UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
(MARK ONE)
(X) QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the Quarterly Period Ended June 30, 2003
OR
( ) TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from ________ to ________
Commission File Number 0-25923
EAGLE BANCORP, INC
(Exact name of registrant as specified in its charter)
Maryland 52-2061461
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
7815 Woodmont Avenue, Bethesda, Maryland 20814
(Address of principal executive offices) (Zip Code)
(301) 986-1800
(Registrant's telephone number, including area code)
N/A
(Former name, former address and former fiscal year,
if changed since last report)
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes [X] No [ ]
Indicate by check mark whether the registrant is an accelerated filer
(as defined in Rule 12b-2 of the Exchange Act Yes [ ] No [X]
Indicate the number of shares outstanding of each of the issuer's
classes of common stock, as of the latest practical date.
As of August 7, 2003, the registrant had 5,356,153 shares of Common
Stock outstanding.
Item 1 - Financial Statements
EAGLE BANCORP, INC.
CONSOLIDATED BALANCE SHEETS
JUNE 30, 2003 AND DECEMBER 31, 2002
(dollars in thousands)
ASSETS
June 30, December 31,
2003 2002
(unaudited)
------------------ -----------------
Cash and due from banks $ 33,732 $ 18,569
Interest bearing deposits with other
banks 20,755 6,119
Federal funds sold 9,019 3,012
Investment securities available for sale 83,392 70,675
Loans held for sale 4,181 5,546
Loans 261,392 236,860
Less: allowance of credit losses (2,952) (2,766)
------------------ -----------------
Loans, net 258,440 234,094
Premises and equipment, net 4,142 3,601
Deferred income taxes 569 464
Other assets 6,406 5,749
------------------ -----------------
TOTAL ASSETS $ 420,636 $ 347,829
================== =================
LIABILITIES AND STOCKHOLDERS' EQUITY
LIABILITIES:
Deposits:
Noninterest-bearing demand $ 81,513 $ 64,432
Interest-bearing transaction 45,327 39,968
Savings and money market 101,668 92,324
Time, $100,000 or more 45,941 46,989
Other time 34,050 34,721
------------------ -----------------
Total deposits 308,499 278,434
Customer repurchase agreements 27,186 25,054
Other short-term borrowings 13,940 8,600
Other long-term borrowings 12,333 14,333
Other liabilities 1,275 1,380
Escrowed subscriptions received 35,835 --
------------------ -----------------
Total liabilities 399,068 327,801
STOCKHOLDERS' EQUITY:
Common stock, $.01 par value; 20,000,000
authorized, 2,907,174 (2003) 2,897,704 (2002)
issued and outstanding 29 29
Additional paid in capital 16,631 16,541
Retained earnings 4,688 3,066
Accumulated other comprehensive income 220 392
------------------ -----------------
Total stockholders' equity 21,568 20,028
------------------ -----------------
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $ 420,636 $ 347,829
================== =================
See notes to consolidated financial statements
2
EAGLE BANCORP, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
SIX AND THREE MONTHS ENDED JUNE 30, 2003 AND 2002
(dollars in thousands, except per share amounts-unaudited)
Six Months Six Months Three Months Three Months
Ended Ended Ended Ended
June 30, 2003 June 30, 2002 June 30, 2003 June 30, 2002
------------- ------------- ------------- -------------
INTEREST INCOME:
Interest and fees on loans $ 7,783 $ 6,824 $ 3,919 $ 3,534
Taxable interest and dividends on
investment securities 916 854 367 479
Interest on balances with other banks 94 4 54 2
Interest on federal funds sold 26 37 13 15
------------ ----------- ----------- ---------
Total interest income 8,819 7,719 4,353 4,030
------------ ----------- ----------- ---------
INTEREST EXPENSE:
Interest on deposits 1,656 2,188 815 1,083
Interest on customer repurchase
agreements 58 108 30 60
Interest on short-term borrowings 144 48 62 29
Interest on long-term borrowings 284 170 160 86
------------ ----------- ----------- ---------
Total interest expense 2,142 2,514 1,067 1,258
------------ ----------- ----------- ---------
NET INTEREST INCOME 6,677 5,205 3,286 2,772
PROVISION FOR CREDIT LOSSES 425 493 201 213
------------ ----------- ----------- ---------
NET INTEREST INCOME AFTER PROVISION
FOR CREDIT LOSSES 6,252 4,712 3,085 2,559
------------ ----------- ----------- ---------
NONINTEREST INCOME:
Service charges on deposit accounts 579 490 307 287
Gain on sale of investment securities 214 -- 22 --
Gain on sale of loans 346 97 98 56
Other income 307 140 146 85
------------ ----------- ----------- ---------
Total noninterest income 1,446 727 573 428
------------ ----------- ----------- ---------
NONINTEREST EXPENSES:
Salaries and employee benefits 2,746 2,115 1,400 1,105
Premises and equipment expenses 934 795 511 417
Advertising 124 83 62 45
Outside data processing 264 229 129 124
Other expenses 1,048 821 549 459
------------ ----------- ----------- ---------
Total noninterest expenses 5,116 4,043 2,651 2,150
NET INCOME BEFORE INCOME TAXES 2,582 1,396 1,007 837
INCOME TAXES 960 499 368 309
------------ ----------- ----------- ---------
NET INCOME $ 1,622 $ 897 $ 639 $ 528
------------ ----------- ----------- ---------
INCOME PER SHARE:
Basic $ 0.56 $ 0.31 $ 0.22 $ 0.18
Diluted $ 0.52 $ 0.29 $ 0.20 $ 0.17
See notes to consolidated financial statements
3
EAGLE BANCORP, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
FOR THE SIX MONTHS ENDED JUNE 30, 2003 and 2002
(dollars in thousands-unaudited)
Six Months Ended Six Months Ended
CASH FLOWS FROM OPERATING ACTIVITIES: June 30, 2003 June 30, 2002
Net income $ 1,622 $ 897
Adjustments to reconcile net income to net cash
provided by operating activities:
Increase (decrease) in deferred income taxes 125 (184)
Provision for credit losses 425 493
Depreciation and amortization 317 257
Gain on sale of loans (346) (97)
Origination of loans held for sale (10,415) (2,734)
Proceeds from sale of loans held for sale 12,126 2,831
Gain on sale of investment securities (214) --
Increase in other assets (657) (1,916)
(Decrease) increase in other liabilities (105) 12
------------------ ----------------------
Net cash provided (used) by operating activities 2,878 (441)
------------------ ----------------------
CASH FLOWS FROM INVESTING ACTIVITIES:
(Increase) decrease in interest bearing deposits with other banks (14,636) 5
Purchases of available for sale investment securities (121,313) (116,120)
Proceeds from maturities of available for sale securities 93,831 103,707
Proceeds from sale of available for sale securities 14,577 --
Increase in federal funds sold (6,007) --
Net increase in loans (24,771) (22,800)
Bank premises and equipment acquired (858) (647)
------------------ ----------------------
Net cash used by investing activities (59,177) (35,855)
------------------ ----------------------
CASH FLOWS FROM FINANCING ACTIVITIES:
Increase in deposits 30,065 38,947
(Decrease) increase in customer repurchase agreements 2,132 7,975
Increase in other short term borrowings 5,340 3,380
Decrease in long-term borrowings (2,000) (1,675)
Issuance of common stock 90 10
Increase in escrowed subscriptions received 35,835 --
------------------ ----------------------
Net cash provided by financing activities 71,462 48,637
------------------ ----------------------
NET INCREASE IN CASH 15,163 12,341
CASH AND DUE FROM BANKS AT BEGINNING OF PERIOD 18,569 6,483
------------------ ----------------------
CASH AND DUE FROM BANKS AT END OF PERIOD $ 33,732 $ 18,824
================== ======================
See notes to consolidated financial statements
4
EAGLE BANCORP, INC
CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY FOR THE SIX MONTHS
ENDED JUNE 30, 2003 AND 2002
(dollars in thousands - unaudited)
Accumulated
Additional Other Total
Common Paid in Retained Comprehensive Stockholders
Stock Capital Earnings Income Equity
--------------------------------------------------------------------------
Balances at January 1, 2003 $ 29 $ 16,541 $ 3,266 $ 392 $ 20,028
Net income 1,622 1,622
Exercise of options for 9,470
shares of common stock 90 90
Other comprehensive income-
Unrealized gain on investment
securities available for sale (172) (172)
--------------
Total comprehensive income 1,540
----------------------------------------------------------------------
Balances at June 30, 2003 $ 29 $ 16,631 $ 4,688 $ 220 $ 21,568
----------------------------------------------------------------------
Balances at January 1, 2002 $ 29 $ 16,515 $ 399 $ 189 $ 17,132
Net income 897 897
Exercise of options for 1,000 shares
of common stock 10 10
Other comprehensive income-unrealized
loss on investment securities available
for sale 234 234
--------------
Total comprehensive income 1,141
----------------------------------------------------------------------
Balances at June 30, 2002 $ 29 $ 16,525 $ 1,296 $ 423 $ 18,273
======================================================================
5
EAGLE BANCORP, INC.
NOTES TO FINANCIAL STATEMENTS
1. BASIS OF PRESENTATION
General - The financial statements of Eagle Bancorp, Inc. (the "Company")
included herein are unaudited; however, they reflect all adjustments
consisting only of normal recurring accruals that, in the opinion of
Management, are necessary to present fairly the results for the periods
presented. The amounts as of December 31, 2002 were derived from audited
financial statements. Certain information and note disclosures normally
included in financial statements prepared in accordance with accounting
principles generally accepted in the United States of America have been
condensed or omitted pursuant to the rules and regulations of the
Securities and Exchange Commission. There have been no significant changes
to the Company's Accounting Policies as disclosed in the 2002 Annual
Report. The Company believes that the disclosures are adequate to make the
information presented not misleading. The results of operations for the six
months ended June 30, 2003 are not necessarily indicative of the results of
operations to be expected for the remainder of the year, or for any other
period.
2. NATURE OF BUSINESS
The Company, through its bank subsidiary, provides domestic financial
services primarily in Montgomery County, Maryland and Washington, DC. The
primary financial services include real estate, commercial and consumer
lending, as well as traditional demand deposits and savings products.
3. INVESTMENT SECURITIES
Amortized cost and estimated fair value of securities available - for -
sale are summarized as follows: (in thousands)
June 30, 2003
Gross Gross Estimated
Amortized Unrealized Unrealized Fair
Cost Gains Losses Value
--------- ---------- ---------- ---------
U. S. Treasury securities $ 39,501 $ -- $ -- $ 39,501
U. S. Government Agency securities 9,051 36 -- 9,087
Mortgage backed securities 32,773 333 (23) 33,083
Federal Reserve Bank and
Federal Home Loan Bank stock 1,460 -- -- 1,460
Other equity investments 275 16 (30) 261
---------------- --------------- --------------- ----------------
$ 83,060 $ 399 $ (53) $ 83,392
================ =============== =============== ================
December 31, 2002
Gross Gross Estimated
Amortized Unrealized Unrealized Fair
Cost Gains Losses Value
--------- ---------- ---------- ---------
U. S. Treasury securities $ 5,501 $ 3 $ -- $ 5,504
U. S. Government Agency securities 19,961 153 (7) 20,114
Mortgage backed securities 42,782 493 43,268
Federal Reserve Bank and Federal Home
Loan Bank stock 1,564 -- -- 1,564
Other equity investments 274 -- (49) 225
---------------- --------------- --------------- ----------------
$ 70,082 $ 649 $ (56) $ 70,675
================ =============== =============== ================
6
4. INCOME TAXES
The Company uses the liability method of accounting for income taxes as
required by SFAS No. 109, "Accounting for Income Taxes." Under the
liability method, deferred-tax assets and liabilities are determined based
on differences between the financial statement carrying amounts and the tax
bases of existing assets and liabilities (i.e., temporary differences) and
are measured at the enacted rates that will be in effect when these
differences reverse.
5. EARNINGS PER SHARE
Earnings per common share are computed by dividing net income by the
weighted average number of common shares outstanding during the period.
Diluted net income per common share is computed by dividing net income by
the weighted average number of common shares outstanding during the period,
including any potential dilutive common shares outstanding, such as options
and warrants. As of June 30, 2003 there were 1,424 shares excluded from the
diluted net income per share computation because the option price exceeded
the average market price and therefore, their effect would be
anti-dilutive.
6. STOCK-BASED COMPENSATION
The Company has adopted the disclosure-only provisions of SFAS No. 123
"Accounting for Stock-Based Compensation" and SFAS No. 148 "Accounting for
Stock-Based Compensation-Transition and Disclosure", but applies Accounting
Principles Board Opinion No. 25 and related interpretations in accounting for
its Plan. No compensation expense related to the Plan was recorded during the
three and six months ended June 30, 2003 and 2002. If the Company had elected to
recognize compensation cost based on fair value at the grant dates for awards
under the Plan consistent with the method prescribed by SFAS No. 123, net income
and earnings per share would have been changed to the pro forma amounts as
follows for the three and six months ended June 30.
Six months Three months
ended June 30 ended June 30
---------------------- -----------------------
2003 2002 2003 2002
---- ---- ---- ----
Net income, as reported $ 1,622 $ 897 $ 639 $ 528
Less pro forma stock-based compensation
expense determined under the fair value
method, net of related tax effects (173) (125) (167) (119)
-------- ------- ------ ------
Pro forma net income $ 1,449 $ 772 $ 472 $ 409
-------- ------- ------ ------
Net income per share:
Basic - as reported $ 0.56 $ 0.31 $ 0.22 $ 0.18
Basic - pro forma $ 0.50 $ 0.27 $ 0.16 $ 0.14
Diluted - as reported $ 0.52 $ 0.29 $ 0.20 $ 0.17
Diluted - pro forma $ 0.46 $ 0.25 $ 0.15 $ 0.13
7
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATION.
The following discussion provides information about the results of
operations, and financial condition, liquidity, and capital resources of the
Company and its subsidiary the Bank. This discussion and analysis should be read
in conjunction with the unaudited Consolidated Financial Statements and Notes
thereto, appearing elsewhere in this report.
This report contains forward looking statements within the meaning of
the Securities Exchange Act of 1934, as amended, including statements of goals,
intentions, and expectations as to future trends, plans, events or results of
Company operations and policies and regarding general economic conditions. In
some cases, forward looking statements can be identified by use of such words as
"may", "will", "anticipate", "believes", "expects", "plans", "estimates",
"potential", "continue", "should", and similar words or phases. These statements
are based upon current and anticipated economic conditions, nationally and in
the Company's market, interest rates and interest rate policy, competitive
factors and other conditions which, by their nature, are not susceptible to
accurate forecast, and are subject to significant uncertainty. Because of these
uncertainties and the assumptions on which this discussion and the forward
looking statements are based, actual future operations and results in the future
may differ materially from those indicated herein. Readers are cautioned against
placing undue reliance on any such forward looking statements.
GENERAL
Eagle Bancorp, Inc. is a growing, one-bank holding company
headquartered in Bethesda, Maryland. We provide general commercial and consumer
banking services through our wholly owned banking subsidiary EagleBank, a
Maryland chartered bank which is a member of the Federal Reserve System. We were
organized in October 1997 to be the holding company for the Bank. The Bank was
organized as an independent, community oriented, full-service alternative to the
super regional financial institutions, which dominate our primary market area.
The cornerstone of our philosophy is to provide superior, personalized service
to our customers. We focus on relationship banking, providing each customer with
a number of services, becoming familiar with and addressing customer needs in a
proactive, personalized fashion. The Bank has five offices serving the southern
portion of Montgomery County and one office in the District of Columbia.
The Company offers full commercial banking services to our business and
professional clients as well as complete consumer banking services to
individuals living and/or working in the service area. We emphasize providing
commercial banking services to sole proprietors, small and medium-sized
businesses, partnerships, corporations, non-profit organizations and
associations, and investors living and working in and near our primary service
area. A full range of retail banking services are offered to accommodate the
individual needs of both corporate customers as well as the community we serve.
These services include the usual deposit functions of commercial banks,
including business and personal checking accounts, "NOW" accounts and savings
accounts, business, construction, and commercial loans, equipment leasing,
residential mortgages and consumer loans and cash management services. We have
developed significant expertise and commitment as an SBA lender, have been
designated a Preferred Lender, and are one of the largest SBA lenders, in dollar
volume, in the Washington Metropolitan area.
In June 2003, the Company formed a second wholly owned subsidiary,
Bethesda Leasing, LLC ("Bethesda Leasing"). Bethesda Leasing was formed for the
purpose of acquiring an impaired loan from the Bank in order to achieve more
efficient administration and collection procedures. See further comments on the
formation of Bethesda Leasing under the section "Allowance for Credit Losses".
CRITICAL ACCOUNTING POLICIES
The Company's consolidated financial statements are prepared in
accordance with accounting principles generally accepted in the United States of
America ("GAAP") and follow general practices within the industry in which it
operates. 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
8
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.
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.
The allowance for credit losses is an estimate of the losses that may
be sustained in our loan portfolio. The allowance is based on two principles of
accounting: (a) Statement on Financial Accounting Standards ("SFAS") 5,
"Accounting for Contingencies", which requires that losses be accrued when they
are 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.
Three basic components comprise our allowance for credit losses: a
specific allowance, a formula allowance and a nonspecific allowance. Each
component is determined based on estimates that can and do change when the
actual events occur. The specific allowance is used to individually allocate an
allowance to loans identified as impaired. An impaired loan may show
deficiencies in the borrower's overall financial condition, payment record,
support available from financial guarantors and/or the fair market value of
collateral. When a loan is identified as impaired a specific reserve is
established based on the Company's assessment of the loss that may be associated
with the individual loan. The formula allowance is used to estimate the loss on
internally risk rated loans, exclusive of those identified as impaired. Loans
identified as special mention, substandard, doubtful and loss, as well as
impaired, are segregated from performing loans. Remaining loans are then grouped
by type (commercial, commercial real estate, construction, home equity or
consumer). Each loan type is assigned an allowance factor based on management's
estimate of the risk, complexity and size of individual loans within a
particular category. Classified loans are assigned higher allowance factors than
non-rated loans due to management's concerns regarding collectibility or
management's knowledge of particular elements regarding the borrower. Allowance
factors grow with the worsening of the internal risk rating. The nonspecific
formula is used to estimate the loss of non-classified loans stemming from more
global factors such as delinquencies, loss history, trends in volume and terms
of loans, effects of changes in lending policy, the experience and depth of
management, national and local economic trends, concentrations of credit,
quality of loan review system and the effect of external factors such as
competition and regulatory requirements. The nonspecific allowance captures
losses whose impact on the portfolio have occurred but have yet to be recognized
in either the formula or specific allowance.
Management has significant discretion in making the judgments inherent
in the determination of the provision and allowance for credit losses, including
in connection with the valuation of collateral, a borrower's prospects of
repayment, and in establishing allowance factors on the formula allowance and
nonspecific allowance components of the allowance. The establishment of
allowance factors is a continuing exercise, based on management's continuing
assessment of the global factors discussed above and their impact on the
portfolio, and allowance factors may change from period to period, resulting in
an increase or decrease in the amount of the provision or allowance, based upon
the same volume and classification of loans. 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 credit losses, refer to the discussion under the caption "Allowance for
Credit Losses" below.
RESULTS OF OPERATIONS
The Company reported net income of $1.62 million for the six months and
$639 thousand for the three months ended June 30, 2003, as compared to net
income of $897 thousand for the six months and $528 thousand for the three
months ended June 30, 2002. Income per basic share was $0.56 for the six months
and $0.22 for the three months ended June 30, 2003, as compared to $0.31 and
$0.18 respectively for the same periods in 2002. Income per
9
diluted share was $0.52 for the six months and $0.20 for the three months end
June 30, 2003, as compared to $0.29 and $0.17 for the same periods in 2002. The
Company had a return on average assets of 0.93% and return on average equity of
15.52% for the first six months of 2003, as compared to returns on average
assets and average equity of 0.70% and 10.22% respectively for the six months of
2002.
The reported net income for the six months ended June 30, 2003,
represents an increase in earnings of 82% from the corresponding period in 2002,
$1.62 million from $897 thousand. The net income for the three months ended June
30, 2003, represents an increase of 21% from the corresponding period in 2002,
$639 thousand from $528 thousand. The six month results, when compared to the
same period in 2002, can be attributed to an increase of 28% in net interest
income, reflecting an increase of 32% in average earning assets offset by a
decline of 12 basis points in net interest margin. Net interest income increased
from $5.2 million to $6.7 million average earning assets increased from $244
million to $323 million. During the same period net interest margin declined
from 4.29% in 2002 to 4.17% in 2003 as market interest rates continued to fall.
Comparing the six month period, noninterest income increased 99%, to $1.45
million from $727 thousand.
For the six months ended June 30, 2003, the Company recorded a
provision for credit losses in the amount of $425 thousand. At June 30, 2003,
the allowance for credit losses was $2.95 million, as compared to $2.77 million
at December 31, 2002. The Company had net charge-offs of $239 thousand during
the first six months of 2003 representing 0.2% of average loans on an annualized
basis. This compared to a provision for credit losses of $493 thousand for the
first six months of 2002, and net charge-offs of $119 thousand for the same
period, representing 0.2% of average loans on an annualized basis.
The following table sets out the annualized returns on average assets, returns
on average equity and equity to assets (average) for the six months ending June
30, 2003 and 2002 and the year ending December 31, 2002:
June June December
2003 2002 2002
---- ---- ----
Return on average assets 0.93% 0.70% 0.91%
Return on average equity 15.52% 10.22% 14.51%
Average equity to average assets 6.02% 6.80% 6.28%
NET INTEREST INCOME AND NET INTEREST MARGIN
Net interest income is the difference between interest income on
earning assets and the cost of funds supporting those assets. Earning assets are
composed primarily of loans and investment securities. The cost of funds
represents interest expense on deposits, customer repurchase agreements and
other borrowings. Noninterest bearing deposits and capital are other components
representing funding sources. Changes in the volume and mix of assets and
funding sources, along with the changes in yields earned and rates paid,
determine changes in net interest income. Net interest income for the first six
months of 2003 was $6.7 million compared to $5.2 million for the first six
months in 2002.
The table labeled "Average Balances, Interest Yields and Rates and Net
Interest Margin" presents the average balances and rates of the various
categories of the Company's assets and liabilities. Included in the table is a
measurement of interest rate spread and margin. Interest spread is the
difference between the rate earned on assets less the cost of funds expressed as
a percentage. While spread provides a quick comparison of earnings rates versus
cost of funds, management believes that margin provides a better measurement of
performance. Margin includes the effect of noninterest bearing liabilities in
its calculation and is net interest income expressed as a percentage of total
earning assets. Interest spread decreased in the six months of 2003 from the
first six months of 2002 by 2 basis points, 3.78% from 3.80%; and margin
decreased 12 basis points, 4.17% from 4.29%. The decrease in both spread and
margin, from period to period, can be attributed to overall lower market
interest rates and the resulting refinancing or renegotiation of older debt and
the negotiation of lower competitive rates on new debt. In addition to lower
interest rates, the change in the mix of Company assets contributed to a decline
in margin. In the six months ended June 30, 2002 loans made up 81% of earning
assets while in the first six months of 2003 loans made up only 77% of earning
assets. The effect was a greater concentration of earning assets in lower
yielding investment instruments as compared to loans. From the first six months
of 2002 to the first six months of 2003, the yield on
10
earning assets declined 91 basis points while the average interest rate on
interest bearing liabilities declined 88 basis points.
The declines in both the yields on earning assets and interest bearing
liabilities from the first six months of 2002 to the first six months of 2003
reflect the continued impact of the significant rate reductions effected by the
Federal Reserve in 2001 and continued into 2002 with the last rate reduction
occurring in June 2003. The investment portfolio yield declined from 2002 to
2003 by 107 basis points as the Bank maintained a portfolio of short term fixed
rate securities and pass through mortgage backed securities. The yield on
mortgage backed securities declined as mortgage refinancing accelerated,
resulting in earlier repayment of mortgage backed securities, and reinvestment
of the proceeds at lower current market rates. In order to keep the investment
portfolio short for liquidity and expectations that rates would start to move
upward, and to obtain better short term yields, the Bank invested $6 million in
interest bearing deposits with other banks in late 2002, currently yielding
2.20%, a relatively attractive rate given their short term nature and low risk,
as compared to the rates offered on federal funds and U. S. Treasury bills. The
remaining $14.6 million of the interest bearing deposits in other banks
represents a portion of the escrowed subscription funds relating to the
Company's offering of common stock. The Company is entitled to the earnings on
such deposits.
The decline in the yield on the loan portfolio, while 62 basis points,
was less than the decline in the yield on other earning assets because
approximately 50% of the loan portfolio is composed of fixed rate loans. The
fixed rate loans stabilize the effects of rate reductions in repricable loans
thereby slowing the decline in the overall yield of the portfolio. Over time, of
course, market pressures and loan repayments and maturities will force the
portfolio yield down even when there may be no further market rate reductions.
On the liability side, management aggressively reduced rates on deposit
accounts. The reduction in the rate on total interest bearing liabilities from
the first six months of 2002 to the first six months of 2003 was 88 basis points
which compares to a reduction of 91 basis points in the yield on earning assets
over the same period. The reduction in the rates paid by the Bank reduced the
average rate on the cost of funds below 2% in the latter part of 2002.
It is anticipated that any further reductions in interest rates may
have a significant adverse effect on earnings as rates paid on interest bearing
liabilities, which are as low as 0.10% on NOW accounts, cannot continue to
decline at the same rate as yields on loans and investments.
11
AVERAGE BALANCES, INTEREST YIELDS, AND RATES, AND NET INTEREST MARGIN
SIX MONTHS ENDED JUNE 30,
2003 2002
--------------------------------------- ---------------------------------------
Average Average Average Average
Balance Interest Yield/Rate Balance Interest Yield/Rate
------- -------- ---------- ------- -------- ----------
ASSETS:
Interest earnings assets:
Interest bearing deposits with
other banks $ 8,647 $ 94 2.20% $ 147 $ 4 5.41%
Loans 247,527 7,783 6.34% 198,502 6,824 6.93%
Investment securities 62,078 916 2.95% 41,186 854 4.15%
Federal funds sold and other 4,704 26 1.14% 4,664 37 1.60%
------------ ----------- ------------ -----------
Total interest earning assets 322,946 8,819 5.46% 244,499 7,719 6.36%
Total noninterest earning assets 27,022 15,820
Less: allowance for credit losses 2,881 2,282
------------ ------------
Total noninterest earning assets 24,141 13,538
------------ ------------
TOTAL ASSETS $ 347,087 $ 258,037
============ ============
LIABILITIES AND STOCKHOLDERS' EQUITY:
Interest bearing liabilities:
NOW accounts $ 36,355 49 0.27% 25,880 40 0.31%
Savings and money market accounts 98,308 652 1.34% 72,092 752 2.10%
Certificates of deposit 76,792 955 2.51% 75,547 1,396 3.73%
Customer repurchase agreements 20,921 58 0.56% 14,096 108 1.55%
Short-term borrowing 8,060 144 3.60% 2,375 48 4.08%
Long-term borrowing 16,436 284 3.48% 8,000 170 4.28%
------------ ----------- ------------ -----------
Total interest bearing liabilities 256,872 2,142 1.68% 197,990 2,514 2.56%
------------ ----------- ------------ -----------
Noninterest bearing liabilities:
Noninterest bearing deposits 64,222 41,400
Other liabilities 1,489 1,091
Escrowed subscriptions received 3,604 --
------------ ------------
Total noninterest bearing liabilities 69,315 42,491
------------ ------------
Stockholders' equity 20,900 17,556
TOTAL LIABILITIES AND
STOCKHOLDERS' EQUITY $ 347,087 $ 258,037
============ ============
Net interest income $ 6,677 $ 4,712
=========== ============
Net interest spread 3.78% 3.80%
Net interest margin 4.17% 4.29%
12
ALLOWANCE FOR CREDIT LOSSES
The provision for credit losses represents the expense recognized to
fund the allowance for credit losses. The amount of the allowance for credit
losses is based on many factors which reflect management's assessment of the
risk in the loan portfolio. Those factors include economic conditions and
trends, the value and adequacy of collateral, volume and mix of the portfolio,
performance of the portfolio, and internal loan processes of the Company and
Bank.
Management has developed a comprehensive review process to monitor the
adequacy of the allowance for credit losses. The review process and guidelines
were developed utilizing guidance from federal banking regulatory agencies. The
results of this review process, in combination with conclusions of the Bank's
outside loan review consultant, support management's view as to the adequacy of
the allowance as of the balance sheet date. During the first six months of 2003,
a provision for credit losses was made in the amount of $425 thousand before net
charge-offs of $239 thousand. Please refer to the discussion under the caption,
"Critical Accounting Policies" for an overview of the underlying methodology
management employs on a quarterly basis to maintain the allowance.
At June 30, 2003, the Company had two loans classified as nonaccrual in
the amount of $486 thousand, $123 thousand of which was guaranteed by the SBA.
One loan in the amount of $363 thousand is considered impaired as defined by
Statement of Financial Accounting Standards ("SFAS No. 114") and is discussed
below. As part of its comprehensive loan review process, the Bank's Board of
Director's Loan Committee and/or Board of Directors Credit Review Committee
carefully evaluates loans over thirty days past due and considers if such loans
should be classified as nonaccrual. The Committee(s) makes a thorough assessment
of the conditions and circumstances surrounding each past due loan. The Bank's
loan policy requires that loans be placed on nonaccrual if they are ninety days
past due, unless they are well secured and in the process of collection.
The $363 thousand loan was extended to an automobile leasing company
for the purpose of funding individual leases. During 2002, the loan became
delinquent, and management worked with the borrower in efforts to return the
loan to a current status. During the third quarter of 2002, management
discovered that payments on the underlying leases were being diverted and not
being used to service the loan as required by the loan agreement. The Bank
exercised its rights under the loan agreement and instructed the lessees of the
underlying leases to send all future lease payments directly to the Bank under a
lockbox arrangement. The diversion of funds is believed to be the primary reason
for the loan's delinquency. Subsequently, the borrower declared bankruptcy,
however, the trustee assigned in the bankruptcy proceedings allowed the Bank to
continue to collect payments directly from the lessees.
At March 31, 2003, the balance of the loan was $605 thousand. During
the second quarter of 2003 payments were received which further reduced the
balance to $499 thousand. During the quarter the Bank was placed on notice by
the trustee in bankruptcy that the bankruptcy estate would be closed out. The
Bank was permitted to retain its collateral, however, the titling of the
collateral, which had been with the trustee, would transfer to the Bank.
Management thoroughly considered the ongoing administration and collection
activities related to the account and determined that a more efficient and
economical means of administering the required functions would be through a
separate entity of the Company. In June 2003, Bethesda Leasing LLC, was formed
as a wholly owned subsidiary of the Company. On June 30, 2003 the LLC purchased
the loan from the Bank for $363 thousand, under a fair market value formula,
which required the Bank to further write down the loan by $136 thousand.
The provision for credit losses of $425 thousand in the first six
months of 2003 compared to a provision for credit losses of $493 thousand in the
first six months of 2002. The lower provision in 2003 is attributable to the
level of growth in the loan portfolio from December 31, 2002 to June 30, 2003.
The amount of growth was $7 million, less than the Company has historically
experienced from period to period. The amount of the first quarter 2003
provision was affected by the level of net charge-offs experienced during the
quarter, as well as trends in delinquencies and changes in the relative risk
composition of the loan portfolio.
As the portfolio and allowance review process matures, there will be
changes to different elements of the allowance and this may have an effect on
the overall level of the allowance maintained. To date the Bank has enjoyed a
very high quality portfolio with minimal net charge offs and very low
delinquency. The maintenance of a
13
high quality portfolio will continue to be management's prime objective as it
relates to the lending process and to the allowance for credit losses.
Management, aware of the strong loan growth experienced by the Company
over its history and the problems which could develop in an unmonitored
environment, is intent on maintaining a strong credit review system and risk
rating process. In January 2003, the Company established a credit department to
perform interim analysis, manage classified credits and develop a credit scoring
system for small business credits. Over time, this department will increase its
review of credit analysis and processes. The Company is also reviewing its risk
rating systems and is exploring the implementation of additional analytical
procedures for risk ratings. The entire loan portfolio analysis process is an
ongoing and evolving practice directed at maintaining a portfolio of quality
credits and quickly identifying any weaknesses before they become irremediable.
The following table sets forth activity in the allowance for credit
losses for the periods indicated.
--------------------------------------------------------------
Six Months Ended Year Ended
--------------------------------------------------------------
(dollars in thousands) June 30, December 31,
--------------------------------------------------------------
2003 2002 2002 2001 2000
----------- --------- -------- --------- ---------
Balance at beginning of year $ 2,766 $ 2,111 $ 2,111 $ 1,142 $ 579
Charge-offs: -- -- -- -- --
Commercial (290) (104) (192) -- --
Real estate - commercial -- -- -- -- --
Construction -- -- -- -- --
Home equity -- -- -- -- --
Other consumer (8) (35) (40) (23) (18)
----------- --------- -------- --------- ---------
Total (298) (139) (232) (23) (18)
----------- --------- -------- --------- ---------
Recoveries:
Commercial 58 -- 26 -- --
Real estate - commercial -- -- -- -- --
Construction -- -- -- -- --
Home equity -- -- -- -- --
Other consumer 1 20 18 13 --
----------- --------- -------- --------- ---------
Total 59 20 44 13 --
----------- --------- -------- --------- ---------
Net charge-offs (239) (119) (188) (10) (18)
----------- --------- -------- --------- ---------
Additions charged to operations 425 493 843 979 581
----------- --------- -------- --------- ---------
Balance at end of period $ 2,952 $ 2,485 $ 2,766 $ 2,111 $ 1,142
=========== --------- ======== ========= =========
Ratio of net charge-offs during
the period to average loans
outstanding during the period 0.02% 0.01% 0.09% 0.01% 0.02%
----------- --------- -------- --------- ---------
14
The following table reflects the allocation of the allowance for credit
losses at the dates indicated. The allocation of the allowance to each category
is not necessarily indicative of future losses or charge-offs and does not
restrict the use of the allowance to absorb losses in any category.
(dollars in thousands) As of June 30, As of December 31,
---------------------------------------------------------------
2003 2002
---------------------------- -----------------------------
Amount Percent (1) Amount Percent (1)
------------- -------------- ------------- ---------------
Commercial $ 1,301 26.8% $ 1,134 27.5%
Real estate - commercial 855 50.0 862 48.5
Construction 298 9.2 231 9.8
Home equity 210 12.2 253 12.9
Other consumer 109 1.8 83 1.3
Unallocated 179 - 203 -
------------- -------------- ------------- ---------------
Total allowance for credit losses $ 2,952 100% $ 2,766 100%
============= ============== ============= ===============
(1) Represents the percent of loans in category to gross loans.
NON-PERFORMING ASSETS
The Company's non-performing assets, which are comprised of loans
delinquent 90 days or more, non-accrual loans, and other real estate owned,
totaled $486 thousand at June 30, 2003 compared to $243 thousand at June 30,
2002 and $965 thousand at December 31, 2002. The percentage of non-performing
assets to total assets was 0.11% at June 30, 2003, compared to no non performing
assets at June 30, 2002 and 0.28% at December 31, 2002.
Non-performing loans constituted all of the non-performing assets at
June 30, 2003, June 30, 2002 and December 31, 2002. Non-performing loans at June
30, 2003 consist of loans in non-accrual status in the amount of $123 thousand
and nonaccruing impaired loans of $363 thousand compared to no non-accrual loans
and loans past due over ninety days of $22 thousand at June 30, 2002.
The Company had no other real estate owned at either June 30, 2003 or
2002.
The following table shows the amounts of non-performing assets at the
dates indicated.
June 30,
------------------------ December 31,
(dollars in thousands) 2003 2002 2002
---------- ---------- -------------
Nonaccrual Loans
Commercial $ 486 $ -- $ 147
Consumer -- -- --
Real estate -- -- --
Accrual loans-past due 90 days
Commercial -- 243 818
Consumer -- -- --
Real estate -- -- --
Restructured loans -- -- --
Real estate owned
---------- ---------- -------------
Total non-performing assets $ 486 $ 243 $ 965
========== ========== =============
At June 30, 2003, there were no performing loans considered potential
problem loans, defined as loans which are not included in the past due,
nonaccrual or restructured categories, but for which known information about
possible credit problems causes management to be uncertain as to the ability of
the borrowers to comply with the present loan repayment terms.
15
NONINTEREST INCOME
Noninterest income primarily represents deposit account service charges
and fees, gains on the sale of loans, other noninterest loan fees, income from
bank owned life insurance ("BOLI") and other service fees. For the six months
ended June 30, 2003 noninterest income was $1.45 million which included $214
thousand in gains on the sale of investment securities. This compared to $727
thousand of noninterest income for the six months ended June 30, 2002 which
included no gains on the sale of investment securities. For the quarter ending
June 30, 2003, the Company had $573 in noninterest income, which included $22
thousand in gains on the sale of investment securities, this compared to $428
thousand for the same period in 2002 which included no gains on the sale of
investment securities. The Company has become a significant SBA lender in its
market area and during the quarter realized gains on the sale of the insured
portion of many of the loans it had originated. The Company has also been active
in the origination of mortgage loans, on a pre-sold basis, and the historically
low interest rate environment has made this a very active program. These two
sale activities contributed $346 thousand in the first six months of 2003
compared to $97 thousand in the first six months of 2002. For the quarter ending
June 30, 2003, the Company had $98 thousand in gains on the sale of loans
compared to $56 thousand for the same period in 2002. The second quarter of 2003
income was less than the first quarter because of a slow down in SBA activity.
Based on current activity the SBA income is expected to increase in the third
quarter. The gains from sales of both of these types of credits are considered a
continuing and regular operating income source for the Bank. However, the
activity in our mortgage sales can be reduced significantly if interest rates
were to rise.
Service charges on deposit accounts increased to $579 thousand in the
first six months of 2003 compared to $490 thousand in the first six months of
2002. The increase of 18% is primarily attributable to an increase in the number
of deposit accounts over that period and the low interest rate environment. As
rates decline so do the earning allowances (which are used to offset service
charges) on demand deposit accounts so that an account, with the same activity,
which paid no service charge when interest rates were high may currently be
paying a charge because the earnings allowance is insufficient to cover activity
charges. For the quarter ending June 30, 2003, the Company had $307 thousand in
service charge income compared to $287 thousand in the same period of 2002, an
increase of 7%. Other income increased 119% from $140 thousand in the first six
months of 2002 to $307 thousand in the first six months of 2003. The significant
component contributing to this increase was income from BOLI contracts of $112
thousand compared to no BOLI related income in 2002. For comparative quarters
ending 2003 and 2002, the income increase was 72%, $146 thousand from $85
thousand. BOLI income was the significant factor in this increase contributing
$57 thousand.
NONINTEREST EXPENSE
Noninterest expense was $5.1 million for the six months ended June 30,
2003 compared to $4.0 million for the six months ended June 30, 2002. This
represented a 28% increase from period to period. The increase for the quarter
ending June 30, or each year was also 28%, increasing from $2.2 million to $2.7
million. Increases in noninterest expense primarily relate to increases in the
expense category salaries and employee benefits which increased 30% from the
first six months of 2002 to the first six months of 2003, $2.1 million to $2.7
million, and increased 27% for the respective quarters ending June 30, $1.1
million to $1.4 million. During the first quarter of 2003, to accommodate the
growth experienced by the Bank in 2002 and accommodate the growth anticipated in
2003, a number of additions to staff were made in the lending and operations
(customer service) areas. Management felt that these additions and the
associated expenses were necessary to assure a continued growth pattern and
quality of service which characterized the Company since its inception. The
increase of 17% in premises and equipment for the six months, $795 thousand to
$934 thousand and 22% for the quarter from period to period, $417 thousand to
$511 thousand can be attributed to the expenses for the Bank's Shady Grove
Office, which opened in March of 2002 and new loan administration offices in
Bethesda acquired to house an expanded lending staff. These offices were
occupied in June of 2003. Other expenses which increased 28% from $821 to $1,048
for the six months ending June 30, 2003 compared to the six months ending June
30, 2002, represent a number of expense categories ranging from business
development, office supplies to charitable contributions. Management monitors
these expenses closely and believes that the increase in them is consistent with
the needs of an aggressively growing Company. For the quarters ending June 30,
these expenses increased 20%, $459 thousand to $549 thousand.
16
FINANCIAL CONDITION
As of June 30, 2003, assets were $421 million and deposits were $309
million. Assets grew from December 31, 2002, by $73 million and deposits by
approximately $30 million. The growth in deposits experienced in the second
quarter of 2003, particularly beginning in June, was encouraging when compared
to the first quarter when both asset and deposit growth was below historical
levels experienced by the Company. Management believes that weather conditions,
local and national economic conditions and international events did not provide
an ideal environment for business and contributed significantly to the
relatively flat growth in the first quarter. The effects of these factors
carried into the second quarter and growth was relatively flat until mid June.
During the six months ended June 30, 2003, deposits grew $30 million
and assets grew $73 million, with 50% of asset growth coming from subscriptions
for new capital stock which the Company began accepting, through its escrow
agent, in mid May. The total amount of subscription funds received as of June
30, 2003, was $36 million. In early August, following the closing of the
subscription period on July 11, 2003 and termination of the withdrawal period,
the Company broke escrow on subscriptions for approximately 2.45 million shares
of common stock, for gross proceeds of approximately $30 million, and returned
escrowed funds relating to over subscriptions. The Company used approximately
$10 million of the proceeds to reduce its borrowings. If these transactions had
been effective at June 30, 2003, total assets would have been approximately $404
million. Please refer to the section "Capital Resources and Adequacy" for
further information concerning the Company's stock offering.
Loans
Total loans, excluding loans held for sale, increased approximately $25
million from December 31, 2002 to June 30, 2003, from $237 million to $262
million. Approximately $23 million of the increase in loans occurred during the
second quarter of 2003, representing a strong turnaround from the first quarter.
This improvement was in line with management's expectations as it had noted in
late March that loan demand was improving.
Loans, net of amortized deferred fees and costs, at June 30, 2003, June
30, 2002 and December 31, 2002 are summarized by type as follows:
June 30, Percent June 30, Percent December 31, Percent
2003 of Total 2002 of Total 2002 of Total
----------- --------- ----------- -------- ------------- --------
Commercial $ 70,087 26.8% $ 51,981 24.7% $ 64,869 27.5%
Real estate - commercial 130,583 50.0% 105,578 50.1% 114,961 48.5%
Construction 24,111 9.2% 17,793 8.4% 23,180 9.8%
Home equity 31,908 12.2% 31,511 15.0% 30,631 12.9%
Other consumer 4,703 1.8% 3,866 1.8% 3,219 1.3%
---------- ----- ----------- ---- ----------- ----
Total loans 261,392 100% 210,729 100% 236,860 100%
Less: allowance for credit losses (2,952) (2,485) (2,766)
---------- ----------- -----------
Loans, net $ 258,440 $ 208,244 $ 234,094
=========== =========== ===========
Deposits And Other Borrowings
The principal sources of funds for the Bank are core deposits,
consisting of demand deposits, NOW accounts, money market accounts, savings
accounts and relationship certificates of deposits, from the local market areas
surrounding the Bank's offices. The Bank's deposit base includes transaction
accounts, time and savings accounts and accounts which customers use for cash
management and which provide the Bank with a source of fee income and
cross-marketing opportunities as well as a low-cost source of funds. Time and
savings accounts, including money market deposit accounts, also provide a
relatively stable and low-cost source of funding.
17
For the six months ending June 30, 2003 from December 31, 2002,
deposits grew $30 million, from $278 million to $308 million. Almost $29.5
million of the growth in deposits came in the second quarter as some of the
uncertainties in international, national and local conditions became somewhat
clearer.
Approximately 26% of the Bank's deposits are made up of certificates of
deposits, which are generally the most expensive form of deposit because of
their fixed rate and term. Certificates of deposit in denominations of $100
thousand or more can be more volatile and more expensive than certificates of
less than $100 thousand. However, because the Bank focuses on relationship
banking and does not accept brokered certificates, its historical experience has
been that large certificates of deposit have not been more volatile or
significantly more expensive than smaller denomination certificates. It has been
the practice of the Bank to pay posted rates on its certificates of deposit
whether under or over $100 thousand. The Bank has paid negotiated rates for
deposits in excess of $500 thousand but the rates paid have rarely been more
than 25 to 50 basis points higher than posted rates and deposits also have been
negotiated at below market rates. In late 2000, to fund strong loan demand, the
Bank began accepting certificates of deposits, generally in denominations of
less than $100 thousand on a non brokered basis, from bank and credit union
subscribers to a wholesale deposit rate line. The Bank has found rates on these
deposits to be generally competitive with rates in our market given the speed
and minimal noninterest cost at which deposits can be acquired, although it is
possible for rates to significantly exceed local market rates it has not been
the experience of the Bank. At June 30, 2003 the Bank held $15.2 million of
these deposits at an average rate of 4.00% as compared to $20.5 million of these
deposits, at an average rate of 4.09% at June 30, 2002. With the strong core
deposit growth experienced by the Bank in 2002, these deposits were allowed to
mature without renewal or replacement. However, during the second quarter of
2003 management felt that there was an opportunity to acquire longer maturities
of these deposits at attractive interest rates and again began accepting these
deposits with three and four year maturities.
At June 30, 2003, the Company had approximately $81 million in
noninterest bearing demand deposits, representing an 26% of total deposits. This
compared to $64 million of these deposits at December 31, 2002. These are
primarily business checking accounts on which the payment of interest is
prohibited by regulations of the Federal Reserve. Proposed legislation has been
introduced in each of the last several sessions of Congress which would permit
banks to pay interest on checking and demand deposit accounts established by
businesses. If legislation effectively permitting the payment of interest on
business demand deposits is enacted, of which there can be no assurance, it is
likely that we may be required to pay interest on some portion of our
noninterest bearing deposits in order to compete with other banks. Payment of
interest on these deposits could have a significant negative impact on our net
income, net interest income, interest margin, return on assets and equity, and
indices of financial performance.
As an enhancement to the basic noninterest bearing demand deposit
account, the Company offers a sweep account, "customer repurchase agreement",
allowing qualifying businesses to earn interest on short term excess funds which
are not suited for either a CD investment or a money market account. The
balances in these accounts were $27 million at June 30, 2003 compared to $25
million at December 31, 2002. Customer repurchase agreements are not deposits
and are not FDIC insured but are secured by US Treasury and/or US government
agency securities. These accounts are particularly suitable to businesses with
significant change in the levels of cash flow over a very short time frame often
measured in days. Attorney and title company escrow accounts are an example of
accounts which can benefit from this product, as are customers who may require
collateral for deposits in excess of $100 thousand but do not qualify for other
pledging arrangements. This program requires the Company to maintain a
sufficient investment securities level to accommodate the fluctuations in
balances which may occur in these accounts.
At June 30, 2003, the Company had drawn $9.9 million against a line of
credit provided by a correspondent bank as compared to $4.6 million at December
31, 2002. The borrowings in the six months ending June 30, 2003 were to fund
loan participations with the Bank and a direct loan made by the Company. The
Company also borrowed $1 million to provide additional capital to the Bank.
Prior borrowings were principally to fund additions of capital to the Bank in
order to maintain its "well capitalized" ratio. As noted above, the Company
expects to reduce the balance on it correspondent line of credit from the
proceeds of the offering. At June 30, 2003, the Bank had $16.3 million of FHLB
short and long-term borrowings, as compared to $18.3 million at December 31,
2002. These advances are secured 50% by US government agency securities and 50%
by a blanket lien on qualifying loans in the Bank's commercial mortgage loan
portfolio.
18
LIQUIDITY MANAGEMENT
Liquidity is the measure of the Bank's ability to meet the demands
required for the funding of loans and to meet depositor requirements for use of
their funds. The Bank's sources of liquidity consist of cash balances, due from
banks, loan repayments, federal funds sold and short term investments. These
sources of liquidity are supplemented by the ability of the Company and Bank to
borrow funds. During 2002, the Company increased an established line of credit,
with a correspondent bank, from $5 million to $10 million. In the second quarter
of 2003, the line was temporarily increased $2 million to a total of $12 million
against which it had drawn $9.9 million as of June 30, 2003. In early August
2003, the balance on the line of credit was paid off from the proceeds of the
Company's public stock offering. Following such reduction the Company is able to
make additional draws on the line of credit to the full $10 million limit of the
line. The Bank can purchase up to $12 million in federal funds on an unsecured
basis and enter into reverse repurchase agreements up to $10 million. At June
30, 2003, the Bank was also eligible to take FHLB advances of up to $70 million,
of which it had advances outstanding of $16.3 million.
The loss of deposits, through disintermediation, is one of the greater
risks to liquidity. Disintermediation occurs most commonly when rates rise and
depositors withdraw deposits seeking higher rates than the Bank may offer. The
Bank was founded under a philosophy of relationship banking and, therefore,
believes that it has less of an exposure to disintermediation and resultant
liquidity concerns than do banks which build an asset base on non-core deposits
and other borrowings. The history of the Bank, while just under five years,
includes a period of rising interest rates and significant competition for
deposit dollars. During that period the Bank grew its core business without
sacrificing its interest margin in higher deposit rates for non-core deposits.
There is, however, a risk that some deposits would be lost if rates were to
spike up and the Bank elected not to meet the market. Under those conditions the
Bank believes that it is well positioned to use other liability management
instruments such as FHLB borrowing, reverse repurchase agreements and Bank lines
to offset a decline in deposits in the short run. Over the long term an
adjustment in assets and change in business emphasis could compensate for a loss
of deposits. Under these circumstances, further asset growth could be limited as
the Bank utilizes its liquidity sources to replace, rather than supplement, core
deposits.
Certificates of deposit acquired through the subscription service may
be more sensitive to rate changes and pose a greater risk of disintermediation
than deposits acquired in the local community. The Bank has limited the amount
of such deposits to less than 15% of total assets, an amount which it believes
it could replace with alternative liquidity sources, although there can be no
assurance of this.
The mature earning pattern of the Bank is also a liquidity management
resource for the Bank. The earnings of the Bank are now at a level that allows
the Bank to pay higher rates to retain deposits over a short period, while it
adjusts its asset base repricing to offset a higher cost of funds. The cost of
retaining business in the short run and the associated reduction in earnings can
be preferable to reducing deposit and asset levels and restricting growth.
At June 30, 2003, under the Bank's liquidity formula, it had $77
million of liquidity representing 20.3% of total Bank assets.
ASSET/LIABILITY MANAGEMENT AND QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT
MARKET RISK
A fundamental risk in banking, outside of credit risk, is exposure to
market risk, or interest rate risk, since a bank's net income is largely
dependent on net interest income. The Bank's Asset Liability Committee (ALCO) of
the Board of Directors formulates and monitors the management of interest rate
risk within policies established by it and the Board of Directors. In its
consideration of establishing guidelines for levels and/or limits on market
risk, the ALCO committee considers the impact on earnings and capital, the level
and direction of interest rates, liquidity, local economic conditions, outside
threats and other factors. Banking is generally a business of attempting to
match asset and liability components to produce a spread sufficient to provide
net income to the bank at nominal rate risk. The Company, through ALCO,
continually monitors the interest rate environment in which it operates and
adjusts rates and maturities of its assets and liabilities to meet the market
conditions. In the current low interest rate environment, the Company is keeping
its assets either variably priced or with short term maturities or short average
lives. At the same time it strives to attract longer term liabilities to lock in
the lower cost of funds. In the current market, due to competitive factors and
customer preferences, the effort to attract longer term fixed priced liabilities
has not been as successful as the Company's best case asset liability mix would
prefer. When interest rates begin to
19
rise, the Company expects that it will seek to keep asset maturities and
repricing periods short until rates appear to be nearing their peak and then
extend maturities to extend the benefit of higher rates. There can be no
assurance that the Company will be able to successfully carry out this
intention, as a result of competitive pressures, customer preferences and the
inability to perfectly forecast future interest rates.
One of the tools used by the Company to manage its interest rate risk
is a static GAP analysis presented below. The Company also uses an earning
simulation model on a quarterly basis to closely monitor interest sensitivity
and to expose its balance sheet and income statement to different scenarios. The
model is based on current Company data and adjusted by assumptions as to growth
patterns, noninterest income and noninterest expense and interest rate
sensitivity, based on historical data, for both assets and liabilities. The
model is then subjected to a "shock test" assuming a sudden interest rate
increase of 200 basis points or a decrease of 200 basis points, but not below
zero. The results are measured by the effect on net income. The Company, in its
latest model, shows a positive effect on income when interest rates immediately
rise 200 basis points because of the short maturities of assets and a negative
impact if rates were to decline further. With rates already at historic lows, a
further reduction would reduce income on earning assets which could not be
offset by a corresponding reduction in the cost of funds.
The following table reflects the result of a "shock test" simulation on
the March 31, 2003, earning assets and interest bearing liabilities and the
change in net interest income resulting from the simulated immediate increase
and decrease in interest of 100 and 200 basis points. Also shown is the change
in the Market Value Portfolio Equity resulting from the simulation. The model as
presented is projected for one year. The March simulation is the most recent
analysis completed. Management believes that the subsequent "shock test", to be
prepared as of June 30, 2003, will reflect similar change patterns and
percentages as the March shock.
Percentage change
Change in interest Percentage change in net Percentage change in in Market Value of
rates (basis points) interest income net income Portfolio Equity
-------------------- --------------------- -------------------- ---------------------
+ 200 + 8.8% + 21.1% + 10.7%
+ 100 + 4.8% + 11.4% + 6.8%
0 -- -- --
- 100 - 6.3% - 15.1% - 9.2%
- 200 - 16.2% - 39.0% - 16.7%
Certain shortcomings are inherent in the method of analysis presented
in the foregoing table. For example, although certain assets and liabilities may
have similar maturities or repricing periods, they may react in different
degrees to changes in market interest rates. Also, the interest rates on certain
types of assets and liabilities may fluctuate in advance of changes in market
interest rates, while interest rates on other types may lag behind changes in
market rates. Additionally, certain assets, such as adjustable-rate mortgage
loans, have features that restrict changes in interest rates on a short-term
basis and over the life of the loan. Further, in the event of a change in
interest rates, prepayment and early withdrawal levels could deviate
significantly from those assumed in calculating the tables. Finally, the ability
of many borrowers to service their debt may decrease in the event of a
significant interest rate increase.
GAP
Banks and other financial institutions are dependent upon net interest
income, the difference between interest earned on interest earning assets and
interest paid on interest bearing liabilities. In falling interest rate
environments, net interest income is maximized with longer term, higher yielding
assets being funded by lower yielding short-term funds; however, when interest
rates trend upward this asset/liability structure can result in a significant
adverse impact on interest income. The current interest rate environment is
signaling steady to possibly higher rates. Management has for a number of months
shortened maturities in the Bank's investment portfolio and where possible also
has shorten repricing opportunities for new loan requests. While management
believes that this will help minimize interest rate risk in a rising
environment, there can be no assurance as to actual results.
GAP, a measure of the difference in volume between interest earning
assets and interest bearing liabilities, is a means of monitoring the
sensitivity of a financial institution to changes in interest rates. The chart
below provides an indicator of the rate sensitivity of the Company. A negative
GAP indicates the degree to which the
20
volume of repriceable liabilities exceeds repriceable assets in particular time
periods. At June 30, 2003, the Bank had a positive GAP of 22.8% out to three
months and a cumulative negative GAP of 6.9% out to twelve months.
If interest rates were to continue to decline, the Bank's interest
income and margin may be adversely effected. Because of the positive GAP measure
in the 0 - 3 month period, continued decline in the prime lending rate will
reduce income on repriceable assets within thirty to ninety days, while the
repricing of liabilities may occur over future time periods and there may not be
an ability to reduce the cost of interest bearing liabilities to fully offset
the reduction in short term interest rates. This will result in a decline in net
interest income and net income. Management has carefully considered its strategy
to maximize interest income by reviewing interest rate levels, economic
indicators and call features of some of its assets. These factors have been
thoroughly discussed with the Board of Directors Asset Liability Committee and
management believes that current strategies are appropriate to current economic
and interest rate trends. The negative GAP is carefully monitored and will be
adjusted as conditions change. The following GAP table is presented on the basis
of the Bank only as inclusion of escrowed subscription assets and noninterest
bearing escrowed subscription liabilities would create a distorted
representation of the operating GAP.
GAP ANALYSIS
June 30, 2003
(dollars in thousands)
0-3 4-12 13-36 37-60 Over 60
Repriceable in: Months Months Months Months Months Total
----------------------------------------------------------------------------
ASSETS:
Investment securities $ 27,873 $ 7,874 $ 8,500 $ 6,500 $ 12,693 $ 63,440
Interest bearing deposits in
other banks 1,387 991 2,477 -- -- 4,855
Loans 104,030 21,296 48,473 68,505 23,270 265,574
Federal funds sold 9,019 -- -- -- -- 9,019
----------------------------------------------------------------------------
Total repriceable assets 142,309 30,161 59,450 75,005 35,963 342,888
============================================================================
LIABILITIES:
NOW accounts -- 23,511 4,533 18,131 -- 46,175
Savings and Money Market accounts 39,382 32,747 19,691 9,847 -- 101,667
Certificates of deposit 15,488 52,114 10,621 1,769 -- 79,992
Customer repurchase agreements
and federal funds purchased 8,156 10,874 2,718 5,438 -- 27,186
Other borrowing-short and long term 1,000 12,940 12,333 -- -- 26,273
----------------------------------------------------------------------------
Total repriceable liabilities 64,026 132,186 49,896 35,185 -- 281,293
============================================================================
GAP $ 78,283 $ (102,025) $ 9,554 $ 39,820 $ 35,963 $ 61,595
Cumulative GAP 78,283 (23,742) (14,188) 25,632 61,595
Interval gap/earnings assets 22.83% (29.75)% 2.79% 11.62% 10.49%
Cumulative gap/earning assets 22.83% (6.92)% (4.14)% 7.48% 17.96%
Although, NOW and MMA accounts are subject to immediate repricing, the
Bank's GAP model has incorporated a repricing schedule to account for the
historical lag in effecting rate changes and the amount of those rate changes
relative to the amount of rate change in assets.
CAPITAL RESOURCES AND ADEQUACY
The assessment of capital adequacy depends on a number of factors such
as asset quality, liquidity, earnings performance, changing competitive
conditions and economic forces, and the overall level of growth. The adequacy of
the Company's current and future capital needs is monitored by management on an
ongoing basis. Management seeks to maintain a capital structure that will assure
an adequate level of capital to support anticipated asset growth and to absorb
potential losses.
The capital position of the Company's wholly-owned subsidiary, the
Bank, continues to meet regulatory requirements. The primary indicators relied
on by bank regulators in measuring the capital position are the Tier 1
risk-based capital, total risk-based capital, and leverage ratios. Tier 1
capital consists of common and qualifying
21
preferred stockholders' equity less goodwill. Total risk-based capital consists
of Tier 1 capital, qualifying subordinated debt, and a portion of the allowance
for credit losses. Risk-based capital ratios are calculated with reference to
risk-weighted assets. The leverage ratio compares Tier1 capital to total average
assets. At June 30, 2003, the Company's and Bank's capital ratios were in excess
of the mandated minimum requirements.
During the six months ending June 30, 2003, the Company borrowed funds
under a line of credit with a correspondent bank in order to fund loan
participations with the Bank and a direct loan made by the Company. At June 30,
2003, the amount outstanding under the line of credit was $9.9 million. The
ability of the Company to continue to grow is dependent on its earnings and the
ability to obtain additional funds for contribution to the Bank's capital,
through additional borrowing, the sale of additional common stock, the sale of
preferred stock, or through the issuance of additional qualifying equity
equivalents, such as subordinated debt or trust preferred securities. On April
25, 2003 the Company commenced an offering of up to 979,591 shares of its common
stock at an offering prince of $12.25 per share, for aggregate gross proceeds of
approximately $12 million. The number of shares offered could be increased to
1,142,457, for aggregate gross proceeds of $14 million. On June 23, 2003, the
Company increased the size of the offering by more than 100%. The number of
shares offered for sale was increased to 2,040,816 at $12.25 per share and that
number of shares could be increased by an additional 408,163 shares. In early
August 2003, the Company completed the offering with the sale of approximately
2.45 million shares, for gross proceeds of approximately $30 million.
CAPITAL
- -------
The actual capital amounts and ratios for the Company and Bank as of June 30,
2003 and 2002 are presented in the table below:
To Be Well
Capitalized Under
For Capital Prompt Corrective
Company Bank Adequacy Action
In thousands Actual Actual Purposes Provisions**
As of June 30, 2003 Amount Ratio Amount Ratio Ratio Ratio
------ ----- ------ ----- ----- -----
Total capital (to risk-weighted
assets) $ 23,727 9.2% $ 27,793 10.9% 8.0% 10.0%
Tier 1 capital (to risk-weighted
assets) $ 20,866 8.1% 24,953 9.8% 4.0% 6.0%
Tier 1 capital (to average assets) $ 20,866 6.2% 24,953 7.4% 3.0% 5.0%
As of June 30, 2002
Total capital (to risk-weighted
assets) $ 19,599 9.6% $ 20,813 10.2% 8.0% 10.0%
Tier 1 capital (to risk $ 17,312 8.5% 18,526 9.0% 4.0% 6.0%
weighted assets)
Tier 1 capital ( to average
assets) $ 17,312 7.9% 18,526 7.5% 3.0% 5.0%
** Applies to Bank only
Bank and holding company regulations, as well as Maryland law, impose certain
restrictions on dividend payments by the Bank, as well as restricting extension
of credit and transfers of assets between the Bank and the Company. At June 30,
2003, the Bank could pay dividends to the parent to the extent of its earnings
and so long as it maintained required capital ratios.
22
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Please refer to Item 2 of this report, "Management's Discussion and
Analysis of Financial Condition and Results of Operations", under the caption
"Asset/Liability Management and Quantitative and Qualitative Disclosure About
Market Risk".
ITEM 4. CONTROLS AND PROCEDURES
The Company's management, under the supervision and with the
participation of the Company's Chief Executive Officer and Chief Financial
Officer, evaluated as of the last day of the period covered by this report the
effectiveness of the operation of the Company's disclosure controls and
procedures, as defined in Rule 13a-14 under the Securities and Exchange Act of
1934. Based on that evaluation, the Chief Executive Officer and Chief Financial
Officer concluded that the Company's disclosure controls and procedures were
adequate. There were no changes in the Company's internal control over financial
reporting (as defined in Rule 13a-15 under the Securities Act of 1934) during
the quarter ended June 30, 2003 that has materially affected, or is reasonably
likely to materially affect, the Company's internal control over financial
reporting.
23
PART II OTHER INFORMATION
ITEM 1 LEGAL PROCEEDINGS
From time to time the Company may become involved in legal proceedings.
At the present time there are no proceedings which the Company believes will
have an adverse impact on the financial condition or earnings of the Company.
ITEM 2 CHANGES IN SECURITIES AND USE OF PROCEEDS None
ITEM 3 DEFAULTS UPON SENIOR SECURITIES None.
ITEM 4 SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS None
ITEM 5. OTHER INFORMATION None.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits
Exhibit No. Description of Exhibit
- ----------- ----------------------
3(a) Certificate of Incorporation of the Company, as amended (1)
3(b) Bylaws of the Company (2)
10.1 1998 Stock Option Plan (3)
10.2 Employment Agreement between H.L. Ward and the Company and Bank (4)
10.3 Employment Agreement between Thomas D. Murphy and the Bank (4)
10.4 Employment Agreement between Ronald D. Paul and the Company (4)
10.5 Consulting Agreement between Leonard L. Abel and the Company (4)
10.6 Employment Agreement between Susan G. Riel and the Bank (4)
10.7 Employment Agreement between Martha F. Tonat and the Bank(1)
11 Statement Regarding Computation of Per Share Income
21 Subsidiaries of the Registrant
31(a) Certification of Ronald D. Paul
31(b) Certification of Wilmer L. Tinley
31(c) Certification of H. L. Ward
32(a) Certification of Ronald D. Paul
32(b) Certification of Wilmer L. Tinley
32(c) Certification of H. L. Ward
- -----------------------------
(1) Incorporated by reference to the exhibit of the same number to the
Company's Quarterly Report on Form 10-QSB for the period ended
September 30, 2002.
(2) Incorporated by reference to Exhibit 3(b) to the Company's Registration
Statement on Form SB-2, dated December 12, 1997.
(3) Incorporated by reference to Exhibit 10.1 to the Company's Annual
Report on Form 10-KSB for the year ended December 31, 1998.
(4) Incorporated by reference to the exhibit of the same number in the
Company's Annual Report on Form 10-KSB for the year ended December 31,
2000.
(b) Reports on Form 8-K
On April 15, 2003, the Company filed a Current Report on Form 8-K,
under Items 5, 9 and 12 thereof, reporting earnings for the quarter ended March
31, 2003.
24
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934,
the registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
EAGLE BANCORP, INC.
Date: August 7, 2003 By: /s/ Ronald D. Paul
---------------------------------------
Ronald D. Paul, President and CEO
Date: August 7, 2003 By: /s/ Wilmer L. Tinley
---------------------------------------
Wilmer L. Tinley, Senior Vice President and CFO
25