-COUNTY FINANCIAL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR THE YEARS ENDED DECEMBER 31, 2004, 2003, AND 2002
NOTE 1- SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
PRINCIPLES OF CONSOLIDATION
The consolidated financial statements include the accounts of Tri-County
Financial Corporation and its wholly owned subsidiaries, Community Bank of
Tri-County (the "Bank") and Tri-County Capital Trust I and the Bank's wholly
owned subsidiaries, Tri-County Investment Corporation and Community Mortgage
Corporation of Tri-County (collectively, the "Company"). All significant
intercompany balances and transactions have been eliminated in consolidation.
The accounting and reporting policies of the Company conform with accounting
principles generally accepted in the United States of America and to general
practices within the banking industry. Certain reclassifications have been made
to amounts previously reported to conform with classifications made in 2004.
NATURE OF OPERATIONS
The Company provides a variety of financial services to individuals and small
businesses through its offices in southern Maryland. Its primary deposit
products are demand, savings, and time deposits and its primary lending products
are consumer and commercial mortgage loans and commercial loans.
USE OF ESTIMATES
In preparing consolidated financial statements in conformity with accounting
principles generally accepted in the United States of America, management is
required to make estimates and assumptions that affect the reported amounts of
assets and liabilities as of the date of the balance sheet and reported amounts
of revenues and expenses during the reporting period. Actual results could
differ from those estimates. Material estimates that are particularly
susceptible to significant change in the near term relate to the determination
of the allowance for loan losses, the valuation of foreclosed real estate, and
deferred tax assets.
SIGNIFICANT GROUP CONCENTRATIONS OF CREDIT RISK
Most of the company's activities are with customers located in the Southern
Maryland area comprising St. Mary's, Charles, and Calvert counties. Note 3
discusses the types of securities held by the Company. Note 4 discusses the type
of lending in which the Company is engaged. The Company does not have any
significant concentration to any one customer or industry.
CASH AND CASH EQUIVALENTS
For purposes of the consolidated statements of cash flows, the Company considers
all highly liquid debt instruments with original maturities of three months or
less when purchased to be cash equivalents.
SECURITIES
Debt securities that management has the positive intent and ability to hold to
maturity are classified as "held to maturity" and recorded at amortized cost.
Securities not classified as held to maturity or trading, including equity
securities with readily determinable fair values are classified as "available
for sale" and recorded at estimated fair value, with unrealized gains and losses
excluded from earnings and reported in other comprehensive income.
21
TRI-COUNTY FINANCIAL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR THE YEARS ENDED DECEMBER 31, 2004, 2003, AND 2002
Purchase premiums and discounts are recognized in interest income using the
interest method over the terms of the securities. Declines in the estimated fair
value of held to maturity and available for sale securities below their cost
that are deemed to be other than temporary are reflected in earnings as realized
losses. In estimating other than temporary impairment losses, management
considers: (1) the length of time and the extent to which the fair value has
been less than cost, (2) the financial condition and near term prospects of the
issuer, and (3) the intent and ability of the Company to retain its investment
in the issuer for a period of time sufficient to allow for any anticipated
recovery in fair value. Gains and losses on the sale of securities are recorded
on the trade data and are determined using the specific identification method.
Investment in Federal Reserve Bank and Federal Home Loan Bank of Atlanta stock
are recorded at cost and are considered restricted as to marketability. The Bank
is required to maintain investments in the Federal Reserve Bank and Federal Home
Loan Bank based upon levels of financial activity.
LOANS HELD FOR SALE
Loans originated and intended for sale in the secondary market are carried at
the lower of cost or estimated fair value, in the aggregate. Net unrealized
losses, if any, are recognized through a valuation allowance by charges to
income.
Mortgage loans held for sale are generally sold with the mortgage servicing
rights retained by the Company. The carrying value of mortgage loans sold is
reduced by the cost allocated to the associated servicing rights. Gains or
losses on sales of mortgage loans are recognized based on the difference between
the selling price and the carrying value of the related mortgage loans sold,
using the specific identification method.
LOANS
The Company originates mortgage, commercial, and consumer loans to customers. A
substantial portion of the loan portfolio is represented by loans throughout
southern Maryland. The ability of the Company's debtors to honor their contracts
is dependent upon the real estate and general economic conditions in this area.
Loans that management has the intent and ability to hold for the foreseeable
future or until maturity or payoff are reported at their outstanding unpaid
principal balances adjusted for the allowance for loan losses, and any deferred
fees or costs on originated loans. Interest income is accrued on the unpaid
principal balance. Loan origination fees, net of certain direct origination
costs, are deferred and recognized as an adjustment of the related loan yield
using the interest method.
The accrual of interest on mortgage and commercial loans is discontinued at the
time the loan is 90 days delinquent unless the credit is well secured and in the
process of collection. Consumer loans are charged-off no later than 180 days
past due. In all cases, loans are placed on nonaccrual or charged-off at an
earlier date if collection of principal or interest is considered doubtful.
All interest accrued but not collected from loans that are placed on nonaccrual
or charged-off is reversed against interest income. The interest on these loans
is accounted for on the cash-basis or cost-recovery method, until qualifying for
return to accrual. Loans are returned to accrual status when all principal and
interest amounts contractually due are brought current and future payments
22
TRI-COUNTY FINANCIAL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR THE YEARS ENDED DECEMBER 31, 2004, 2003, AND 2002
are reasonably assured.
ALLOWANCE FOR LOAN LOSSES
The allowance for loan losses is established as probable losses are estimated to
have occurred through a provision for loan losses charged to earnings. Loan
losses are charged against the allowance when management believes that the
uncollectibility of a loan balance is confirmed. Subsequent recoveries, if any,
are credited to the allowance.
The allowance for loan losses is evaluated on a regular basis by management and
is based upon management's periodic review of the collectibility of the loans in
light of historical experience, the nature and volume of the loan portfolio,
adverse situations that may affect the borrower's ability to repay, estimated
value of any underlying collateral and prevailing economic conditions. This
evaluation is inherently subjective as it requires estimates that are
susceptible to significant revision as more information becomes available.
The allowance for loan losses consists of a specific component and a general
component. The specific component relates to loans that are classified as either
doubtful, substandard, or special mention. For such loans that are also
classified as impaired, an allowance is established when the discounted cash
flows (or collateral value or observable market price) of the impaired loan is
lower than carrying value of that loan. The general component covers the
non-classified loans and is based on historical loss experience, peer group
comparisons, industry data and loss percentages used for similarly graded loans
adjusted for qualitative factors.
A loan is considered impaired when, based on current information and events, it
is probable that the Company will be unable to collect the scheduled payments of
principal or interest when due according to the contractual terms of the loan
agreement. Factors considered by management in determining impairment include
payment status, collateral value, and the probability of collecting scheduled
principal and interest payments when due. Loans that experience insignificant
payment delays and payment shortfalls generally are not classified as impaired.
Management determines the significance of payment delays and payment shortfalls
on a case-by-case basis, taking into consideration all of the circumstances
surrounding the loan and the borrower, including the length of the delay, the
reasons for the delay, the borrower's prior payment record, and the amount of
the shortfall in relation to the principal and interest owed. Impairment is
measured on a loan by loan basis for commercial and construction loans by either
the present value of expected future cash flows discounted at the loan's
effective interest rate, the loan's observable market price, or the fair value
of the collateral if the loan is collateral dependent.
Large groups of smaller homogeneous loans are collectively evaluated for
impairment. Accordingly, the Company does not separately identify individual
consumer and residential loans for impairment disclosures, unless such loans are
the subject of a restructuring agreement.
SERVICING
Servicing assets are recognized as separate assets when rights are acquired
through purchase or through the sale of financial assets. Generally, purchased
servicing rights are capitalized at the cost to acquire the rights. For sales of
mortgage loans, a portion of the cost of originating the loan is
23
TRI-COUNTY FINANCIAL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR THE YEARS ENDED DECEMBER 31, 2004, 2003, AND 2002
allocated to the servicing based on relative estimated fair value. Estimated
fair value is based on market prices for comparable mortgage servicing
contracts, when available, or alternatively, is based on a valuation model that
calculates the present value of estimated future net servicing. The valuation
model incorporates assumptions that market participants would use in estimating
future net servicing income, such as the cost to service, the discount rate, an
inflation rate, ancillary income, prepayment speeds and default rates and
losses. Capitalized servicing rights are reported in other assets and are
amortized into noninterest income in proportion to, and over the period of, the
estimated future net servicing income of the underlying financial assets.
Servicing assets are evaluated for impairment based upon the estimated fair
value of the rights as compared to amortized cost. Impairment is determined by
stratifying rights into tranches based on predominant risk characteristics, such
as interest rate, loan type and investor type. Impairment is recognized through
a valuation allowance for an individual tranche, to the extent that fair value
is less than the capitalized amount for the tranche. If the Company later
determines that all or a portion of the impairment no longer exists for a
particular tranche, a reduction of the allowance may be recorded as an increase
to income.
Servicing fee income is recorded for fees earned for servicing loans. The fees
are based on a contractual percentage of the outstanding principal; or a fixed
amount per loan and recorded as income when earned. The amortization of mortgage
servicing rights is netted against loan servicing fee income.
PREMISES AND EQUIPMENT
Land is carried at cost. Premises and improvements and equipment are carried at
cost, less accumulated depreciation and amortization computed by the
straight-line method over the estimated useful lives of the assets which are as
follows:
Buildings and improvements 15 - 50 years
Furniture and equipment 3 - 15 years
Automobiles 5 years
Maintenance and repairs are charged to expense as incurred while improvements
that extend the useful life of premises and equipment are capitalized.
FORECLOSED REAL ESTATE
Assets acquired through, or in lieu of, loan foreclosure are held for sale and
are initially recorded at the lower of cost or estimated fair value at the date
of foreclosure, establishing a new cost basis. Subsequent to foreclosure,
valuations are periodically performed by management and the assets are carried
at the lower of carrying amount or estimated fair value less cost to sell.
Revenue and expenses from operations and changes in the valuation allowance are
included in noninterest expense.
24
TRI-COUNTY FINANCIAL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR THE YEARS ENDED DECEMBER 31, 2004, 2003, AND 2002
TRANSFERS OF FINANCIAL ASSETS
Transfers of financial assets are accounted for as sales, when control over the
assets has been surrendered. Control over transferred assets is deemed to be
surrendered when: (1) the assets have been isolated from the Company, (2) the
transferee obtains the right (free of conditions that constrain it from taking
advantage of that right) to pledge or exchange the transferred assets, and (3)
the Company does not maintain effective control over the transferred assets
through an agreement to repurchase them before their maturity.
ADVERTISING COSTS
The Company expenses advertising costs as incurred.
INCOME TAXES
The Company files a consolidated federal income tax return with its
subsidiaries. Deferred tax assets and liabilities are determined using the
liability (or balance sheet) method. Under this method, the net deferred tax
asset or liability is determined based on the tax effects of the temporary
differences between the book and tax bases of the various balance sheet assets
and liabilities and gives current recognition to changes in tax rates and laws.
OFF BALANCE SHEET CREDIT RELATED FINANCIAL INSTRUMENTS
In the ordinary course of business, the Company has entered into commitments to
extend credit, including commitments under commercial lines of credit, letters
of credit, and standby letters of credit. Such financial instruments are
recorded when they are funded.
STOCK-BASED COMPENSATION
Statement of Financial Accounting Standards (SFAS) No. 123, Accounting for Stock
Based Compensation, encourages all entities to adopt a fair value based method
of accounting for employee stock compensation plans, whereby compensation cost
is measured at the grant date based on the value of the award and is recognized
over the service period, which is usually the vesting period. However, it also
allows an entity to continue to measure compensation cost for these plans using
the intrinsic value based method of accounting prescribed by Accounting
Principles Board Opinion No. 25, Accounting for Stock Issued to Employees,
whereby compensation cost is the excess, if any, of the quoted market price of
the stock at the grant date (or other measurement date) over the amount an
employee must pay to acquire the stock. The Company has elected to continue with
the accounting methodology in Opinion No. 25. Stock options issued under the
Company's stock option plans have no intrinsic value at the grant date, and
under Opinion No. 25 no compensation cost is recognized for them.
However, SFAS No. 123 was revised as SFAS No. 123R in December 2004, with an
effective date of July 2005. This revision is discussed further in the "Recent
Accounting Pronouncements" section of this Note.
At December 31, 2004, the Company maintains stock-based compensation plans,
which are more fully described in Note 12. Had compensation cost for the
Company's stock option plans been determined based on the fair value based
method of accounting at the grant dates for awards under
25
TRI-COUNTY FINANCIAL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR THE YEARS ENDED DECEMBER 31, 2004, 2003, AND 2002
the plan consistent with the method prescribed by SFAS No. 123, the Company's
net income and earnings per share would have been adjusted to the pro forma
amounts indicated below:
Years Ended December 31,
----------------------------------------
2004 2003 2002
----------- ------------ ----------
Net income, as reported $ 3,719,834 $ 2,445,898 $1,967,821
Additional expense determined under fair value based method (735,180) (141,000) (217,187)
----------- ------------ ----------
Pro forma net income $ 2,984,654 $ 2,304,898 $1,750,634
=========== ============ ==========
Earnings per share as reported
Basic $ 3.24 $ 2.16 $ 1.72
Diluted 3.10 2.05 1.63
Pro forma earnings per share
Basic 2.60 2.03 1.53
Diluted 2.49 1.93 1.45
Per share amounts have been adjusted retroactively to reflect the 3 for 2 stock
split in December 2004.
For the purpose of computing the pro forma amounts indicated above, the fair
value of each option on the date of grant is estimated using the Black-Scholes
option pricing model with the following weighted-average assumptions used for
the grants:
2004 2003 2002
-------- -------- --------
Dividend Yield 1.80% 2.17% 1.41%
Expected Volatility 25.51% 17.24% 35.00%
Risk - free interest rate 4.31% 4.29% 4.82%
Expected lives (in years) 10 10 10
Weighted average fair value $ 12.68 $ 10.22 $ 17.24
EARNINGS PER COMMON SHARE
Basic earnings per common share represents income available to common
stockholders divided by the weighted average number of common shares outstanding
during the period. Diluted earnings per share reflects additional common shares
that would have been outstanding if dilutive potential common shares had been
issued, as well as any adjustment to income that would result from the assumed
issuance. Potential common shares that may be issued by the Company relate
solely to outstanding stock options, and are determined using the treasury stock
method. In 2004 there were 46,271 options excluded from the calculation as their
effect would be anti-dilutive.
26
TRI-COUNTY FINANCIAL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR THE YEARS ENDED DECEMBER 31, 2004, 2003, AND 2002
Earnings per common share have been computed based on the following:
Years Ended December 31,
------------------------
2004 2003 2002
----------- ----------- -----------
Net income $ 3,719,834 $ 2,445,898 $ 1,967,821
=========== =========== ===========
Average number of common share outstanding 1,146,339 1,131,066 1,142,126
Effect of dilutive options 52,341 62,966 64,058
----------- ----------- -----------
Average number of shares used to calculate diluted
earnings per share outstanding 1,198,680 1,194,032 1,206,183
=========== =========== ===========
The numbers of common shares outstanding have been adjusted to give retroactive
effect to the 3 for 2 stock split in December 2004.
COMPREHENSIVE INCOME
Accounting principles generally require that recognized revenue, expenses, gains
and losses be included in net income. Although certain changes in assets and
liabilities, such as unrealized gains and losses on available for sale
securities, are reported as a separate component of the equity section of the
balance sheet, such items, along with net income, are components of
comprehensive income.
The components of other comprehensive income and related tax effects are as
follows:
Years Ended December 31,
------------------------
2004 2003 2002
----------- ----------- -----------
Net income $ 3,719,834 $ 2,445,898 $ 1,967,821
Other comprehensive income items
Unrealized holding gains (losses) on available for sale securities
net of tax of expense (benefit)of $76,465, $(268,756), $(24,455) 148,433 (496,821) (61,822)
respectively
Plus: reclassification adjustment for losses net of tax benefit of
$21,038 40,797 - -
----------- ----------- -----------
Total other comprehensive income $ 189,270 $ (496,821) $ (61,822)
----------- ----------- -----------
Total comprehensive income $ 3,909,104 $ 1,949,077 $ 1,905,999
=========== =========== ===========
The components of accumulated other comprehensive income, included in
stockholders' equity are as follows:
December 31,
------------
2004 2003
---------- ----------
Net unrealized gains (losses) on securities available for sale $ 282,031 $ (4,742)
Tax effect (95,891) 1,612
---------- ----------
Net of tax amount $ 186,140 $ (3,130)
========== ==========
27
TRI-COUNTY FINANCIAL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR THE YEARS ENDED DECEMBER 31, 2004, 2003, AND 2002
RECENT ACCOUNTING PRONOUNCEMENTS
In December 2004, the Financial Accounting Standards Board ("FASB") issued SAFS
No. 153, "Exchanges of Nonmonetary Assets, an amendment of APB Opinion No. 29,
Accounting for Nonmonetary Transactions." This statement amends the principle
that exchanges of nonmonetary assets should be measured based on the fair value
of the assets exchanged and more broadly provides for exceptions regarding
exchanges of nonmonetary assets that do not have commercial substance. This
Statement is effective for nonmonetary asset exchanges occurring in fiscal
periods beginning after June 15, 2005. The adoption of this standard is not
expected to have a material impact on financial condition, results of
operations, or liquidity.
In December 2004, FASB issued SFAS No. 123R, "Share-Based Payment," which is a
revision of SFAS No. 123, "Accounting for Stock Issued for Employees." SFAS No.
123R requires that all share-based payments to employees, including grants of
employee stock options, be valued at fair value on the grant date and be
expensed over the applicable vesting period. SFAS No. 123R is effective for the
Company on July 1, 2005. The Company will transition to SFAS No. 123R using the
"modified prospective application." Under the "modified prospective
application," compensation costs will be recognized in the financial statements
for all new share-based payments granted after July 1, 2005. Additionally, the
Company will recognize compensation costs for the portion of previously granted
awards for which the requisite service has not been rendered ("nonvested
awards") that are outstanding as of July 1, 2005 over the remaining requisite
service period of the awards. The compensation expense to be recognized for the
nonvested awards will be based on the fair value of the awards. The Company does
not expect the impact of utilizing the "modified prospective application" to
adopt SFAS No. 123R to be materially different from the pro forma information
shown above in this Note 1 under "Stock-Based Compensation."
In March 2004, FASB Emerging Issues Task Force (EITF) released Issue 03-01,
"Meaning of Other Than Temporary Impairment and Its Application to Certain
Investments." EITF 03-1 provides guidance for determining whether impairment for
certain debt and equity investments is other-than-temporary and the measurement
of the impaired loss. Certain disclosure requirements of EITF 03-1 were adopted
in 2003 and the Company complied with the new disclosure requirements in its
consolidated financial statements. The recognition and measurement requirements
of EITF 03-01 were initially effective for periods beginning after June 15,
2004. In September 2004, however, the FASB staff issued FASB Staff Position
("FSP") EITF 03-1-1, which delayed the effective date for certain measurement
and recognition guidance contained in Issue 03-1. The FSP requires the
application of pre-existing other-than-temporary guidance during the period of
delay until a final consensus is reached. Management does not anticipate the
issuance of the final consensus will have a material impact on financial
condition, the results of operations, or liquidity. During 2004, the Company
recorded a $65,000 impairment loss relating to its investment in FHLMC preferred
stock whose decline in value was determined to be other-than-temporary.
In December 2003, the American Institute of Certified Public Accountants issued
Statement of Position (SOP) 03-3, "Accounting for Certain Loans or Debt
Securities Acquired in a Transfer". SOP 03-3 requires acquired loans, including
debt from the seller for those-individually-evaluated
28
TRI-COUNTY FINANCIAL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR THE YEARS ENDED DECEMBER 31, 2004, 2003, AND 2002
loans that have evidence of deterioration in credit quality since origination,
and it is probable all contractual cash flows on the loan will be unable to be
collected. SOP 03-3 also requires the excess of all undiscounted cash flows
expected to be collected at acquisition over the purchase's initial investment
to be recognized as interest income on a level-yield basis over the life of the
loan. Subsequent increases in cash flows expected to be collected are recognized
as impairment. Loans carried at fair value, loans held for sale, and loans to
borrowers in good standing under revolving credit agreements are excluded from
the scope of SOP 03-3. The guidance is effective for loans acquired in fiscal
years beginning after December 15, 2004 and is not expected to have a material
impact on the Company's financial condition, result of operations, or liquidity.
NOTE 2--RESTRICTIONS ON CASH AND AMOUNTS DUE FROM BANK
The Bank is required to maintain average balances on hand or with the Federal
Reserve Bank. At December 31, 2004 and 2003, these reserve balances amounted to
$225,000.
29
TRI-COUNTY FINANCIAL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR THE YEARS ENDED DECEMBER 31, 2004, 2003, AND 2002
NOTE 3--INVESTMENT SECURITIES
The amortized cost and estimated fair values of securities with gross unrealized
losses and gains are:
December 31, 2004
-----------------
Amortized Gross Gross Estimated
Cost Unrealized Gains Unrealized Losses Fair Value
------------ ---------------- ----------------- -------------
Asset-backed securities issued by GSEs $ 11,543,520 $ 113,741 $ 104,584 $ 11,552,677
Corporate equity securities 481,010 290,467 5,000 766,477
Bond mutual funds 642,408 - 12,591 629,817
------------ ---------------- ----------------- -------------
Total securities available for sale $ 12,666,938 $ 404,208 $ 122,175 $ 12,948,971
============ ================ ================= =============
Securities held-to-maturity
Asset-backed securities issued by:
GSEs $108,862,740 $ 127,154 $ 1,275,511 $ 107,714,383
Other 51,796,259 350,848 234,149 51,912,958
------------ ---------------- ----------------- -------------
Total debt securities held-to-maturity 160,658,999 478,002 1,509,660 159,627,341
U.S. Government obligations 301,181 - 726 300,455
Other investments 1,780,975 - 44,017 1,736,958
------------ ---------------- ----------------- -------------
Total securities held to maturity $162,741,155 $ 478,002 $ 1,554,403 $ 161,664,754
============ ================ ================= =============
December 31, 2003
-----------------
Amortized Gross Gross Estimated
Securities available for sale Cost Unrealized Gains Unrealized Losses Fair Value
------------ ---------------- ----------------- -------------
Asset-backed securities issued by GSEs $ 34,902,854 $ 102,973 $ 309,722 $ 34,696,105
Corporate equity securities 546,010 250,423 40,000 756,433
Bond mutual funds 2,845,950 - 8,415 2,837,535
------------ ---------------- ----------------- -------------
Total securities available for sale $ 38,294,814 $ 353,396 $ 358,137 $ 38,290,074
============ ================ ================= =============
Securities held-to-maturity
Asset-backed securities issued by:
GSEs $ 50,067,413 $ 103,018 $ 646,379 $ 49,524,052
Other 7,284,039 - - 7,284,039
------------ ---------------- ----------------- -------------
Total debt securities held-to-maturity 57,351,452 103,018 646,379 56,808,091
U.S. Government obligations 300,000 - 249 299,751
Other investments 3,953,723 157,750 - 4,111,473
------------ ---------------- ----------------- -------------
Total securities held-to-maturity $ 61,605,175 $ 260,768 $ 646,628 $ 61,219,315
============ ================ ================= =============
Other investments consist of certain CD strip instruments whose estimated fair
value is estimated based on market returns on similar risk and maturity
instruments because no active market exists for these instruments. At December
31, 2004, U.S. Government obligations with a carrying value of $300,000 were
pledged to secure municipal deposits and for other purposes required or
permitted
30
TRI-COUNTY FINANCIAL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR THE YEARS ENDED DECEMBER 31, 2004, 2003, AND 2002
by law. In addition, at December 31, 2004, certain other securities with a
carrying value of $7,598,000 were pledged to secure certain deposits. At
December 31, 2004, securities with a carrying value of $72,194,000 were pledged
as collateral for advances from the Federal Home Loan Bank of Atlanta.
Gross unrealized losses and estimated fair value by length of time that the
individual available-for-sale securities have been in a continuous unrealized
loss position at December 31, 2004 are as follows:
Continuous unrealized losses
existing for
------------
Less than More than
Estimated 12 12 Total unrealized
Fair Value months months losses
------------ ------------ ------------ ----------------
Asset-backed securities issued by GSEs $ 6,438,501 $ 104,584 $ - $ 104,584
Corporate equity securities 435,000 - 5,000 $ 5,000
Bond mutual funds 595,758 12,591 - 12,591
------------ ------------ ------------ ----------------
$ 7,469,259 $ 117,175 $ 5,000 $ 122,175
============ ============ ============ ================
The available-for-sale investment portfolio has an estimated fair value of
approximately $12.9 million of which approximately $7.5 million of the
securities have some unrealized losses from their purchase price. Of these
securities, $6.4 million, or 86%, are mortgage backed securities issued by GSEs,
$600,000 or 8% are short duration mutual fund shares, and $435,000 or 6% are
equity securities. The unrealized losses that exist in the mortgage backed
securities and mutual fund shares are the result of market changes in interest
rates since the original purchase.
The mutual fund shares have a modest duration and are backed by one year
adjustable rate mortgage backed securities. The asset backed securities have an
average duration of 3.3 years and are guaranteed by their issuer as to credit
risk. Total unrealized losses on these investments are minimal (approximately
2%). We believe that the losses in the equity securities are temporary.
Persistent losses may require a reevaluation of these losses. These factors
coupled with the fact the Company has both the intent and ability to hold these
investments for a period of time sufficient to allow for any anticipated
recovery in fair value substantiates that the unrealized losses in the
available-for-sale portfolio are temporary.
Gross unrealized losses and estimated fair value by length of time that the
individual held-to-maturity securities have been in a continuous unrealized loss
position at December 31, 2004 are as follows:
31
TRI-COUNTY FINANCIAL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR THE YEARS ENDED DECEMBER 31, 2004, 2003, AND 2002
Continuous unrealized losses
existing for
------------ Total
Estimated Fair Less than 12 More than 12 unrealized
Value months months Losses
-------------- ------------ ------------ -----------
Asset-backed securities issued by GSEs $ 71,536,064 $ 708,062 $ 567,449 $ 1,275,511
Asset-backed securities issued by other 30,182,784 186,187 47,963 234,149
U.S. Government obligations 301,181 726 - 726
Other Investments 1,780,975 44,017 - 44,017
-------------- ------------ ------------ -----------
$ 103,801,004 $ 938,991 $ 615,411 $ 1,554,403
============== ============ ============ ===========
The held-to-maturity investment portfolio has an estimated fair value of
approximately $161.7 million of which approximately $103.8 million of the
securities have some unrealized losses from their purchase price. Of these
securities, $101.7 million, or 98%, are mortgage backed securities and the
remainder is a short duration U.S. Treasury note and a CD strip investment. The
U.S.Treasury note will mature within three months from the balance sheet date at
full face value. The CD strip will mature within 3 years. The remaining asset
backed securities have a duration of approximately 5 years, are guaranteed as to
payment by the issuer, and have minimal losses compared to carrying value
(approximately 1.5%). The unrealized losses that exist are the result of market
changes in interest rates since the original purchase. These factors coupled
with the Company's intent and ability to hold these investments for a period of
time sufficient to allow for any anticipated recovery in fair value
substantiates that the unrealized losses in the held-to-maturity portfolio are
temporary.
The amortized cost and estimated fair value of debt securities at December 31,
2004, by contractual maturity, are shown below. Expected maturities will differ
from contractual maturities because the issuers of the securities may have the
right to prepay obligations without prepayment penalties.
Available for Sale Held to Maturity
------------------ ----------------
Estimated Estimated
Amortized Fair Amortized Fair
Cost Value Cost Value
-------------- ------------ ------------- --------------
Within one year $ 642,408 $ 629,817 $ 1,478,181 $ 1,448,365
Over one year through five years - - 603,975 589,048
Over five years through ten years - - - -
-------------- ------------ ------------- --------------
642,408 629,817 2,082,156 2,037,413
Mortgage-backed securities 11,543,520 11,552,676 160,658,999 159,627,341
-------------- ------------ ------------- --------------
$ 12,185,928 $ 12,182,493 $ 162,741,155 $ 161,664,754
============== ============ ============= ==============
Total sales of investments available for sale during 2004 were $36,900,000,
these sales produced a net loss of $61,875. There were no sales of investment
securities available for sale during 2003 or 2002. Asset-backed securities are
comprised of mortgage-backed securities as well as mortgage derivative
securities such as collateralized mortgage obligations and real estate mortgage
investment conduits.
32
TRI-COUNTY FINANCIAL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR THE YEARS ENDED DECEMBER 31, 2004, 2003, AND 2002
NOTE 4 -- LOANS RECEIVABLE AND ALLOWANCE FOR LOAN LOSSES
A summary of the balances of loans are as follows:
2004 2003
---- ----
Commercial real estate $ 136,341,596 $ 93,824,812
Residential first mortgages 59,087,000 42,971,076
Construction and land development 17,597,911 19,598,992
Home equity and second mortgage loans 23,925,108 19,561,771
Commercial loans 39,136,777 30,435,729
Consumer loans 3,462,613 4,096,926
Commercial equipment 13,595,978 10,473,403
---------------- ----------------
293,146,983 220,962,709
---------------- ----------------
Less:
Deferred loan fees 764,374 649,756
Allowance for loan losses 3,057,558 2,572,799
---------------- ----------------
3,821,932 3,222,556
---------------- ----------------
$ 289,325,051 $ 217,740,153
================ ================
An analysis of the allowance for loan losses follows:
2004 2003 2002
---- ---- ----
Balance January 1, $ 2,572,799 $ 2,314,074 $ 2,281,581
Add:
Provision charged to operations 452,998 316,963 160,000
Recoveries 49,083 2,446 2,795
Less:
Charge-offs 17,322 60,684 130,302
------------ ------------ ------------
Balance, December 31 $ 3,057,558 $ 2,572,799 $ 2,314,074
============ ============ ============
No loans included within the scope of SFAS No. 114 were identified as being
impaired at December 31, 2004 or 2003 and for the years then ended.
Loans on which the recognition of interest has been discontinued, which were not
included within the scope of SFAS No. 114, amounted to approximately $675,000,
$379,000, and $597,000 at
33
TRI-COUNTY FINANCIAL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR THE YEARS ENDED DECEMBER 31, 2004, 2003, AND 2002
December 31, 2004, 2003, and 2002, respectively. If interest income had been
recognized on nonaccrual loans at their stated rates during 2004, 2003, and
2002, interest income would have been increased by approximately $44,391,
$11,626, and $33,320, respectively. Income in the amount of $21,955 and $29,066
was recognized on these loans in 2004 and 2003, respectively. No income was
recognized for these loans in 2002.
Included in loans receivable at December 31, 2004 and 2003 is $1,268,353 and
$593,452 due from officers and directors of the Bank. These loans are made in
the ordinary course of business at substantially the same terms and conditions
as those prevailing at the time for comparable transactions with outsiders and
are not considered to involve more than the normal risk of collectibility. For
the years ending December 31, 2004 and 2003 all loans to directors and officers
of the Bank were performing according to the original loan terms. Activity in
loans outstanding to officers and directors is summarized as follows:
2004 2003
---- ----
Balance, beginning of year $ 593,452 $ 1,022,846
New loans made during year 1,211,526 528,106
Repayments made during year (285,765) (931,108)
Reductions due to change in
directors and officers (250,860) (26,392)
---------------- ----------------
Balance, end of year $ 1,268,353 $ 593,452
================ ================
NOTE 5 -- LOAN SERVICING
Loans serviced for others are not reflected in the accompanying balance sheets.
The unpaid principal balances of mortgages serviced for others were $39,327,875
and $54,660,488 at December 31, 2004 and 2003, respectively.
Servicing loans for others generally consists of collecting mortgage payments,
maintaining escrow accounts, disbursing payments to investors and foreclosure
processing. Loan servicing income is recorded on the accrual basis and includes
servicing fees from investors and certain charges collected from borrowers, such
as late payment fees. The following table presents the activity of the mortgage
servicing rights ("MSR").
34
TRI-COUNTY FINANCIAL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR THE YEARS ENDED DECEMBER 31, 2004, 2003, AND 2002
Year Ended December 31,
--------------------------------------------
2004 2003 2002
----------- ---------- -----------
Balance at beginning of the year $ 676,940 $ 780,408 $ 525,075
Additions 7,861 284,327 303,333
Amortization (207,599) (177,795) (48,000)
Application of valuation allowance to permanently impaired MSRs - (210,000) -
----------- ---------- -----------
Balance at end of year $ 477,202 $ 676,940 $ 780,408
=========== ========== ===========
Valuation allowance for impairment
Balance at beginning of the year $ - $ - $ -
Additions - 210,000
Application of valuation allowance to permanently impaired MSRs - (210,000) -
----------- ---------- -----------
Balance at end of year $ - $ - $ -
=========== ========== ===========
NOTE 6 - FORECLOSED REAL ESTATE
Foreclosed assets are presented net of an allowance for losses. An analysis of
the allowance for losses on foreclosed assets is as follows:
Years ended December 31,
----------------------------------------
2004 2003 2002
----------- --------- ---------
Balance at beginning of year $ 972,899 $ 972,899 $ -
Provision for losses 114,606 - 972,899
Charge-offs (415,765) - -
----------- --------- ---------
Balance at end of year $ 671,740 $ 972,899 $ 972,899
=========== ========= =========
Expenses applicable to foreclosed assets include the following:
Years ended December 31,
--------------------------------
2004 2003 2002
--------- ---------- ---------
Net loss on sale of foreclosed real estate $ - $ - $ (64,755)
Donation of property 25,000
Provision for losses 114,606 - 972,889
Operating expenses 6,278 10,153 12,176
--------- ---------- ---------
$ 145,884 $ 10,153 $ 920,310
========= ========== =========
35
TRI-COUNTY FINANCIAL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR THE YEARS ENDED DECEMBER 31, 2004, 2003, AND 2002
NOTE 7 --PREMISES AND EQUIPMENT
A summary of the cost and accumulated depreciation of premises and equipment
follows:
2004 2003
----------- -----------
Land $ 1,368,077 $ 1,368,077
Building and improvements 5,048,190 4,619,671
Furniture and equipment 3,137,954 2,574,424
Automobiles 168,425 124,388
----------- -----------
Total cost 9,722,647 8,656,560
Less accumulated depreciation 3,710,734 3,106,371
----------- -----------
Premises and equipment, net $ 6,011,913 $ 5,580,189
=========== ===========
Certain bank facilities are leased under various operating leases. Rent expense
was $190,306, $197,157, and $211,200 in 2004, 2003 and 2002, respectively.
Future minimum rental commitments under noncancellable operating leases are as
follows:
2005 $ 253,860
2006 276,360
2007 210,360
2008 208,560
2009 208,560
Thereafter 550,320
----------
Total $1,708,020
==========
During 2004, the Bank committed to build a new location at a total cost of
approximately $700,000. Approximately $260,000 of these costs are in buildings
and improvements at December 31, 2004.
36
TRI-COUNTY FINANCIAL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR THE YEARS ENDED DECEMBER 31, 2004, 2003, AND 2002
NOTE 8 -- DEPOSITS
Deposits at December 31 consist of the following:
2004 2003
------------- -------------
Noninterest-bearing demand $ 35,552,503 $ 29,270,007
Interest-bearing:
Demand 57,855,849 29,674,110
Money market deposits 34,692,434 44,473,200
Savings 36,851,744 34,670,884
Certificates of deposit 101,801,974 89,466,367
------------- -------------
Total interest-bearing 231,202,001 198,284,561
------------- -------------
Total deposits $ 266,754,504 $ 227,554,568
============= =============
The aggregate amount of time deposits in denominations of $100,000 or more at
December 31, 2004 and 2003 was $32,268,000 and $26,869,000, respectively.
At December 31, 2004, the scheduled maturities of time deposits are as follows
(in thousands):
2005 $ 57,758
2006 19,785
2007 14,308
2008 4,672
2009 5,276
2010 3
---------
$ 101,802
=========
NOTE 9--SHORT TERM BORROWINGS AND LONG-TERM DEBT
The Bank's long-term debt consists of advances from the Federal Home Loan Bank
of Atlanta. The Bank classifies debt based upon original maturity, and does not
reclassify debt to short term status during its life. These include fixed rate,
adjustable rate, and convertible advances. Rates and maturities on these
advances are as follows:
37
TRI-COUNTY FINANCIAL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR THE YEARS ENDED DECEMBER 31, 2004, 2003, AND 2002
Fixed Adjustable Fixed Rate
Rate Rate Convertible
----- ---------- -----------
2004
Highest rate 5.43% 2.97% 6.25%
Lowest rate 1.13% 2.97% 3.27%
Weighted average rate 3.98% 2.97% 4.68%
Matures through 2022 2005 2013
2003
Highest rate 5.43% 1.96% 6.25%
Lowest rate 1.00% 1.96% 3.27%
Weighted average rate 3.94% 1.96% 5.15%
Matures through 2022 2005 2011
The Bank's fixed rate debt generally consists of advances with monthly interest
payments and principal due at maturity. The Bank's adjustable rate long-term
debt adjusts quarterly based upon a margin over the three month London Interbank
Offered Rate ("LIBOR"). The margin is set at 80 basis points. The debt has a
minimum interest of 0.80% and a maximum rate of 5.30%. The Bank's fixed rate,
convertible, long-term debt is callable by the issuer, after an initial period
ranging from six months to five years. These advances become callable in 2005.
Depending on the specific instrument, the instrument is callable either
continuously after the initial period (Bermuda option) or only at the date
ending the initial period (European). All advances have a prepayment penalty,
determined based upon prevailing interest rates. The contractual maturities of
long-term debt are as follows:
December 31, December 31,
2004 2003
-------------------------------------------------------------------
Fixed Adjustable Fixed Rate
Rate Rate Convertible Total Total
----------- ----------- ----------- ----------- -----------
Due in 2005 $ 74,000 $ 5,000,000 $ - $ 5,074,000 $15,074,000
Due in 2006 12,000,000 - - 12,000,000 12,000,000
Due in 2007 5,000,000 - - 5,000,000 5,000,000
Due in 2008 - - - - -
Due in 2009 15,000,000 - - 15,000,000 -
Thereafter 5,857,113 - 40,000,000 45,857,113 30,889,176
----------- ----------- ----------- ----------- -----------
$37,931,113 $ 5,000,000 $40,000,000 $82,931,113 $62,963,176
=========== =========== =========== =========== ===========
From time to time, the Bank also has daily advances outstanding, which are
classified as short-term debt. These advances are repayable at the Bank's option
at any time and reprice daily. These advances totaled $36,000,000 and
$31,000,000 at December 31, 2004 and 2003, respectively. The rate on the
short-term debt at December 31, 2004 was 2.44%.
38
TRI-COUNTY FINANCIAL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR THE YEARS ENDED DECEMBER 31, 2004, 2003, AND 2002
Under the terms of an Agreement for Advances and Security Agreement with Blanket
Floating Lien (the "Agreement"), the Company maintains eligible collateral
consisting of 1 - 4 unit residential first mortgage loans, discounted at 80% of
the unpaid principal balance, equal to 100% at December 31, 2004, of its total
outstanding long and short-term Federal Home Loan Bank advances. During 2003 and
2004, the Bank entered into addendums to the Agreement that expanded the types
of eligible collateral under the Agreement to include certain commercial real
estate and second mortgage loans. These loans are subject to eligibility rules,
and collateral values are discounted at 50% of the unpaid loan principal
balance. In addition, only 50% of total collateral for Federal Home Loan Bank
advances may consist of commercial real estate loans. In addition the Bank has
pledged its Federal Home Loan Bank stock of $6,054,300 and securities with a
carrying value of $72,194,000 as additional collateral for its advances. The
Bank is limited to total advances of up to 40% of assets or $202 million. The
Bank had sufficient collateral to borrow this amount.
In addition, the Bank had outstanding notes payable to the U.S. Treasury, which
are Federal treasury tax and loan deposits accepted by the Bank and remitted on
demand to the Federal Reserve Bank. At December 31, 2004 and 2003, such
borrowings were $454,210 and $191,285, respectively. The Bank pays interest on
these balances at a slight discount to the federal funds rate. The notes are
secured by investment securities with an amortized cost of approximately
$5,948,600 and $5,948,600 at December 31, 2004 and 2003, respectively.
In addition to the other short-term borrowings noted above, the Bank had
outstanding agreements to repurchase certain securities which had been sold.
These agreements are classified as short-term debt and are reflected as the cash
received in connection with the transaction. Generally these agreements mature
within three months. The Bank may be required to provide additional collateral
based on the fair value of these underlying securities. Total amounts
outstanding at December 31, 2004 were $78,850,000.
NOTE 10 -- INCOME TAXES
Allocation of federal and state income taxes between current and deferred
portions is as follows:
2004 2003 2002
------------- ------------- -------------
Current
Federal $ 1,284,026 $ 961,686 $ 1,312,000
State 91,118 92,965 154,000
------------- ------------- -------------
1,375,144 1,054,651 1,466,000
------------- ------------- -------------
Deferred
Federal 57,973 (19,561) (327,000)
State 7,877 (2,658) (72,000)
------------- ------------- -------------
65,850 (22,219) (399,000)
------------- ------------- -------------
Total Income Tax Expense $ 1,440,994 $ 1,032,432 $ 1,067,000
============= ============= =============
39
TRI-COUNTY FINANCIAL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR THE YEARS ENDED DECEMBER 31, 2004, 2003, AND 2002
The reasons for the differences between the statutory federal income tax rate
and the effective tax rates are summarized as follows:
2004 2003 2002
-------------------------- ------------------------- -------------------------
Percent Percent of Percent of
of Pre Tax Pre Tax Pre Tax
Amount Income Amount Income Amount Income
------------ ---------- ------------ ---------- ------------ ----------
Expected income tax expense at
federal tax rate $ 1,754,682 34.00% $ 1,182,632 34.00% $ 1,031,839 34.00%
State taxes net of federal benefit 65,337 1.27 59,603 1.70 61,666 2.00
Nondeductible expenses 2,527 0.05 14,130 0.40 20,908 0.70
Nontaxable income (179,443) (3.48) (213,613) (6.10) (109,198) (3.60)
Donation of property (202,109) (3.92) - - - -
Other - - (10,320) (0.30) 61,785 2.00
------------ ----- ------------ ----- ------------ -----
$ 1,440,994 27.92% $ 1,032,432 29.70% $ 1,067,000 35.20%
============ ===== ============ ===== ============ =====
The net deferred tax assets in the accompanying balance sheets include the
following components:
2004 2003
----------- -----------
Deferred tax assets:
Deferred fees $ 7,609 $ 9,612
Allowance for loan losses 1,151,205 960,130
Deferred compensation 159,396 152,838
Valuation allowance on foreclosed real estate 259,991 375,730
Unrealized loss on investment
securities available for sale - 1,612
----------- -----------
Total deferred tax assets 1,578,201 1,499,922
----------- -----------
Deferred tax liabilities:
FHLB stock dividends 152,896 152,896
Depreciation 406,797 261,057
Unrealized gain on investment
securities available for sale 95,891 -
----------- -----------
Total deferred tax liabilities 655,584 413,953
----------- -----------
Net deferred tax assets $ 922,617 $ 1,085,969
=========== ===========
Retained earnings at December 31, 2004, included approximately $1.2 million of
bad debt deductions allowed for federal income tax purposes (the "base year tax
reserve") for which no deferred income tax has been recognized. If, in the
future, this portion of retained earnings is used
40
TRI-COUNTY FINANCIAL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR THE YEARS ENDED DECEMBER 31, 2004, 2003, AND 2002
for any purpose other than to absorb bad debt losses, it would create income for
tax purposes only and income taxes would be imposed at the then prevailing
rates. The unrecorded income tax liability on the above amount was approximately
$463,000 at December 31, 2004.
Prior to January 1, 1996, the Bank computed its tax bad debt deduction based
upon the percentage of taxable income method as defined by the Internal Revenue
Code. The bad debt deduction allowable under this method equaled 8% of taxable
income determined without regard to the bad debt deduction and with certain
adjustments. The tax bad debt deduction differed from the bad debt expense used
for financial accounting purposes.
In August 1996, the Small Business Job Protection Act (the "Act") repealed the
percentage of taxable income method of accounting for bad debts effective for
years beginning after December 31, 1995. The Act required the Bank to change its
method of computing reserves for bad debts to the experience method. This method
is available to banks with assets less than $500 million and allows the Bank to
maintain a tax reserve for bad debts and to take bad debt deductions for
reasonable additions to the reserve. As a result of this change, the Bank has to
recapture into income a portion of its existing tax bad debt reserve. This
recapture occurs ratably over a six-taxable year period, beginning with the 1998
tax year. For financial reporting purposes, this recapture does not result in
additional tax expense as the Bank adequately provided deferred taxes in prior
years. Furthermore, this change does not require the Bank to recapture its base
year tax reserve.
NOTE 11 -- COMMITMENTS AND CONTINGENCIES
The Bank 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 are commitments to extend credit. These instruments may,
but do not necessarily, involve, to varying degrees, elements of credit and
interest rate risk in excess of the amount recognized in the balance sheets. The
Bank's exposure to credit loss in the event of nonperformance by the other party
to the financial instrument is represented by the contractual amount of those
instruments. The Bank uses the same credit policies in making commitments as it
does for on-balance-sheet loans receivable.
As of December 31, 2004 and 2003, in addition to the undisbursed portion of
loans receivable of approximately $25,294,533 and $11,568,404, respectively, the
Bank had outstanding loan commitments approximating $578,000 and $2,871,000,
respectively.
Standby letters of credit written are conditional commitments issued by the Bank
to guarantee the performance of a customer to a third party. These guarantees
are issued primarily to support construction borrowing arrangements. The credit
risk involved in issuing letters of credit is essentially the same as that
involved in extending loan facilities to customers. The Bank holds cash or a
secured interest in real estate as collateral to support those commitments for
which collateral is deemed necessary. Standby letters of credit outstanding
amounted to $8,998,000 and $9,538,000 at December 31, 2004 and 2003,
respectively. In addition to the commitments noted above, customers had
approximately $39,200,000 and $28,600,000 available under lines of credit at
December 31, 2004 and 2003, respectively.
41
TRI-COUNTY FINANCIAL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR THE YEARS ENDED DECEMBER 31, 2004, 2003, AND 2002
NOTE 12 -- STOCK OPTION AND INCENTIVE PLAN
The Company had a stock option and incentive plan to attract and retain
personnel and provide incentive to employees to promote the success of the
business. At January 31, 2005, the Company's incentive stock option plan which
was enacted in 1995 expired. All shares authorized and available under this plan
were awarded as of December 31, 2004. In addition, the Company had a stock
option plan for its non-employee directors, which has expired. The exercise
price for options granted under either plan is set at the discretion of the
Board of Directors, but is not less than the market value of the shares as of
the date of grant. An option's maximum term is ten years and the options
generally vest immediately upon issuance.
The following tables summarize activity in the plan:
2004 2003 2002
-------------------- -------------------- --------------------
Weighted Weighted Weighted
Average Average Average
Exercise Exercise Exercise
Shares Price Shares Price Shares Price
------- --------- ------- --------- ------- ---------
Outstanding at beginning of year 154,194 $ 16.81 146,402 $ 14.31 149,519 $ 12.66
Granted 57,971 34.52 25,223 27.64 18,893 21.11
Exercised (30,804) 7.84 (17,430) 11.49 (21,117) 8.61
Forfeitures (2,079) (19.27) - - (893) 17.51
------- ------- -------
Outstanding at end of year 179,281 $ 24.12 154,194 $ 16.81 146,402 $ 14.31
======= ======= =======
Option amounts and exercise prices have been adjusted retroactively to give
effect to the 3 for 2 stock split. Options outstanding are all currently
exercisable and are summarized as follows:
Weighted
Average Weighted
Number Remaining Average
Outstanding Contractual Exercise
December 31, 2004 Life Price
- ----------------- ----------- --------
9,902 1 years $ 6.85
26,896 4 years 16.15
11,244 5 years 17.73
20,754 6 years 17.77
20,360 7 years 17.79
11,460 8 years 26.00
20,696 9 years 28.67
57,969 10 years 34.52
-------
179,281 24.12
=======
42
TRI-COUNTY FINANCIAL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR THE YEARS ENDED DECEMBER 31, 2004, 2003, AND 2002
NOTE 13 -- EMPLOYEE BENEFIT PLANS
The Bank has an Employee Stock Ownership Plan (ESOP) which covers substantially
all of the Bank's employees. The ESOP acquires stock of the Bank's parent
corporation, Tri-County Financial Corporation. The Company accounts for its ESOP
in accordance with AICPA Statement of Position 93-6. Accordingly, unencumbered
shares held by the ESOP are treated as outstanding in computing earnings per
share. Shares issued to the ESOP but pledged as collateral for loans obtained to
provide funds to acquire the shares are not treated as outstanding in computing
earnings per share. Dividends on ESOP shares are recorded as a reduction of
retained earnings. The ESOP may acquire in the open market up to 195,700 shares.
At December 31, 2004, the Plan owned 81,149 shares.
The Company also has a 401(k) plan. The Bank matches a portion of the employee
contributions. This ratio is determined annually by the Board of Directors.
During 2002 one-half of an employee's first 6% deferral was matched. In 2003 and
2004, the Company matched one-half of the employee's first 8% deferral. All
employees who have completed one year of service and have reached the age of 21
are covered under this defined contribution plan. Contributions are determined
at the discretion of management and the Board of Directors. For the years ended
December 31, 2004, 2003, and 2002, the Company charged $89,000, $81,000, and
$108,000, respectively, against earnings to fund the Plans.
In addition, the Bank has a separate nonqualified retirement plan for
non-employee directors. Directors are eligible for a maximum benefit of $3,500 a
year for ten years following retirement from the Board of Community Bank of
Tri-County. The maximum benefit is earned at 15 years of service as a
non-employee director. Full vesting occurs after 2 years of service. Expense
recorded for this plan was $(18,000), $24,000, and $11,000 for the years ending
December 31, 2004, 2003, and 2002, respectively.
NOTE 14 -- REGULATORY MATTERS
The Company and the Bank are subject to various regulatory capital requirements
administered by the federal and state 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 and the Bank's financial statements. Under
capital adequacy guidelines and the regulatory framework for prompt corrective
action, the Bank must meet specific capital guidelines that involve quantitative
measures of the Bank's assets, liabilities and certain off-balance-sheet items
as calculated under regulatory accounting practices. The Bank's capital amounts
and classification are also subject to qualitative judgments by the regulators
about components, risk weightings, and other factors.
Quantitative measures established by regulation to ensure capital adequacy
require the Company and the Bank to maintain minimum amounts and ratios (set
forth in the table below) of tangible and core capital (as defined in the
regulations) to total adjusted assets (as defined), and of risk-based capital
(as defined) to risk-weighted assets (as defined). Management believes, as of
December 31,
43
TRI-COUNTY FINANCIAL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR THE YEARS ENDED DECEMBER 31, 2004, 2003, AND 2002
2004, that the Company and the Bank meet all capital adequacy requirements to
which they are subject.
As of December 31, 2004, the most recent notification from the Federal Reserve
categorized the Bank as well-capitalized under the regulatory framework for
prompt corrective action. To be categorized as well-capitalized, the Bank must
maintain minimum total risk-based, Tier 1 risk-based, and Tier 1 leverage ratios
as set forth in the table. There are no conditions or events since that
notification that management believes have changed the Company's or the Bank's
category. The Company's and the Bank's actual capital amounts and ratios for
2004 and 2003 are presented in the tables below:
To be considered well
capitalized under
Required for capital prompt
Actual adequacy purposes corrective action
-------------- -------------------- ---------------------
At December 31, 2004
Total capital (to risk weighted assets)
The Company $41,368 11.89% $27,842 8.00%
The Bank $40,605 11.67% $27,826 8.00% $34,782 10.00%
Tier 1 capital (to risk weighted assets)
The Company $38,310 11.01% $13,921 4.00%
The Bank $37,548 10.80% $13,913 4.00% $20,869 6.00%
Tier 1 capital (to average assets)
The Company $38,310 9.29% $16,494 4.00%
The Bank $37,548 9.13% $16,454 4.00% $20,568 5.00%
At December 31, 2003
Total capital (to risk weighted assets)
The Company $30,488 12.20% $19,992 8.00%
The Bank $29,193 11.73% $19,912 8.00% $24,890 10.00%
Tier 1 capital (to risk weighted assets)
The Company $27,915 11.17% $9,996 4.00%
The Bank $26,630 10.70% $9,956 4.00% $14,934 6.00%
Tier 1 capital (to average assets)
The Company $27,915 8.04% $13,881 4.00%
The Bank $26,630 7.70% $13,841 4.00% $17,302 5.00%
NOTE 15 -- FAIR VALUE OF FINANCIAL INSTRUMENTS
The estimated fair value amounts have been determined by the Company using
available market information and appropriate valuation methodologies. However,
considerable judgment is necessarily required to interpret market data to
develop the estimates of fair value. Accordingly, the estimates presented herein
are not necessarily indicative of the amounts the Company could realize in a
current market exchange. The use of different market assumptions and/or
estimation methodologies may have a material effect on the estimated fair value
amounts. Therefore, any aggregate unrealized gains or losses should not be
interpreted as a forecast of future earnings or
44
TRI-COUNTY FINANCIAL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR THE YEARS ENDED DECEMBER 31, 2004, 2003, AND 2002
cash flows. Furthermore, the fair values disclosed should not be interpreted as
the aggregate current value of the Company.
December 31, 2004 December 31, 2003
------------------------------- -------------------------------
Estimated Estimated
Carrying Fair Carrying Fair
Amount Value Amount Value
-------------- -------------- -------------- --------------
Assets:
Cash and cash equivalents $ 6,795,615 $ 6,795,615 $ 3,257,466 $ 3,257,466
Interest bearing deposits with banks 10,920,164 10,920,164 8,912,332 8,912,332
Investment securities and stock in FHLB
and FRB 181,834,426 180,758,025 104,672,099 104,281,498
Loans receivable, net 289,325,051 292,988,000 217,740,153 226,213,642
Loans held for sale - - 474,880 482,003
Liabilities:
Savings, NOW, and money market accounts $ 164,952,530 $ 164,952,530 $ 138,088,201 $ 138,088,201
Time certificates 101,801,974 101,448,140 89,466,367 91,095,780
Long-term debt and other borrowed funds 198,235,323 199,752,029 94,242,461 97,940,064
At December 31, 2004 and 2003, the Company had outstanding loan commitments and
standby letters of credit of $9.0 million and $12.4 million, respectively. Based
on the short-term lives of these instruments, the Company does not believe that
the fair value of these instruments differs significantly from their carrying
values.
Valuation Methodology
Cash and Cash Equivalents - For cash and cash equivalents, the carrying amount
is a reasonable estimate of fair value.
Investment Securities - Fair values are based on quoted market prices or dealer
quotes. If a quoted market price is not available, fair value is estimated using
quoted market prices for similar securities.
Mortgage-Backed Securities - Fair values are based on quoted market prices or
dealer quotes. If a quoted market price is not available, fair value is
estimated using quoted market prices for similar securities.
Loans Receivable and Loans Held for Sale - For conforming residential
first-mortgage loans, the market price for loans with similar coupons and
maturities was used. For nonconforming loans with maturities similar to
conforming loans, the coupon was adjusted for credit risk. Loans which did not
have quoted market prices were priced using the discounted cash flow method. The
discount rate used was the rate currently offered on similar products. Loans
priced using the discounted cash flow method included residential construction
loans, commercial real estate loans, and consumer loans. The estimated fair
value of loans held for sale is based on the terms of the related sale
commitments.
45
TRI-COUNTY FINANCIAL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR THE YEARS ENDED DECEMBER 31, 2004, 2003, AND 2002
Deposits - The fair value of checking accounts, saving accounts, and money
market accounts was the amount payable on demand at the reporting date.
Time Certificates - The fair value was determined using the discounted cash flow
method. The discount rate was equal to the rate currently offered on similar
products.
Long-Term Debt and Other Borrowed Funds - These were valued using the discounted
cash flow method. The discount rate was equal to the rate currently offered on
similar borrowings.
Off-Balance sheet instruments - The Company charges fees for commitments to
extend credit. Interest rates on loans for which these commitments are extended
are normally committed for periods of less than one month. Fees charged on
standby letters of credit and other financial guarantees are deemed to be
immaterial and these guarantees are expected to be settled at face amount or
expire unused. It is impractical to assign any fair value to these commitments.
The fair value estimates presented herein are based on pertinent information
available to management as of December 31, 2004 and 2003. Although management is
not aware of any factors that would significantly affect the estimated fair
value amounts, such amounts have not been comprehensively revalued for purposes
of these financial statements since that date and, therefore, current estimates
of fair value may differ significantly from the amount presented herein.
NOTE 16-- GUARANTEED PREFERRED BENEFICIAL INTEREST IN JUNIOR SUBORDINATED
DEBENTURES
On July 22, 2004, Tri-County Capital Trust I ("Capital Trust I"), a Delaware
business trust formed, funded and wholly owned by the Company, issued $7,000,000
of variable-rate capital securities with an interest rate of 4.22% in a private
pooled transaction. The variable rate is based on the 90-day LIBOR rate plus
2.60%. The Trust used the proceeds from this issuance, along with the Company's
$217,000 capital contribution for Capital Trust 1's common securities, to
purchase $7.2 million of the Company's junior subordinated debentures. The
interest rate on the debentures and the trust preferred securities is variable
and adjusts quarterly. The Company has, through various contractual
arrangements, fully and unconditionally guaranteed all of Capital Trust I's
obligations with respect to the capital securities. These debentures qualify as
Tier I capital and are presented in the Consolidated Balance Sheets as
"Guaranteed Preferred Beneficial Interests in Junior Subordinated Debentures."
Both the capital securities of Capital Trust I and the junior subordinated
debentures are scheduled to mature on July 22, 2034, unless called by the
Company not earlier than July 22, 2009.
Costs associated with the issuance of the trust-preferred securities were less
than $10,000 and were expensed as period costs.
46
TRI-COUNTY FINANCIAL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR THE YEARS ENDED DECEMBER 31, 2004, 2003, AND 2002
NOTE 17--CONDENSED FINANCIAL STATEMENTS - PARENT COMPANY ONLY
Financial information pertaining only to Tri-County Financial Corporation is as
follows:
Balance Sheets
December 31,
------------------------------
2004 2003
------------- -------------
Assets
Cash-noninterest bearing $ 269,072 $ 298,364
Cash-interest bearing 181,516 255,108
Investment securities available for sale 34,666 33,152
Investment in wholly owned subsidiaries 37,951,438 26,627,098
Other assets 194,074 957,544
------------ ------------
$ 38,630,766 $ 28,171,266
============ ============
Liabilities and Stockholders' Equity
Current liabilities $ 290,191 $ 259,356
Guaranteed preferred beneficial interest in junior Subordinated Debentures 7,217,000 -
------------ ------------
Total liabilities 7,507,191 259,356
Stockholders' equity
Common stock 11,469 7,533
Surplus 8,252,152 7,975,036
Retained earnings 22,833,112 20,071,630
Total accumulated other comprehensive income (loss) 186,140 (3,130)
Unearned ESOP shares (159,298) (139,159)
------------ ------------
31,123,575 27,911,910
$ 38,630,766 $ 28,171,266
============ ============
Condensed Statements of Income:
Year Ended December 31,
--------------------------------------------
2004 2003 2002
------------ ------------ ------------
Dividends from subsidiary $ - $ 500,000 $ 1,000,000
Interest income 6,349 10,356 18,644
Interest expense 140,341 - -
----------- ----------- -----------
Net interest Income (133,992) 510,356 1,018,644
Miscellaneous expenses (166,364) (174,595) (154,995)
----------- ----------- -----------
Income before income taxes and equity in (300,356) 335,761 863,649
undistributed net income of subsidiary
Federal and state income tax benefit 102,120 55,841 46,000
Equity in undistributed net income of subsidiary 3,918,070 2,054,296 1,058,172
----------- ----------- -----------
NET INCOME $ 3,719,834 $ 2,445,898 $ 1,967,821
=========== =========== ===========
47
TRI-COUNTY FINANCIAL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR THE YEARS ENDED DECEMBER 31, 2004, 2003, AND 2002
Condensed Statements of Cash Flows:
Year Ended December 31,
--------------------------------------------
2004 2003 2002
------------ ------------ ------------
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income $ 3,719,834 $ 2,445,898 $ 1,967,821
Adjustments to reconcile net income to net cash
provided by operating activities:
Equity in undistributed earnings of subsidiary (3,918,070) (2,054,296) (1,058,172)
Decrease (Increase) in other assets 763,470 (72,560) (147,776)
Increase in current liabilities 30,835 5,008 14,222
----------- ----------- -----------
Net cash provided by operating activities 596,069 324,050 730,095
----------- ----------- -----------
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchase of investment securities available for sale (1,514) (714) -
Maturity or redemption of investment securities
available for sale - - 79,146
----------- ----------- -----------
Net cash provided (used) by investing activities (1,514) (714) 79,146
----------- ----------- -----------
CASH FLOWS FROM FINANCING ACTIVITIES:
Proceeds from guaranteed preferred beneficial interests
in Junior Subordinated Securities 7,217,000 - -
Downstream of capital to subsidiary (7,000,000)
Investment in trust subsidiary (217,000)
Dividends paid (541,633) (422,361) (385,129)
Exercise of stock options 248,661 218,713 161,004
Net change in ESOP loan 8,506 63,435 48,000
Redemption of common stock (412,973) (769,720) (443,568)
----------- ----------- -----------
Net cash used in financing activities (697,439) (909,933) (619,693)
----------- ----------- -----------
INCREASE (DECREASE) IN CASH (102,884) (586,597) 276,927
CASH AT BEGINNING OF YEAR 553,472 1,140,069 950,521
----------- ----------- -----------
CASH AT END OF YEAR $ 450,588 $ 553,472 $ 1,227,448
=========== =========== ===========
48
TRI-COUNTY FINANCIAL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR THE YEARS ENDED DECEMBER 31, 2004, 2003, AND 2002
NOTE 18 --QUARTERLY FINANCIAL RESULTS (UNAUDITED)
A summary of selected consolidated quarterly financial data for the two
years ended December 31, 2004 is reported as follows:
2004 2004 2004 2004
Fourth Third Second First
Quarter Quarter Quarter Quarter
---------- ---------- ---------- ----------
Interest and dividend income $6,455,056 $5,943,358 $4,621,114 $4,593,811
Interest Expense 2,560,878 2,086,208 1,602,035 1,564,289
---------- ---------- ---------- ----------
Net interest income 3,894,178 3,857,150 3,019,079 3,029,522
Provision for loan loss 136,028 232,996 13,772 70,202
---------- ---------- ---------- ----------
Net interest income after provision 3,758,150 3,624,154 3,005,307 2,959,320
Noninterest income 422,187 302,372 461,529 396,228
Noninterest expense 2,747,623 2,307,562 2,317,511 2,395,723
Income before income taxes 1,432,714 1,618,964 1,149,325 959,825
Provision for income taxes 486,960 537,658 345,749 70,627
Net income $ 945,754 $1,081,306 $ 803,576 $ 889,198
========== ========== ========== ==========
Earnings per common share
Basic $ 0.81 $ 0.94 $ 0.70 $ 0.79
Diluted $ 0.78 $ 0.90 $ 0.67 $ 0.75
2003 2003 2003 2003
Fourth Third Second First
Quarter Quarter Quarter Quarter
---------- ---------- ---------- ----------
Interest and dividend income $4,112,111 $4,210,624 $3,923,796 $3,918,384
Interest Expense 1,524,537 1,431,824 1,378,744 1,361,294
---------- ---------- ---------- ----------
Net interest income 2,587,574 2,778,800 2,545,052 2,557,090
Provision for loan loss 171,623 31,013 108,941 5,386
---------- ---------- ---------- ----------
Net interest income after provision 2,415,951 2,747,787 2,436,111 2,551,704
Noninterest income 580,039 332,762 453,793 387,954
Noninterest expense 2,163,566 2,190,164 2,125,494 1,948,547
Income before income taxes 832,424 890,385 764,410 991,111
Provision for income taxes 133,667 293,550 255,215 350,000
Net income $ 698,757 $ 596,835 $ 509,195 $ 641,111
========== ========== ========== ==========
Earnings per common share
Basic $ 0.62 $ 0.53 $ 0.45 $ 0.56
Diluted $ 0.58 $ 0.50 $ 0.43 $ 0.53
All per share amounts have been adjusted for the 3 for 2 stock split which
occurred in December 2004.
49