Dear Shareholder:
On the tenth anniversary of this company's existence as a publicly held
financial institution, I am pleased to report to you the activities of
Tri-County Financial Corporation and its banking subsidiary, Tri-County Federal
Savings Bank. The year closed with the resolution of several major legislative
initiatives and the refocusing of our strategic business plan.
The first occurrence to impact the Company was the legislation passed by
Congress to protect the thrift's bad debt reserves previously recorded under
then current IRS guidelines. This watershed bill permitted those institutions
who wished to restructure as a bank charter to do so without incurring material
tax liabilities. Secondly, Congress passed a bill to recapitalize the FDIC's
Savings Association Insurance Fund (SAIF). That action expropriated an
additional $820,000 of our pre-tax income to fund the SAIF reserves.
The most exciting event was the result of the first legislative action, in
that Tri-County Federal Savings Bank was now able to convert its charter to that
of a commercial bank. I am pleased to announce that as of this writing, approval
of the charter has been granted and the conversion to the Community Bank of
Tri-County will occur on March 31,1997.
Our business plan, as a community bank, will be to grow the business and
consumer portion of the portfolio while maintaining our most profitable lines in
the residential lending field. In addition, our plan includes a concentration of
effort to attract more transactional accounts and business deposits. To assist
us in this challenge, we have contracted with a national bank consulting group
to implement a quality sales, quality service culture on a bank wide basis.
What your Board proposes to accomplish with these bold changes in the
business plan of the Company is to prevent a migration of the franchise value as
the new world order of providing financial services rearranges itself in the
marketplace. With most financial products reduced to that of a commodity, we
believe that new strategies have to be put in place to bundle those products
into a service that will add long term value to a financial institution like the
Community Bank.
As you will see in the following financial statements, the Company
continues its growth and profitability trend with sound earnings potential and
quality assets. The net income was down due to the FDIC recapitalization
mentioned above and an increase in the loan loss reserve to achieve an adequate
reserve level in light of the Bank's portfolio risk. Even with these
extraordinary charges, the Company returned 7.9% on equity while earning .77
basis points on average assets. This return was earned despite paying over $1.1
million dollars in FDIC assessments and $198,000 in additional loan loss
reserves. To put this in perspective, a bank like NationsBank, would have paid
only $2,000 for the same FDIC coverage! Without these charges, earnings were on
track to be close to the record year of 1995.
It is with excitement that we begin our new journey as a community bank and
I sincerely appreciate the support and confidence that our shareholders have
shown over these last ten years. On behalf of your Board of Directors and our
staff of community bankers, I look forward to serving you in the coming year.
Yours truly
Michael L. Middleton
President and Chairman
1
Tri-County Federal Savings Bank
-------------------------------
Peer Group Comparative Performance Ratios
-----------------------------------------
--------------------------------------------------------------------------------------------
1996 1995 1994 1993 1992
--------------------------------------------------------------------------------------------
TCFSB MD Thrifts TCFSB MD Thrifts TCFSB MD Thrifts TCFSB MD Thrifts TCFSB MD Thrifts
Yield on Interest-earning Assets 8.30% 7.92% 8.44% 8.09% 8.11% 7.73% 8.83% 8.16% 9.46% 8.97%
Cost of Funds 4.29% 4.92% 4.31% 4.88% 3.92% 4.17% 4.35% 4.37% 5.30% 5.42%
Yield Spread 4.01% 3.04% 4.14% 3.30% 4.20% 3.57% 4.47% 3.75% 4.16% 3.49%
Net Operating Margin 1.30% 0.65% 2.11% 1.17% 1.93% 1.45% 2.14% 1.65% 1.72% 1.40%
Net Income before Taxes 1.33% 0.66% 2.17% 1.21% 1.85% 1.46% 2.31% 1.66% 1.96% 1.42%
Return on Average Assets 0.84% 0.40% 1.30% 0.79% 1.08% 0.96% 1.42% 1.10% 1.22% 0.92%
Return on Average Tangible Capital 8.88% 3.53% 14.54% 8.03% 12.99% 9.69% 18.29% 13.31% 18.30% 12.36%
Nonperforming Loans and REO 0.48% 2.20% 0.34% 2.33% 0.88% 3.18% 0.98% 3.63% 0.96% 4.55%
- ---------------------------------------------------------------------------------------------------------------------------------
Source: FHLB Comparative Performance
Reports
2
[Bar Graphs showing:
Regulatory Capital Position (1992 through 1996);
Rate Spread Between Interest-Earning Loans and Interest-Bearing Deposits
(1992 through 1996);
Return of Assets(1992 through 1996);
Net Income (1992 through 1996);
and Primary Net Income Per Common Share (1992 through 1996).]
3
At December 31,
----------------------------------------------------------------------------------
1996 1995 1994 1993 1992
----------------------------------------------------------------------------------
Total Amount of:
Loans Outstanding............................ $112,036,851 $107,817,075 $ 98,689,129 $ 85,506,126 $ 84,225,071
Mortgage-backed Securities.................... 43,354,206 31,954,354 29,796,793 33,583,509 30,344,094
Interest and Noninterest-bearing Cash......... 3,903,612 4,050,219 3,471,953 4,020,960 5,342,331
Investment Securities......................... 13,429,115 14,903,798 14,729,588 10,269,094 7,111,972
Assets........................................ 178,320,557 164,262,643 153,050,998 139,570,352 130,484,013
Savings Deposits.............................. 134,818,992 129,348,276 126,069,320 120,016,995 111,771,247
Borrowed Money................................ 24,733,466 17,552,845 12,480,128 6,543,919 7,474,823
Stockholders' Equity.......................... 17,251,683 15,971,148 13,368,494 12,135,593 10,261,697
Number of:
Loans Outstanding............................. 2,854 2,792 2,667 2,597 2,644
Savings Accounts.............................. 14,849 14,090 14,409 13,816 13,542
Offices Open - All Full Service............... 8 6 6 6 6
For the Year Ended December 31,
----------------------------------------------------------------------------------
1996 1995 1994 1993 1992
----------------------------------------------------------------------------------
Weighted Average Yield on:
Loan and Mortgage-backed Security Portfolio... 8.55% 8.80% 8.44% 9.18% 9.67%
Investment Portfolio.......................... 5.52 5.90 5.24 4.38 5.15
All Interest-earning Assets................... 8.24 8.44 8.03 8.65 9.32
Weighted Average Rate Paid on:
Savings Deposits and Escrow................... 4.05 4.06 3.67 3.94 4.84
Federal Home Loan Bank Advances and Other
Borrowings.................................... 5.46 6.21 7.02 9.60 9.62
All Interest-bearing Liabilities.............. 4.22 4.28 3.87 4.29 5.21
Interest Rate Spread (Spread Between Weighted
Average Rate on All Interest-earning Assets
and All Interest-bearing Liabilities)......... 4.02 4.16 4.16 4.36 4.11
Net Yield (Net Interest Income as a
Percentage of Average Interest-earning Assets) 4.32 4.45 4.38 4.53 4.21
4
SELECTED CONSOLIDATED FINANCIAL AND OTHER DATA (CONTINUED)
SUMMARY OF OPERATIONS
At December 31,
------------------------------------------------------------------------
1996 1995 1994 1993 1992
------------------------------------------------------------------------
Interest Income............................. $13,471,595 $12,900,876 $11,262,969 $11,337,676 $11,578,297
Interest Expense............................ 6,406,756 6,094,968 5,117,503 5,390,004 6,322,559
------------------------------------------------------------------------
Net Interest Income.......................... $ 7,064,839 $ 6,805,908 $ 6,145,466 $ 5,947,672 $ 5,255,738
Loss Provision and Charge offs of Loans...... 408,000 210,000 154,000 144,000 151,000
------------------------------------------------------------------------
Net Interest Income
After Provision for Loss on Loans....... $ 6,656,839 $ 6,595,908 $ 5,991,466 $ 5,803,672 $ 5,104,738
Other Income................................. 930,970 857,467 562,297 823,159 803,834
Less Noninterest Expense..................... 5,482,882 4,098,561 3,928,991 3,514,998 3,353,613
------------------------------------------------------------------------
Income Before Federal Income Tax............ $ 2,104,927 $ 3,354,814 $ 2,624,772 $ 3,111,833 $ 2,554,959
Income Tax Expense........................... 785,200 1,327,000 1,041,715 1,289,852 963,328
Income Tax Benefit - Change in Accounting
for Deferred Taxes... - - - 57,108 -
-------------------------------------------------------------------------
Net Income................................... $ 1,319,727 $ 2,027,814 $ 1,583,057 $ 1,879,089 $ 1,591,631
-------------------------------------------------------------------------
Net Income Per Common Share (1) - Primary... $ 1.61 $ 2.62 $ 2.08 $ 2.57 $ 2.09
Fully-Diluted... $ 1.60 $ 2.59 $ 2.00 $ 2.40 $ 2.06
Cash Dividends Declared Per Common Share(2) 70,574 64,751 60,545 - -
(1) Restated to reflect 1993, 1994, 1995, 1996 and 1997 stock dividends.
(2) A $0.10 per common share cash dividend was declared on January 27, 1994,
payable to shareholders of record March 5, 1994;
a $0.10 per common share cash dividend was declared on January 31, 1995,
payable to shareholders of record March 3, 1995;
a $0.10 per common share cash dividend was declared on January 24, 1996,
payable to shareholders of record March 4, 1996;
a $0.10 per common share cash dividend was declared on January 24,
1997, payable to shareholders of record March 7, 1997;
MANAGEMENT'S DISCUSSION AND ANALYSIS
GENERAL
Management believes that the year ended December 31, 1996 will be
recorded as one of the most significant years for the thrift industry in its
endeavor to compete in the financial markets of this country. Several
legislative initiatives were resolved in favor of those thrifts whose business
plans include structural change to address the emerging needs of a financial
institution's primary customer base. The United States Congress approved a bill
preserving bad debt reserves previously recorded under Internal Revenue Service
regulations then in force. This created an opportunity for thrifts, who were
previously constrained by the threat of a material bad debt recapture situation,
to convert to banking charters which would best fit their business plans. With
that obstacle removed, the Board of Directors of Tri-County Financial
Corporation ("the Company") authorized a feasibility study of converting to a
commercial bank charter. The optimum charter appeared to be that of a state
chartered, Federal Reserve member bank. The Board then directed the Bank's
management to initiate the effort to convert to a bank charter. In December
1996, the required documents were filed with the appropriate authorities. On
March 7, 1997 regulatory approval was granted and the new bank will open on
March 31,1997.
BUSINESS STRATEGY TO IMPLEMENT COMMERCIAL BANKING
Management believes that this business strategy should allow the newly
chartered bank, named "Community Bank of Tri-County", to capture more market
share from the larger regional banks who appear to have lost the community bank
image. For several years, the Bank's management has been implementing the
technology and staffing required to meet the demands of a commercial bank
operation. It feels well prepared to begin full scale operations immediately
after conversion.
The conversion to a state chartered, Federal Reserve member bank will
affect the business of the Bank in that certain asset allocation regulations,
such as the Qualified Thrift Lender Test (QTL) will no longer apply to the
capital asset allocation strategies utilized by management. Over time, the asset
allocation of the Bank will evolve from a thrift portfolio to that of a typical
community bank. Management and the Board of Directors do not anticipate the
conversion to result in changes in the Bank's historically profitable and
increasingly efficient residential mortgage and builder business product lines.
Attention has been given to new delivery systems designed to help the growth of
consumer and small business lending. These product lines are expected to expand
in an effort to capitalize on what management perceives as the void created by
the merger of larger community banks into larger super regional institutions.
In addition, it is expected that more transactional accounts will be
attracted to the new Community Bank and should help reduce the overall cost of
funds in the future.
Management has recently contracted the services of a national banking
consultant to create a bank wide Quality Sales, Quality Service Culture to
assist it in its change from
5
that of a thrift to a dynamic, sales oriented, financial services company. It is
anticipated that future product lines will evolve around the total financial
service needs of its customer rather than a fragmented product offering that was
typical of a thrift. The new bank anticipates that it will invest heavily in
technology and engage in building affiliations with financial service providers
to accomplish this objective.
OTHER DEVELOPMENTS
The second major legislative initiative to be resolved was the
re-capitalization of the FDIC's Savings Association Insurance Fund (SAIF).
Thrifts were assessed a 65.7 basis point special insurance fee that was payable
on September 30, 1996. The fund became fully capitalized and the future FDIC
assessment fee for the Bank dropped from 23.5 basis points per year to 6.5 basis
points in 1997. This will allow SAIF insured institutions such as the Community
Bank of Tri-County to better compete with other financial institutions for
deposits. This fee, coupled with the current annual assessment, translated into
$1.1 million dollars in FDIC insurance expense charged to operations for the
Bank in 1996.
The economic environment has not changed considerably over the last
year and the flat yield curve in the interest rates is expected to continue in
the near term. At this writing, the Federal Reserve has openly hinted of an
interest rate change to cool off any heating up of the economy through monetary
policy. This bears watching in that any shift in short term rates will directly
impact the net interest margin of the Company and its subsidiary Bank.
The local market of Southern Maryland continues to benefit from the
enhanced naval presence in St. Mary's county as well as in Charles county, two
of the primary markets of the Bank. However, with growth comes intensified
competitive pressures from financial institutions desiring to capitalize on
these growth sectors of the State. Merger and acquisitions of mid sized
financial institutions by large regional and money center banks will bring to
the market a presence that previously did not exist in this area. With the trend
toward total financial product delivery systems of the super regional banks,
community banks will have to quickly adjust their sales and technology
strategies to outmaneuver the larger providers.
In that light, the Bank has opened its newest stand alone branch in
Bryans Road, Maryland. It brings the count of free standing branches throughout
the Southern Maryland area to seven. Each is geographically located to permit
coverage of the major business areas in the marketplace. To augment the delivery
systems employed by the Bank, it opened its first "micro" branch, utilizing
limited square footage to provide full customer service, at the Charles County
Community College on February 28, 1997. This strategy of utilizing lower cost
delivery systems supported by larger stand alone branches will be followed until
sufficient penetration of the market is achieved to enable the Bank to bring its
services to the customers in a cost effective manner.
6
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
Net income for the Company was down by $708,087 or $1.01 per share.
This compared negatively to the increase of $444,757 or $.54 per share in net
income for the year ended December 1995 over the comparable year in 1994. Net
income was adversely affected primarily by two events during the course of the
year. The first, mentioned above, was the effect of the re-capitalization of the
SAIF fund of the FDIC. The special 65.7 basis point assessment resulted in a
pre-tax charge to income of $820,000 for an after tax cost of $504,000. This
represents $.61 per primary share. For the year, the Bank paid out $1,120,668 in
FDIC insurance compared to $287,628 in 1995 and $275,339 in 1994.
The second factor impacting net income was the increase in the Provision
for Loan Losses by $198,000 or $.24 per share over the same period in 1995. The
Board of the Bank elected to increase the Reserve for Loan Loss to achieve a
sufficient reserve level commensurate with the Bank's portfolio risk. With the
loan loss charge in 1996, the Reserve for Loan Loss approximates one percent of
the loan portfolio at December 31, 1996. The coverage ratio of net loan charge
offs for 1996 was 19.0 while it was 5.24 in 1995 and 3.86 in 1994. It is the
intent of the Bank to continue to add to the reserve as its product mix expands
and changes to reflect increased portfolio risk. As this shift occurs, the
reserve is likely to be more closely aligned with the commercial bank average of
1.4 % of loans outstanding. Because the transition from thrift assets, which
generally have a lower risk profile, to those of a traditional commercial bank
will take several years, management believes that a constant level of annual
provisions will achieve the desired reserve within two years.
The weighted average yield on all interest-earning assets was 8.24% in
1996, 8.44% in 1995 and 8.03% in 1994. The interest rate trend during the year
was flat and experienced very little variance over the period. This resulted in
an erosion of the weighted average yield as little yield gain was available by
extending maturities of investments. Management's asset/liability strategy was
to protect against upside movements in interest rates, therefore, maturity
extension of investments would have been counterproductive to the strategy.
The most significant increase among the asset categories occurred in
mortgage-backed securities available for sale, which increased by $11.7 million.
This reflects a strategy employed by the bank to leverage its net worth with
matched investments and wholesale borrowings to provide additional revenue to
the Bank. The investments are risk rated below those of whole mortgage loans and
therefore more effectively leverage the risk-based capital ratio maintained by
the Bank to comply with overall capital requirements of the Office of Thrift
Supervision.
The weighted average rate paid on all interest-bearing liabilities was
4.22% in 1996, 4.28% in 1995 and 3.87% in 1994. Thus while declining slightly in
1996, the rate paid on liabilities continues to reflect the negative pressure
exerted by a flat yield curve which offers little relief to short term
borrowings or core deposits.
7
The net interest rate spread was 4.02% in 1996 compared to 4.16% in
1995 and 4.16% in 1994 . While the trend has been level over the past several
years, it is the belief of management that there exists an upside rate movement
risk in the near future and therefore, the Bank is shifting the portfolio to
protect against cyclical interest rate shifts. The interest rate sensitivity
analysis follows this section and will provide a more detailed discussion.
The loan portfolio continues to hold its quality and has a relatively
low amount of non-performing loans for 1996 at $699,000 or .6% of total loans
compared to $ 566,000 or .5% of total loans for 1995. The Bank owned real estate
acquired through foreclosure with a fair market value of $155,000 at December
31,1996. This property was sold in early l997 at a small profit.
Operating expense increased by 34% or $1,384,321 compared to an
increase of $169,570 or 4% for 1995. Included in this total is the previously
mentioned SAIF assessment of $820,000. Other expenses included start up staffing
and promotional expense associated with the new branch opened in Bryans Road,
Maryland during the year. It is expected that personnel expense will increase in
the future as the Bank staffs to a level necessary to handle the expected
increase in transactional and business activity. In order to better link
performance with pay, the Board of the Bank approved an incentive plan for all
branch managers in 1997. This measure brings the percentage of personnel who are
compensated based on Bank performance to over 50%.
Net premises and equipment increased by 20% or $645,762 for the year. This
reflects the completion of the new Bryans Road facility and increased investment
in technology platforms to assist in lower cost delivery of services in the
future. The ongoing investment in technology is expected to increase as services
become more standardized and computer driven. The Bank purchased software to
upgrade several of its branch office retail platforms and anticipates completing
the task at the remaining branches during 1997. In addition, the Bank purchased
software to automate its consumer loan processing activities in anticipation of
the increase in that line of business as a community bank.
The Bank's wholesale borrowing, consisting mainly of advances from the
Federal Home Loan Bank of Atlanta, increased from $13,250,000 in 1995 to
$24,000,000 or 81% in 1996. These borrowings were used to fund specific loan
projects or to create arbitrages with authorized investments matched to the
borrowings for a managed spread. This strategy allows for the prudent leveraging
of net worth to maximize revenue production while managing asset and liability
interest rate risk.
Stockholders' average equity for the year ended 1996 grew by 8% or
$1,280,535 to $17,251,683. This represents an average net worth to total assets
ratio of 9.7%. For historical comparison, the net worth to total assets at
December 31,1986, the end of the year which the Bank converted to stock form,
was 5.6% with a total net worth of $4,323,600.
The net unrealized gain on investment and mortgage-backed securities
available for sale declined by 62% or $143,345 due to the effects of the flat
yield curve on interest
8
rates. The prolonged flat curve produces little opportunity to improve yield
unless one increases the duration of investments or loans. When the long term
rate moves up, the impact on the market value of the securities declines. This
valuation allowance is subject to the fluctuations in the money markets on a
monthly basis and will be reflected in the quarterly statements to the
regulatory agencies and shareholders.
The Bank's capital position relative to regulatory requirements was as
follows:
Tangible capital required to be held $ 2,661,000
Actual tangible capital on hand 16,447,000
----------
Excess capital $13,786,000
Minimum core capital required $ 5,322,000
Core capital on hand 16,447,000
----------
Excess core capital $11,125,000
Risk based capital required $ 8,404,000
Actual risk based capital held 17,567,000
----------
Excess risk based capital $ 9,163,000
The Bank's capital position exceeds all levels of required regulatory
capital and the Bank is considered a well capitalized institution by the FDIC.
INTEREST RATE SENSITIVITY ANALYSIS
The interest rate sensitivity of the Bank's portfolio is continually
monitored by the Bank's management and regularly reported to its board of
directors. The sensitivity of the market value of the portfolio equity and
interest rate sensitivity of net income are calculated as follows:
Market value of portfolio equity
Interest rate changes: Adverse scenario 1995 1996
------------------
Up 200 basis points -10% -10%
Up 400 basis points -24% -30%
Down 200 basis points + 9% + 3%
Down 400 basis points +19% +10%
Interest rate sensitivity
Interest rate changes: Adverse scenario 1995 1996
------------------
Up 200 basis points + 1% + 5%
Up 400 basis points + 4% + 9%
Down 200 basis points - 3% - 6%
Down 400 basis points - 6% -15%
The change in percentage for the Market Value of Portfolio Equity remained
constant at the adverse scenario of 200 basis points in interest rate movement.
The 400 basis point movement reflects a more exaggerated shift in market value
loss of 30% in
9
market value of the portfolio. The management of the Bank is less concerned with
the shock of interest rates on the market value than it is on the interest rate
sensitivity because the assets are employed for their income production rather
that value appreciation upon sale.
The sensitivity of Net Interest Income shows a significant change in the
outcome of assumed interest rate changes. In those scenarios, the adverse
scenario is the result of downward movement of rates. It is the opinion of
management that the most probable damage to the institution would be the
greatest from upside rate movements. Therefore, the portfolio has been
structured in an attempt to reasonably minimize the impact from sudden and
prolong upward shifts in interest rates.
Interest rate sensitivity may also be analyzed by examining the extent to
which such assets and liabilities are "interest rate sensitive" and by
monitoring an institution's interest rate sensitivity "gap". An asset or
liability is said to be interest rate sensitive within a specific period if it
will mature or reprice within that period. The interest rate sensitivity gap is
defined as the difference between the amount of interest earning assets maturing
or repricing within a specific time period and the amount of interest-bearing
liabilities maturing or repricing within that time period. Gap is considered
positive when the amount of interest rate sensitive assets exceeds the amount of
interest rate sensitive liabilities, and 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, a
negative gap would adversely affect net interest income and a positive gap would
result in an increase in net interest income while, conversely, during a period
of falling interest rates, a negative gap would result in an increase in net
interest income and a positive gap would adversely affect net interest income.
10
The following table sets forth the amounts of interest-earning
assets and interest-bearing liabilities outstanding at December 31, 1996 which
are expected to mature or reprice in each of the time periods shown.
INTEREST-EARNING ASSETS AND INTEREST-BEARING LIABILITIES
(000's)
THREE THREE SIX MONTHS ONE THRU MORE THAN OVER FIVE
MONTHS MONTHS THRU THRU ONE THREE YEARS THREE THRU YEARS
OR LESS SIX MONTHS YEAR FIVE YEARS
------------- ------------- ------------- ------------ ------------ ---------
INTEREST EARNING ASSETS:
MORTGAGE LOANS AND
MORTGAGE-BACKED
SECURITIES $ 25,042 $ 8,863 $ 14,616 $ 55,477 $ 16,017 $35,376
INVESTMENTS $ 16,221 - - - - -
TOTAL $ 41,263 $ 8,863 $ 14,616 $ 55,477 $ 16,017 $35,376
INTEREST EARNING LIABILITIES:
SAVINGS DEPOSITS $ 15,575 $ 5,428 $ 34,762 $ 48,408 $ 15,036 $15,610
BORROWED MONEY $ 13,270 - 5,000 6,000 463 -
TOTAL $ 28,845 $ 5,428 $ 39,762 $ 54,408 $ 15,499 $15,610
INTEREST SENSITIVITY GAP $ 12,418 $ 3,435 $ (25,146) $ 1,069 $ 518 $19,766
CUMULATIVE INTEREST
SENSITIVITY GAP $ 12,418 $ 15,853 $ (9,293) $ (8,224) $ (7,706) $12,060
PERCENT OF CUMULATIVE
GAP TO TOTAL ASSETS 6.9% 8.9% (5.2)% (4.6%) (4.3%) 6.8%
The Realm and Bank models compute the market value of portfolio equity by
discounting the projected asset, liability and off-balance sheet cash flows,
with adjustments for amortization, prepayments, and decay factors. Discount
rates and prepayment rates vary across the interest rate scenarios. For income
sensitive measures, the size and composition of the balance sheet are held
constant, in accordance with Thrift Bulletin 13. The positions estimated in the
maturity gap report are the maturity and repricing sensitivities calculated from
the starting base scenario.
Certain shortcomings are inherent in the method of analysis presented in
the above table. Although certain assets and liabilities may have similar
maturities or periods of repricing, they may react in different degrees to
changes in market interest rates. The interest rates on certain types of assets
and liabilities may fluctuate in advance of changes
11
in market interest rates, while interest rates on other types of assets and
liabilities may lag behind changes in market interest rates. Certain assets,
such as adjustable-rate mortgages, have features which restrict changes in
interest rates on a short-term basis and over the life of the asset. In the
event of a change in interest rates, prepayment and early withdrawal levels
would likely deviate significantly from those assumed in calculating the table.
The ability of many borrowers to service their debt may decrease in the event of
an interest rate increase.
IMPACT OF INFLATION
The consolidated financial statements and related financial data 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 changes in the
relative purchasing power of money over time due to inflation.
Unlike most industrial companies, virtually all of the assets and
liabilities of a financial institution are monetary in nature. As a result,
interest rates have a more significant impact on a financial institution's
performance than the effects of general levels of inflation. Interest rates do
not necessarily move in the same direction or in the same magnitude as the price
of goods and services. In the current interest rate risk environment, liquidity
and the maturity structure of the Bank's assets and liabilities are critical to
the maintenance of acceptable performance levels.
STOCK INFORMATION
Tri-County Financial Corporation's stock is not traded or listed on any
public exchange. However, stock does change hands over the course of the year.
In 1996, the Company was made aware of several trades which occurred.
A total of 10,285 shares traded, with a high price of $24 and a low price
of $15. The weighted average price was $19.63. The number of shareholders at
March 7, 1997 was 502 and the total outstanding shares was 754,894. On January
24, 1997, the Board of Directors declared a 5% stock dividend and a $.10 per
share cash dividend, both payable on April 15, 1997 to shareholders of record on
March 7,1997. On January 24, 1996, the Board of Directors declared a 5% stock
dividend and a $.10 per share cash dividend which were distributed to holders of
record March 4, 1996.
Federal regulations impose certain limitations on the payment of dividends
and other capital distributions by the Bank.
Following the Bank's conversion to a commercial bank, the Bank's ability to
pay dividends will be governed by the Maryland Financial Institutions Code and
the regulations of the Federal Reserve Board. Under the Maryland Financial
Institutions 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 fund 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.
The Bank's payment of dividends will also be subject to the Federal Reserve
Board's Regulation H, which limits the dividends payable by a state member bank
to the net profits of the Bank then on hand, less the Bank's losses and bad
debts. Additionally, the Federal Reserve Board has the authority to prohibit the
payment of dividends by a Maryland commercial bank when it determines such
payment to be an unsafe and unsound banking practice. Finally, the Bank, like
the Savings Bank, would not be able to pay dividends on its capital stock if its
capital would thereby reduced below the remaining balance of the liquidation
account established in connection with the Stock Conversion.
The Company's ability to pay dividends will be governed by the policies and
regulations of the Federal Reserve Board which prohibit the payment of dividends
under certain circumstances involving the bank holding company's financial
condition and capital adequacy.
12
TRI-COUNTY FINANCIAL CORPORATION
Consolidated Financial Statements at December 31, 1996 and 1995
and for the Three Years Ended December 31, 1996 and Independent
Auditors' Report
13
TRI-COUNTY FINANCIAL CORPORATION
TABLE OF CONTENTS
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INDEPENDENT AUDITORS' REPORT 1
CONSOLIDATED FINANCIAL STATEMENTS AT DECEMBER 31, 1996 AND 1995,
AND FOR THE THREE YEARS ENDED DECEMBER 31, 1996
Consolidated Statements of Financial Condition 2
Consolidated Statements of Income 3
Consolidated Statements of Stockholders' Equity 4
Consolidated Statements of Cash Flows 5-7
Notes to Consolidated Financial Statements 8-30
14
INDEPENDENT AUDITORS' REPORT
To the Board of Directors and Stockholders
Tri-County Financial Corporation
Waldorf, Maryland
We have audited the accompanying consolidated statements of financial condition
of Tri-County Financial Corporation and subsidiary (the Company) as of December
31, 1996 and 1995, and the related consolidated statements of income,
stockholders' equity, and cash flows for the years then ended. These financial
statements are the responsibility of the Company's management. Our
responsibility is to express an opinion on these financial statements based on
our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant 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, such consolidated financial statements present fairly, in all
material respects, the financial position of Tri-County Financial Corporation
and subsidiary as of December 31, 1996 and 1995, and the results of their
operations and their cash flows for the years then ended, in conformity with
generally accepted accounting principles.
/S/ DELOITTE & TOUCHE LLP
March 14, 1997
Washington, D.C.
15
[LETTERHEAD OF CB&M APPEARS HERE]
March 3, 1995
Independent Auditors' Report
----------------------------
The Board of Directors
Tri-County Financial Corporation
Waldorf, Maryland
We have audited the accompanying consolidated statement of financial condition
of Tri-County Financial Corporation and Subsidiary as of December 31, 1994, and
the related consolidated statements of income, stockholders' equity, and cash
flows for the year then ended. These financial statements are the responsibility
of the Corporation's management. Our responsibility is to express an opinion on
these financial statements based on our audit.
We conducted our audit in accordance with generally accepted auditing standards.
Those standards require that we plan and perform the audit to obtain reasonable
assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audit provides a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present
fairly, in all material respects, the financial position of Tri-County Financial
Corporation and Subsidiary as of December 31, 1994, and the results of their
operations and their cash flows for the year then ended, in conformity with
generally accepted accounting principles.
/s/ Councilor, Buchanan & Mitchell, P.C.
Certified Public Accountants
TRI-COUNTY FINANCIAL CORPORATION AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION
DECEMBER 31, 1996 AND 1995
- -----------------------------------------------------------------------------------------------------------
ASSETS 1996 1995
CASH AND CASH EQUIVALENTS:
Noninterest-bearing $ 1,111,894 $ 786,113
Interest-bearing 2,791,718 3,264,106
------------- -----------
Total cash and cash equivalents 3,903,612 4,050,219
Investment securities available for sale at fair value, (amortized
cost of $11,117,063 and $14,798,529, respectively) 11,265,358 14,903,798
Investment securities held-to-maturity at amortized cost,
(fair value of $863,757 in 1996) 863,757 -
Mortgage-backed securities available for sale at fair value, (amortized
cost of $42,473,979 and $30,549,744, respectively) 42,470,319 30,793,682
Mortgage-backed securities held-to-maturity at amortized cost,
(fair value of $919,349 and $1,160,672, respectively) 883,887 1,160,672
Loans receivable, net of allowance for loan losses of $1,120,102 and
$733,573, respectively 111,024,921 107,340,325
Stock in Federal Home Loan Bank - at cost 1,300,000 881,600
Loans held for sale 1,011,930 476,750
Accrued interest receivable 1,165,191 1,093,113
Premises and equipment, net 3,824,568 3,178,806
Other assets 607,014 383,678
-------------- --------------
$ 178,320,557 $ 164,262,643
TOTAL ASSETS ============== ==============
See notes to consolidated financial statements.
- -----------------------------------------------------------------------------------------------------------
LIABILITIES AND STOCKHOLDERS' EQUITY 1996 1995
LIABILITIES:
Deposits $ 134,818,992 $ 129,348,276
Advances from Federal Home Loan Bank 24,000,000 13,250,000
Notes payable and other borrowings 733,466 4,302,845
Advance payments by borrowers for taxes and insurance 715,171 685,767
Accounts payable, accrued expenses, and other liabilities 724,055 614,952
Current and deferred income taxes 77,190 89,655
------------ ------------
Total liabilities 161,068,874 148,291,495
COMMITMENTS AND CONTINGENCIES
STOCKHOLDERS' EQUITY:
Common stock, $.01 par value - 15 million shares
authorized; 750,960 and 685,112 shares issued and
outstanding respectively 7,510 6,851
Additional paid-in capital 5,724,729 5,021,350
Retained earnings 11,430,666 10,710,824
Net unrealized gain on investment and mortgage-backed
securities available for sale, net of taxes 88,778 232,123
---------- ----------
Total stockholders' equity 17,251,683 15,971,148
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $ 178,320,557 $ 164,262,643
============== ==============
See notes to consolidated financial statements.
16
TRI-COUNTY FINANCIAL CORPORATION AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF INCOME
YEARS ENDED DECEMBER 31, 1996, 1995, AND 1994
- -----------------------------------------------------------------------------------------
1996 1995 1994
INTEREST INCOME:
Interest on loans $10,045,429 $ 9,771,990 $ 8,317,111
Interest on mortgage-backed securities 2,502,968 2,001,872 1,995,402
Interest and dividends on investment securities 923,198 1,127,014 950,456
----------- ----------- -----------
Total interest income 13,471,595 12,900,876 11,262,969
----------- ----------- -----------
INTEREST EXPENSES:
Deposits 5,397,181 5,198,160 4,553,471
Federal Home Loan Bank advances 850,612 492,004 341,208
Notes payable and other borrowings 158,963 404,804 222,824
----------- ----------- -----------
Total interest expenses 6,406,756 6,094,968 5,117,503
----------- ----------- -----------
Net interest income 7,064,839 6,805,908 6,145,466
Provision for loan losses 408,000 210,000 154,000
----------- ----------- -----------
Net interest income after 6,656,839 6,595,908 5,991,466
provision for loan losses
OTHER INCOME:
Loan service charges 280,126 284,635 261,140
Gain (loss) on sale of investments and
mortgage-backed securities available for sale -- 1,802 (70,877)
Gain (loss) on sale of loans 192,468 88,437 (40,546)
Service charges 382,228 399,079 293,596
Other 76,148 83,514 118,984
----------- ----------- -----------
Total other income 930,970 857,467 562,297
----------- ----------- -----------
OPERATING EXPENSES:
Employee compensation and benefits 2,432,293 2,141,438 1,972,787
Occupancy expense 353,246 341,449 357,830
Federal insurance premiums and surety
bond premiums 1,165,816 348,025 328,175
Data processing expenses 262,375 207,632 222,511
Other 1,269,152 1,060,017 1,047,688
----------- ----------- -----------
Total operating expenses 5,482,882 4,098,561 3,928,991
----------- ----------- -----------
INCOME BEFORE INCOME TAXES 2,104,927 3,354,814 2,624,772
INCOME TAX EXPENSE:
Current 929,000 1,400,000 859,915
Deferred (143,800) (73,000) 181,800
----------- ----------- -----------
Total income tax expense 785,200 1,327,000 1,041,715
----------- ----------- -----------
$ 1,319,727 $ 2,027,814 $ 1,583,057
NET INCOME =========== =========== ===========
EARNINGS PER SHARE:
Primary $ 1.61 $ 2.62 $ 2.08
On a Fully Diluted Basis 1.60 2.59 2.00
See notes to consolidated financial statements
17
TRI-COUNTY FINANCIAL CORPORATION AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
YEARS ENDED DECEMBER 31, 1996, 1995, AND 1994
- ----------------------------------------------------------------------------------------------------------------------------------
Net Unrealized
Additional Gain (Loss) on
Common Paid In Securities Available Retained
Stock Capital for Sale Earnings Total
BALANCE, JANUARY 1, 1994 $ 6,051 $ 3,605,425 $ (18,856) $ 8,542,973 $ 12,135,593
Net income -- -- -- 1,583,057 1,583,057
$.10 per share cash dividend -- -- -- (60,545) (60,545)
5% stock dividend 300 599,700 -- (600,000) --
Cash paid in lieu of stock
dividend for fractional shares -- -- -- (5,458) (5,458)
Exercise of stock options 73 42,642 -- -- 42,715
Change in unrealized gain (loss)
on mutual funds -- -- (326,868) -- (326,868)
------ ----------- ----------- ------------ ------------
BALANCE, DECEMBER 31, 1994 6,424 4,247,767 (345,724) 9,460,027 13,368,494
Net income -- -- -- 2,027,814 2,027,814
$.10 per share cash dividend -- -- -- (64,751) (64,751)
5% stock dividend 322 707,682 -- (708,004) --
Cash paid in lieu of stock
dividend for fractional shares -- -- -- (4,262) (4,262)
Exercise of stock options 105 65,901 -- -- 66,006
Change in unrealized gain (loss)
on investment and mortgage-backed
securities available for sale -- -- 577,847 -- 577,847
------ ----------- ----------- ------------ ------------
BALANCE, DECEMBER 31, 1995 6,851 5,021,350 232,123 10,710,824 15,971,148
Net income -- -- -- 1,319,727 1,319,727
$.10 per share cash dividend -- -- -- (70,574) (70,574)
5% stock dividend 351 525,489 -- (525,840) --
Cash paid in lieu of stock
dividend for fractional shares -- -- -- (3,471) (3,471)
Exercise of stock options 308 177,890 -- -- 178,198
Change in unrealized gain (loss)
on investment and mortgage-backed
securities available for sale -- -- (143,345) -- (143,345)
------ ----------- ----------- ------------ ------------
BALANCE, DECEMBER 31, 1996 $7,510 $ 5,724,729 $ 88,778 $ 11,430,666 $ 17,251,683
See notes to consolidated financial statements.
18
TRI-COUNTY FINANCIAL CORPORATION AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF CASH FLOWS
YEARS ENDED DECEMBER 31, 1996, 1995, AND 1994
- ------------------------------------------------------------------------------------------------------------------------
1996 1995 1994
CASH FLOWS FROM OPERATING
ACTIVITIES:
Net income $ 1,319,727 $ 2,027,814 $ 1,583,057
Adjustments to reconcile net income to net
cash provided by operating activities:
Provision for loan losses 408,000 210,000 154,000
Provision for depreciation and amortization 264,492 232,589 314,798
Amortization of premium/discount on
mortgage-backed securities
and investment securities (96,060) (87,102) (34,615)
Capitalization of interest expense on notes
payable - 38,553 72,407
Provision for deferred income tax (benefit) (143,800) (73,000) 181,800
Increase in interest receivable (72,078) (14,446) (196,234)
(Decrease) increase in interest payable (24,314) 26,235 10,671
(Decrease) increase in deferred loan fees (85,781) 4,720 110,146
Increase in other liabilities 282,092 301,137 243,860
(Increase) decrease in other assets (200,921) 378,203 (47,398)
(Gain) loss on sale of premises and equipment (9,610) (3,790) 15,278
Originations of loans held for sale (8,812,925) (5,731,850) (2,416,000)
Proceeds from sales of mortgage-backed 14,791,250
securities held for trading - -
Purchase of mortgage-backed securities (14,725,313)
held for trading - -
(Gain) loss on sales of investment securities
and mortgage-backed securities
available for sale - (1,802) 70,877
(Gain) loss on sales of loans held for sale (192,468) (88,437) 40,546
Proceeds from sales of loans held for sale 8,887,468 5,284,394 2,917,000
Federal Home Loan Bank stock dividends - (10,200) (10,800)
-------- --------- ---------
Net cash provided by operating
activities 1,523,822 2,493,018 3,075,330
----------- ----------- ---------
(Continued)
19
TRI-COUNTY FINANCIAL CORPORATION AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF CASH FLOWS
YEARS ENDED DECEMBER 31, 1996, 1995, AND 1994
- ------------------------------------------------------------------------------------------------------------------------
1996 1995 1994
CASH FLOWS FROM INVESTING
ACTIVITIES:
Proceeds from sale or redemption of investments - - 594,201
Purchases of investments - - (9,291,447)
Purchase of Federal Home Loan Bank Stock (418,400) - -
Purchase of investment securities available
for sale (13,607,756) (7,395,830) -
Proceeds from sale of investment
securities available for sale 17,313,408 5,989,044 -
Purchase of investment securities
held-to-maturity (990,273) - -
Proceeds from maturities of investment
securities held-to-maturity 126,515 2,018,385 -
Purchase of mortgage-backed securities
held to maturity - (4,922,455) (5,933,913)
Purchase of mortgage-backed securities
available for sale (14,029,861) - (2,000,000)
Proceeds from sale of mortgage-backed
securities available for sale - 1,805,572 7,067,315
Principal collected on mortgage-backed
securities 2,454,288 1,674,614 6,165,854
Net decrease in short-term investments - - 3,573,176
Principal collected on loans 46,317,302 40,220,762 45,404,454
Loans originated or acquired (50,719,901) (49,037,683) (60,895,293)
Proceeds from sale of real estate - 200,437 -
Purchases of premises and equipment (859,884) (511,290) (120,798)
Proceeds from sale of premises and equipment 9,610 101,446 -
Investment in real estate - (232,305) -
----------- ------------ ------------
Net cash used in investing activities (14,404,952) (10,089,303) (15,436,451)
----------- ------------ ------------
CASH FLOWS FROM FINANCING
ACTIVITIES:
Net increase in deposits 5,470,716 3,278,956 6,052,325
Net increase (decrease) in short-term borrowings 110,587 (107,933) (275,495)
Net increase (decrease) in advance payments
by borrowers for taxes and insurance 29,404 (85,192) 4,679
Proceeds from Federal Home Loan Bank 84,500,000 36,750,000 10,500,000
advances
Payments of maturing Federal Home Loan
Bank advances (73,750,000) (30,750,000) (7,500,000)
(Continued)
20
TRI-COUNTY FINANCIAL CORPORATION AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF CASH FLOWS
YEARS ENDED DECEMBER 31, 1996, 1995, AND 1994
- ------------------------------------------------------------------------------------------------------------------------
1996 1995 1994
CASH FLOWS FROM FINANCING
ACTIVITIES (Continued):
Net (decrease) increase in securities sold
under agreement to repurchase (3,358,000) (609,000) 3,967,000
Dividends paid (74,045) (69,013) (66,003)
Exercise of stock options 178,198 66,006 42,715
Repayments on notes payable (372,337) (299,273) (913,107)
------------ ------------ ------------
Net cash provided by financing
activities 12,734,523 8,174,551 11,812,114
------------ ------------ ------------
INCREASE (DECREASE) IN CASH AND
CASH EQUIVALENTS (146,607) 578,266 (549,007)
CASH AND CASH EQUIVALENTS,
BEGINNING OF YEAR 4,050,219 3,471,953 4,020,960
------------ ------------ ------------
CASH AND CASH EQUIVALENTS,
END OF YEAR $ 3,903,612 $ 4,050,219 $ 3,471,953
============ ============ ============
SUPPLEMENTAL DISCLOSURE OF CASH
FLOW INFORMATION:
Cash paid during the year for:
Interest $ 6,414,832 $ 6,067,478 $ 5,116,244
Income taxes 803,000 940,786 1,048,771
NON-CASH TRANSACTIONS:
Mortgage-backed securities totaling $2.0 million were received in 1994 in
exchange for equal amounts of loans receivable. No such exchanges occurred
in 1996 and 1995.
Mortgage-backed securities and investments totaling $28,704,461 and
$9,387,415, respectively, were transferred from the held-to-maturity
category to the available-for-sale category on December 31, 1995.
Transfers from loans receivable to foreclosed real estate were $207,409,
$52,000, and $49,382 in 1996, 1995, and 1994, respectively.
(Concluded)
See notes to consolidated financial statements.
21
TRI-COUNTY FINANCIAL CORPORATION AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR THE THREE YEARS ENDED DECEMBER 31, 1996
- --------------------------------------------------------------------------------
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
The consolidated financial statements include the accounts of Tri-County
Financial Corporation and its wholly owned subsidiary, Tri-County Federal
Savings Bank of Waldorf (the Bank) and the Bank's wholly owned subsidiary,
Tri-County Federal Finance One (collectively, "the Company"). All
significant intercompany balances and transactions between the parent
corporations and their subsidiaries have been eliminated.
The Company is primarily engaged in the business of obtaining funds in the
form of savings deposits and investing such funds in mortgage loans on
residential, construction and commercial real estate and various types of
consumer and other loans, mortgage-backed securities, and investment and
money market securities. The Company grants loans throughout the Southern
Maryland area. Its borrowers' ability to repay is, therefore, dependent
upon the economy of Southern Maryland.
Management Estimates - The preparation of financial statements in
conformity with generally accepted accounting principles requires
management to make estimates and assumptions that affect the reported
amounts of assets and liabilities and disclosure of contingent assets and
liabilities at the date of the financial statements, and the reported
amounts of revenues and expenses during the reporting period. Actual
results could differ from those estimates.
Cash and Cash Equivalents - For purposes of the consolidated statements of
cash flows, the Company considers all highly liquid debt instruments with
original maturities when purchased of three months or less to be cash
equivalents.
Investment Securities and Mortgage-backed Securities - Investment and
equity securities are segregated into the following three categories:
trading, held-to-maturity, and available-for-sale. Trading securities are
purchased and held principally for the purpose of reselling them within a
short period of time. Their unrealized gains and losses are included in
earnings. Debt securities classified as held-to-maturity are accounted for
at amortized cost, and require the Company to have both the positive
intent and ability to hold those securities to maturity. Securities not
classified as either trading or held-to-maturity are considered to be
available-for-sale. Unrealized gains and losses on available-for-sale
securities are excluded from earnings and reported, net of deferred taxes,
as a separate component of stockholders' equity until realized. Realized
gains or losses on the sale of investment and mortgage-backed securities
are reported in earnings and determined using the adjusted cost of the
specific security sold.
In November 1995, the Financial Accounting Standards Board issued a
Special Report, A Guide to Implementation of Statement 115 on Accounting
for Certain Investments in Debt and Equity Securities. The Special Report
provided institutions with a one-time opportunity to reassess the
appropriateness of their categorization of all securities, and allowed the
institutions to transfer securities between categories on or before
December 31, 1995. The report also stated that transfers from the
held-to-maturity category that resulted from this one-time reassessment
would not call into question the institution's intent to hold other debt
securities to maturity in the future.
22
When reassessing the appropriateness of current designations of securities
under the Special Report, the Company considered how it uses securities to
meet liquidity needs and manage interest-rate risk. By having a portion of
its securities portfolio categorized as available-for-sale, the Company
has the ability to respond, through the management of its portfolio, to
changes in market interest rates or to increases in loan demand or deposit
withdrawals.
Given the opportunity to reassess the portfolio, the Company transferred
certain investment and mortgage-backed securities classified as
held-to-maturity to available-for-sale. The investment and mortgage-backed
securities transferred had carrying values of $9.4 million and $28.7
million and market values of $9.4 million and $28.9 million, respectively.
The transfers resulted in an increase in stockholders' equity at December
31, 1995, of $151,000 for the unrealized gain net of income taxes of
$76,000.
Loan Fees and Costs - Loan origination fee revenues and certain costs
directly related to specified activities performed for a loan origination
are deferred and recognized over the contractual life of the loan using a
method approximating level yield. Any unamortized amount of fees and costs
on loans sold or paid off is included in revenue in the year of sale or
payoff.
Loans Receivable - Loans receivable 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 reduced by any
charge-offs or specific valuation allowance accounts, and net of any
deferred fees or costs on originated loans.
Loans Held for Sale - Mortgage loans originated and intended for sale in
the secondary market are carried at the lower of cost or estimated market
value, determined in the aggregate. Market value considers commitment
agreements with investors and prevailing market prices.
Income Recognition on Loans - Interest on loans is credited to income as
earned on the principal amount outstanding using the interest method. An
allowance for accrued interest deemed to be uncollectible is provided.
Accrued interest receivable is reported net of the allowance for
uncollectible interest. For those loans which are carried on nonaccrual
status, interest is recognized on the cash basis. Loans are generally
placed on nonaccrual status when the collection of principal or interest
is 90 days or more past due, or earlier if collection is deemed uncertain.
Allowance for Loan Losses - The allowance for loan losses is maintained at
a level believed by management to be adequate to absorb potential losses
inherent in the loan portfolio. Management's determination of the adequacy
of the allowance is based on a periodic evaluation of the portfolio with
consideration given to the overall loss experience; current economic
conditions; volume, growth, and composition of the loan portfolio;
financial condition of the borrowers; and other relevant factors that, in
management's judgment, warrant recognition in providing an adequate
allowance. The allowance is increased by provisions for loan losses
charged against income. Changes in the allowance are recorded periodically
as conditions change or as more information becomes available. Such
changes could result in material adjustments to future results of
operations.
Impairment of Loans - On January 1, 1995, the Company adopted Statement of
Financial Accounting Standard No. 114, "Accounting by Creditors for
Impairment of a Loan" (SFAS 114), as amended by SFAS 118, "Accounting by
Creditors for Impairment of a Loan-Income Recognition and Disclosures."
These pronouncements require that an impaired loan be measured based on
the present value of expected future cash flows discounted at the
effective interest rate of the loan or, as a practical expedient, at the
loan's observable market price or the fair value of the collateral if the
loan is collateral
23
dependent. The Company considers a loan impaired when it is probable that
the Company will be unable to collect all contractual interest and
principal payments as scheduled in the loan agreement. A loan is not
considered impaired during a period of delay in payment if the ultimate
collectibility of all amounts due is expected. A valuation allowance is
maintained to the extent that the measurement of the impaired loan is less
than the recorded investment.
The Company's residential mortgage and consumer loan portfolios are
collectively evaluated for impairment and are not included within the
scope of SFAS 114. A valuation allowance has been provided for these loans
based on management's estimates of the risks inherent in the portfolios
and analysis of prior loss experience.
Payments received relating to impaired loans and nonaccrual loans are
recorded on a cash basis and are either applied to the outstanding
principal balance or recorded as interest income, depending upon
management's assessment of the ultimate collectibility of the loan.
Premises and Equipment - Depreciation of premises and equipment, which are
carried at cost, is provided by the straight-line method over the
estimated useful lives as follows:
Buildings and improvements 10-50 years
Furniture and equipment 5-20 years
Automobiles 3 years
Foreclosed Real Estate - Real estate acquired through, or in lieu of, loan
foreclosure is initially recorded at the lower of the recorded investment
or fair value at the date of foreclosure. Costs relating to the development
and improvement of property are capitalized, whereas costs relating to the
holding of property are expensed. Valuations are periodically performed by
management and an allowance for losses is established by a charge to
operations if the carrying value of a property exceeds its estimated fair
value less estimated costs to sell. No charge to operations was required as
a result of this review in 1996, 1995, or 1994.
Mortgage-Banking Activities - When the Bank purchases or originates
mortgage loans, the cost of acquiring these loans includes the cost of the
related mortgage servicing rights (MSRs). When the Bank sells or
securitizes mortgage loans and retains the MSRs, it allocates the total
cost of the mortgage loans between the MSRs and the loans (without MSRs)
based on their relative fair values, if practicable. Any cost allocated to
the MSRs is recognized as a separate asset. MSRs are amortized in
proportion to and over the period of estimated net servicing income and are
evaluated for impairment based on their fair value. Total capitalized
mortgage servicing rights approximated $10,000 at December 31, 1996.
Income Taxes - The Company files a consolidated Federal income tax return
with its subsidiary. Deferred tax assets and liabilities are recognized
for the future tax consequences attributed to differences between the
financial statement carrying amounts of existing assets and liabilities
and their respective tax bases. Any deferred tax asset is reduced by the
amount of any tax benefit that more likely than not will not be realized.
Earnings Per Share - Earnings per share was computed by dividing net
earnings by the weighted average number of shares of common stock and
common stock equivalents outstanding during the year. Earnings per share
for all years presented have been restated to reflect the effect of stock
dividends (see Note 13). Per share amounts have been computed based on
average common and common equivalent shares outstanding as follows:
24
1996 1995 1994
Primary 818,222 774,860 761,085
Fully Diluted 823,016 783,311 791,528
New Accounting Pronouncements -
In June 1996, the FASB issued SFAS No. 125, "Accounting for Transfers and
Servicing of Financial Assets and Extinguishments of Liabilities." This
Statement, which is effective for transactions occurring after December
31, 1996 (prospective basis only), provides accounting and reporting
standards for transfers and servicing of financial assets and
extinguishments of liabilities. Those standards are based on consistent
application of a financial-components approach that focuses on control.
Under that approach, after a transfer of financial assets, an entity
recognizes the financial and servicing assets it controls and the
liabilities it has incurred, derecognizes financial assets when control
has been surrendered, and derecognizes liabilities when extinguished. This
Statement provides consistent standards for distinguishing transfers of
financial assets that are sales from transfers that are secured
borrowings.
SFAS 125 also addresses accounting for mortgage-servicing rights and
requires an entity to recognize either a servicing asset or servicing
liability each time the entity undertakes an obligation to service
financial assets. The Statement requires that servicing assets and
liabilities be subsequently measured by (a) amortization in proportion to
and over the period of estimated net servicing income or loss and (b)
assessment for asset impairment or increased obligation based on their
fair values. Upon becoming effective, this Statement will supersede SFAS
122, "Accounting for Mortgage Servicing Rights".
In December 1996, the FASB amended SFAS 125, through its issuance of SFAS
127, "Deferral of the Effective Date of Certain Provisions of FASB
Statement No. 125 - an amendment of FASB Statement No. 125". SFAS 127
defers for one year the effective date of certain provisions of SFAS 125.
The Company does not anticipate that the implementation of SFAS 125 will
materially impact its financial position or results of operations.
In February 1997, the FASB issued Statement No. 128, "Earnings Per Share."
This Statement establishes standards for computing and presenting earnings
per share (EPS) and applies to entities with publicly held common stock or
potential common stock. This Statement simplifies the standards for
computing earnings per share previously found in APB Opinion No. 15,
Earnings per Share, and makes them comparable to international EPS
standards. It replaces the presentation of primary EPS with a presentation
of basic EPS. It also requires dual presentation of basic and diluted EPS
on the face of the income statement for all entities with complex capital
structures and requires a reconciliation of the numerator and denominator
of the basic EPS computation to the numerator and denominator of the
diluted EPS computation. This Statement is effective for financial
statements issued for periods ending after December 15, 1997, including
interim periods; earlier application is not permitted. This Statement
requires restatement of all prior-period EPS data presented. Management
has not yet determined the impact on earnings per share that will result
from implementation of the Statement.
Reclassifications - Certain reclassifications have been made to the prior
year consolidated financial statements to conform to the 1996
presentation.
25
2. INVESTMENT SECURITIES
A summary of amortized cost and approximate fair values of investment
securities are as follows:
December 31, 1996
------------------------------------------------------------
Gross Gross
Amortized Unrealized Unrealized Fair
Cost Gains Losses Value
AVAILABLE-FOR-SALE:
Corporate equity securities $ 763,166 $ 203,479 $ -- $ 966,645
Mutual funds 4,571,297 -- 40,184 4,531,113
Obligations of U.S. Government
Corporations and Agencies 5,782,600 -- 15,000 5,767,600
----------- ----------- --------- -----------
$11,117,063 $ 203,479 $ 55,184 $11,265,358
=========== =========== ========= ===========
HELD-TO-MATURITY:
U.S. Treasury Bills $ 193,257 $ -- $ -- $ 193,257
Other investments 670,500 -- -- 670,500
----------- ----------- --------- -----------
$ 863,757 $ -- $ -- $ 863,757
=========== =========== ========= ===========
December 31, 1996
------------------------------------------------------------
Gross Gross
Amortized Unrealized Unrealized Fair
Cost Gains Losses Value
AVAILABLE-FOR-SALE:
Corporate equity securities $ 763,166 $ 136,330 $ -- $ 899,496
Mutual funds 4,226,167 -- 31,061 4,195,106
Obligations of U.S. Government
Corporations and Agencies 9,809,196 -- -- 9,809,196
----------- -------- -------- ------------
$14,798,529 $ 136,330 $ 31,061 $ 14,903,798
=========== ========== ========= =============
There were no investment securities classified as held-to-maturity at December
31, 1995.
26
The scheduled maturities of obligations of U.S. Government corporations
and agencies at December 31, 1996, are as follows:
Available for Sale
---------------------------------
Amortized Fair
Cost Value
Due in one year or less $ 2,782,600 $ 2,766,350
Due after one year through five years 3,000,000 3,001,250
Due after five years through ten years - -
Due after ten years - -
------------- --------------
$ 5,782,600 $ 5,767,600
============== ==============
Proceeds from sales or maturities of securities available for sale were
$17.3 million, $6.0 million, and $20.1 million for the years ended
December 31, 1996, 1995, and 1994, respectively.
No gross gains were realized on sales of securities available for sale
during 1996 or 1995. Gross gains of $65,938 were realized on these sales
for the year ended December 31, 1994. No gross losses were realized during
1996, 1995, or 1994.
3. MORTGAGE-BACKED SECURITIES
The amortized cost and approximate fair values of mortgage-backed and
related securities are as follows:
December 31, 1996
-------------------------------------------------------------------------------------------
Gross Gross
Amortized Unrealized Unrealized Fair
Cost Gains Losses Value
AVAILABLE FOR SALE:
FHLMC certificates $ 6,663,833 $ 111,354 $ 26,119 $ 6,749,068
GNMA certificates 305,468 5,345 - 310,813
REMICs:
FNMA $11,891,116 - - - -
FHLMC 6,060,269 - - - -
FHLB 3,000,000 - - - -
VA 2,000,000 - - - -
Other 12,553,293 35,504,678 74,176 168,416 35,410,438
----------- ----------- -------- -------- -----------
$42,473,979 $190,875 $194,535 $42,470,319
=========== ======== ======== ===========
HELD-TO-MATURITY:
FHLMC certificates $883,887 $ 35,462 $ - $919,349
=========== ======== ======== ===========
27
December 31, 1995
---------------------------------------------------------------------
Gross Gross
Amortized Unrealized Unrealized Fair
Cost Gains Losses Value
AVAILABLE FOR SALE:
FHLMC certificates $ 7,365,066 $218,082 $ - $ 7,583,148
GNMA certificates 362,096 17,713 - 379,809
REMICs:
FNMA $12,179,983
FHLMC 3,702,316
FHLB 997,600
VA 2,028,350
Other 3,914,333 22,822,582 163,306 155,163 22,830,725
---------- ----------- -------- -------- -----------
$30,549,744 $399,101 $155,163 $30,793,682
=========== ======== ======== ===========
HELD-TO-MATURITY:
FHLMC certificates $ 1,160,672 $ - $ - $ 1,160,672
=========== ======== ======== ===========
Proceeds from sales of mortgage-backed securities available for sale were
$-0-, $1.8 million, and $21.8 million for the years ended December 31,
1996, 1995, and 1994, respectively.
Gross gains of $-0-, $1,802, and $52,465 and gross losses of $-0-, $-0-,
and $189,280 were realized on these sales for the years ended December 31,
1996, 1995, and 1994, respectively.
4. LOANS RECEIVABLE AND LOANS HELD FOR SALE
Loans receivable at December 31, 1996 and 1995, consist of the following:
1996 1995
First mortgage loans:
Conventional $ 116,786,351 $ 116,595,289
Construction 15,326,795 16,148,960
Second mortgage loans 14,147,267 12,155,434
Lines of credit - commercial and builders 7,927,495 6,981,433
Home improvement loans 39,638 57,714
Consumer loans 5,325,918 4,747,204
-------------- -------------
Total 159,553,464 156,686,034
-------------- -------------
Less:
Participations sold on conventional first
mortgage loans 40,995,589 42,841,437
Undisbursed portion of loans receivable 5,326,688 4,598,754
Deferred loan fees 1,086,164 1,171,945
Allowance for loan losses 1,120,102 733,573
----------- ---------
48,528,543 49,345,709
-------------- -------------
TOTAL $ 111,024,921 $ 107,340,325
============== =============
28
The following table sets forth the activity in the allowance for loan
losses:
1996 1995 1994
BALANCE, JANUARY 1 $ 733,573 $ 563,624 $ 449,460
Add:
Provision charged to operations 408,000 210,000 154,000
Recoveries 180 5,687 2,146
Less:
Charge-offs 21,651 45,738 41,982
------------ ---------- ----------
BALANCE, DECEMBER 31 $ 1,120,102 $ 733,573 $ 563,624
============ ========== ==========
At December 31, 1996 and 1995, real estate loans held for sale aggregated
$1,011,930 and $476,750 respectively; all were fixed-rate, conventional
first mortgage loans.
No loans included within the scope of SFAS 114 were identified as being
impaired at December 31, 1996 or 1995.
Loans on which the recognition of interest has been discontinued, which
were not included within the scope of SFAS 114, amounted to approximately
$0.4 million, $0.3 million, and $1.1 million at December 31, 1996, 1995,
and 1994, respectively. If interest income has been recognized on
nonaccural loans at their stated rates during 1996, 1995, and 1994,
interest income would have been increased by approximately $14,000,
$60,000, and $161,000, respectively. No income was recognized for these
loans in 1996, 1995 and 1994.
Commercial real estate loans outstanding at December 31, 1996 and 1995,
aggregated $13.1 million and $3.3 million, respectively. These loans are
considered by management to be of a somewhat greater risk due to the
dependency on income production. At December 31, 1996 and 1995, all of the
outstanding commercial real estate loans were collateralized by real
estate in southern Maryland.
Included in loans receivable at December 31, 1996 and 1995, is $1,031,607
and $1,027,209 due from officers and directors of the Bank. Activity in
loans outstanding to officers and directors is summarized as follows:
1996 1995
BALANCE, BEGINNING OF YEAR $ 1,027,209 $ 991,555
New loans made during year 222,106 98,953
Repayments made during year (217,708) (63,299)
------------ ------------
BALANCE, END OF YEAR $ 1,031,607 $ 1,027,209
============ ============
Loans serviced for others and not reflected in the statements of financial
condition are $40,996,000, $41,681,000, and $44,588,000 at December 31,
1996, 1995, and 1994, 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
29
basis and includes servicing fees from investors and certain charges
collected from borrowers, such as late payment fees.
The Bank grants loans throughout the Southern Maryland area. Its
borrowers' ability to repay is, therefore, dependent upon the economy of
Southern Maryland.
5. PREMISES AND EQUIPMENT
A summary of premises and equipment at December 31, 1996 and 1995, is as
follows:
1996 1995
Land $ 1,486,879 $ 1,504,524
Building and improvements 2,247,122 1,698,497
Furniture and equipment 1,477,536 1,176,522
Automobiles
81,000 70,708
---------- ---------
Total 5,292,537 4,450,251
Less accumulated depreciation 1,467,969 1,271,445
---------- ---------
Net $ 3,824,568 $ 3,178,806
========== =========
Depreciation expense for the years ended December 31, 1996, 1995, and
1994, was $214,120, $182,219, and $201,794, respectively.
30
6. DEPOSITS
A comparative summary of savings deposits at December 31, 1996 and 1995,
is as follows:
1996 1995
------------------------------ --------------------------------
Amount % Amount %
BALANCE BY INTEREST RATE-
Passbook and Statement Accounts:
3.04% $ 23,527,050 17 % $ 27,494,577 21 %
2.89% 37,540 - 35,780 -
2.53% 4,018,539 3 4,577,734 4
2.53% 606,711 - 258,431 -
Negotiable Order of Withdrawal
Accounts:
2.02% 13,329,190 10 12,259,753 10
Noninterest-bearing 5,251,827 4 4,135,222 3
Money Market Deposit Accounts:
2.50 to 3.56% 10,843,953 8 9,436,894 7
---------------- ---- --------------- ----
57,614,810 42 % 58,198,391 45 %
---------------- ---- --------------- ----
Certificate Accounts:
2.00 to 2.99% 375,056 - % 505,305 - %
3.00 to 3.99% 4,972,382 4 6,736,138 5
4.00 to 4.99% 9,255,195 7 8,906,857 7
5.00 to 5.99% 47,050,343 35 34,209,134 27
6.00 to 6.99% 15,551,206 12 18,009,008 14
7.00 to 7.99% - - 2,474,469 2
8.00 to 8.99% - - 308,974 -
-------------- ---- --------------- ----
77,204,182 58 % 71,149,885 55 %
-------------- ---- --------------- ----
TOTAL $ 134,818,992 100 % $ 129,348,276 100 %
============== ==== ================ ====
The weighted average rate paid on deposits at December 31, 1996 and 1995
is 4.18% and 4.32%, respectively.
Certificates of deposit of $100,000 or more aggregated $13,484,000 and
$8,683,993 at December 31, 1996 and 1995, respectively.
31
At December 31, 1996, scheduled maturities of certificates of deposit are
as follows:
1997 $ 35,584,367
1998 24,685,802
1999 8,951,398
2000 5,181,210
2001 and thereafter 2,801,405
-------------
Total $ 77,204,182
=============
7. ADVANCES FROM THE FEDERAL HOME LOAN BANK AND OTHER BORROWINGS
The advances from the Federal Home Loan Bank are as follows:
Weighted
Average
Year Due Interest Rate 1996 1995
1996 5.76 % $ - $ 13,250,000
1997 5.65 % 13,000,000 -
1998 5.00 % 5,000,000 -
1999 5.21 % 6,000,000 -
------------ -----------
Total $ 24,000,000 $ 13,250,000
============ ===========
Under the terms of an Agreement for Advances and Security Agreement with
Blanket Floating Lien, the Company maintains eligible collateral
consisting of 1-4 unit residential first mortgage loans, discounted at 75%
of the unpaid principal balance, equal to 100% at December 31, 1996 and
1995, of its outstanding Federal Home Loan Bank advances. These amounts
were $32,000,000 and $17,667,000 at December 31, 1996 and 1995,
respectively. The advances due in 1998 and 1999 have call provisions under
which the Federal Home Loan Bank may require payment prior to the stated
maturity date.
Tri-County Federal Finance One (Finance One) is obligated on a note
payable issued in connection with its participation in the Salomon Capital
Access Collateralized Mortgage Obligation Bond Program. Under this
program, Finance One has pledged Federal Home Loan Mortgage Corporation
participation certificates having unpaid principal balances at December
31, 1996 and 1995, totaling $883,887 and $1,160,672, respectively, as
security for the notes. The participation certificates are held in trust,
and the principal and interest payments required by the note payable are
made out of the monthly cash proceeds from the certificates.
The maturity dates and interest rates, which are subject to adjustment
based on prepayments of the participation certificates, for the notes
payable at December 31, 1996 and 1995, are as follows:
Unpaid Principal
(Net of Discount)
December 31, Interest Maturity
------------------- Rate Date
1996 1995
Salomon Capital
Access Corp.
Series 1985-3 $ 463,507 $ 785,473 8.50 % July 1, 2010
32
The Company enters into sales of securities under agreements to repurchase
with terms to maturity of less than one month. These agreements are
treated as financings, and the obligations to repurchase securities sold
are reflected as a liability in the statements of financial condition. The
dollar amounts of securities underlying the agreements remain in the asset
accounts. The securities underlying the agreements are book-entry
securities and the securities were delivered by appropriate entry into the
counterparties' accounts maintained at the purchasing securities dealer's
safekeeping house.
The Company is subject to the risk that its interest in the sold
securities is inadequately protected in the event the purchasing
securities dealer fails to perform its obligations. The Company attempts
to reduce the effects of such risks by entering into such agreements only
with well-capitalized securities dealers who are primary dealers in
government securities and by limiting the maximum amount of agreements
outstanding at any time with any single securities dealer.
Additional information regarding repurchase agreements is as follows:
1996 1995
Balance outstanding at December 31 $ - $ 3,358,000
Average balance during the year $ 1,068,698 $ 4,269,704
Average interest rate during the year 5.05 % 6.35 %
Maximum outstanding balance at any
month end during the year $ 4,774,000 $ 6,198,000
Mortgage-backed securities underlying the agreements at year-end:
Carrying value $ - $ 4,710,516
Estimated fair value $ - $ 4,794,721
Other borrowed funds consist of treasury tax and loan deposits that
generally mature within one to 120 days from the transaction date. At
December 31, 1996 and 1995, such borrowings were $269,959 and $159,372,
respectively.
The aggregate scheduled principal maturities on all borrowings outstanding
at December 31, 1996, are as follows:
1997 $ 13,269,959
1998 5,000,000
1999 6,000,000
2000 -
2001 -
After 2001 463,507
-------------
Total $ 24,733,466
=============
33
8. INCOME TAXES
Total income tax expense differed from the amounts computed by applying
the Federal income tax rate of 34% to income before income taxes as a
result of the following:
1996 1995 1994
Expected income tax expense at
Federal tax rate $ 715,700 $ 1,141,000 $ 892,422
State taxes, net of Federal benefit 96,000 155,000 124,668
Amortization and other nondeductible
expenses (4,400) (2,000) (17,560)
Other (22,100) 33,000 42,185
--------- --------- ---------
Total income tax expense $ 785,200 $ 1,327,000 $ 1,041,715
========= ========= =========
The net deferred tax asset (liability) in the accompanying balance sheets
include the following components:
1996 1995
DEFERRED TAX ASSETS:
Deferred fees $ 209,372 $ 239,551
Bad debt reserves 137,674 (8,506)
Pension plan 40,417 -
Other assets 3,058 7,500
------- -------
Total deferred assets 390,521 238,545
------- -------
DEFERRED TAX LIABILITIES:
FHLB stock dividends 152,896 144,786
Depreciation 94,516 94,450
------- -------
Total deferred liabilities 247,412 239,236
------- -------
143,109 (691)
INVESTMENT VALUATION ALLOWANCE (55,859) (134,864)
-------- ---------
NET DEFERRED ASSET (LIABILITY) $ 87,250 $ (135,555)
======== ==========
Retained earnings at December 31, 1996, include 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 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 $458,000 at December 31, 1996.
34
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 requires
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 will allow 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 will have to recapture into
income a portion of its existing tax bad debt reserve. This recapture will
occur ratably over a six-taxable year period, generally beginning with the
1996 tax year. However, the bank can delay the timing of this recapture
for a two-year period provided certain requirements are met. For financial
reporting purposes, this recapture will 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.
9. COMMITMENTS AND CONTINGENCIES
The Company is party to financial instruments with off-balance-sheet risk
in the normal course of business to meet the financing needs of its
borrowers. 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 statements of financial condition. The Company'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 Company uses the same credit policies in making
commitments as it does for on-balance-sheet loans receivable.
As of December 31, 1996 and 1995, in addition to the undisbursed portion
of loans receivable, the Company had outstanding loan commitments
approximating $1,157,000 and $1,516,000, respectively. These commitments
are normally met from savings account growth, loan payments, excess
liquidity, or borrowed money.
Standby letters of credit written are conditional commitments issued by
the Company to guarantee the performance of a customer to a third party.
Those guarantees are primarily issued to support 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 Company holds cash or a secured interest in real estate as
collateral to support those commitments for which collateral is deemed
necessary. Outstanding standby letters of credit amounted to $4,130,000
and $4,168,000 at December 31, 1996 and 1995, respectively.
The Company is obligated under four leases for branch office facilities
with minimum rentals as follows:
1997 $ 104,307
1998
97,338
1999
73,272
2000
47,112
2001
6,056
Total $ 328,085
=========
The composition of total rent expense is as follows:
1996 1995 1994
Minimum rental $ 101,148 $ 95,758 $ 90,322
Contingent rental 5,560 7,440 16,650
-------- --------- ---------
Total $ 106,708 $ 103,198 $ 106,972
======== ========= =========
The Company is a defendant in various lawsuits generally incidental to its
business. Management is of the opinion that the Company's financial
position and results of operations will not be materially affected by the
ultimate resolution of litigation pending or threatened at December 31,
1996.
10. PENSION PLAN
The Company has a qualified, noncontributory defined benefit pension plan
covering substantially all of its employees. The benefits are based on
each employee's years of service up to a maximum of 35 years, and the
average of the highest five consecutive annual salaries out of the ten
years prior to retirement.
The benefit formula used is the individual aggregate actuarial cost
method. An employee becomes fully vested upon completion of seven years of
qualifying service. It is the policy of the Company to fund the amount
required to meet minimum funding standards. No contributions were required
to be made in 1996 or 1995.
Net pension cost for the Company's plan consists of the following:
1996 1995 1994
Service cost $ 68,705 $ 49,913 $ 55,125
Interest cost 61,651 48,577 52,022
Actual return on plan assets (98,075) (125,440) (71,150)
All other components 28,140 60,307 (10,895)
----------- ---------- ----------
Net pension cost $ 60,421 $ 33,357 $ 25,102
============ ========== ==========
35
The reconciliation of the funded status of the plan to the amount reported
in the Company's statements of financial condition as of December 31 is as
follows:
1996 1995
Actuarial Present Value of Benefit Obligation:
Vested benefit obligation $ (438,363) $ (359,933)
Nonvested accumulated benefits
(15,167) (7,487)
--------- -------
Accumulated benefit obligation (453,530) (367,420)
Effect of projected salary increases (553,712) (455,292)
--------- ---------
Projected benefit obligation (1,007,242) (822,712)
Fair value of Plan assets, primarily
cash, equity securities, and bonds 941,602 844,924
Funded status (65,640) 22,212
Deferred transition asset to be
amortized over 17 years (125,585) (133,569)
Unrecognized prior-service cost 32,150 33,516
Unrecognized net loss 54,422 33,609
-------- --------
Accrued pension cost on statements of
financial condition $ (104,653) $ (44,232)
======== ========
Assumptions used to develop the net periodic pension cost were:
Discount rate 7.5% 7.5%
Expected long-term rate of return on plan assets 8% 8%
Rate of increase in compensation levels 5% 5%
11. STOCK OPTION AND INCENTIVE PLAN
The Company has a stock option and incentive plan to attract and retain
personnel and provide incentive to employees to promote the success of the
business. At December 31, 1996, 110,757 shares of stock have been
authorized for grants of options for this plan. In 1995 stock options
previously granted aggregating 9,345 shares at prices ranging from $14.25
- $22.00 per share were cancelled and replaced with 14,543 options at
$11.78 per share.
Effective January 1, 1996, the Company adopted SFAS No. 123, "Accounting
for Stock-Based Compensation." This Statement gave the Company the option
of either (1) continuing to account for stock options and other forms of
stock compensation in accordance with the accounting rules established by
APB No. 25, "Accounting for Stock Issued to Employees" while providing the
disclosures required under SFAS No. 123, or (2) adopting SFAS No. 123
accounting for all stock compensation arrangements. The Company opted to
continue to account for stock options and other forms of stock
compensation using the guidance in APB No. 25. The following table
provides the pro forma disclosures required by SFAS No. 123:
36
1996 1995
Net income As reported $ 1,319,727 $ 2,027,814
Pro forma 1,319,727 1,720,590
Primary earnings per share As reported 1.61 2.62
Pro forma 1.61 2.22
Fully diluted earning per share As reported 1.60 2.59
Pro forma 1.60 2.20
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
Binomial Option pricing model with the following weighted-average
assumptions used for the 1995 grants: dividend yield of 0.8%, expected
volatility of 65%, a risk-free rate of 5.71%, and an expected option life
of 10 years. No stock options were granted in 1996. The weighted-average
fair value of each option granted during 1995 was $8.49. Substantially all
options are 100% vested when granted, and all options expire after 10
years. The following tables summarize activity in the plan.
1996 1995
----------------------------- -------------------------
Weighted-Average Weighted-Average
Shares Exercise Price Shares Exercise Price
------ -------------- ------ --------------
Outstanding at beginning
of year 120,207 8.00 85,842 6.45
Granted -- -- 61,911 10.69
Exercised 30,792 5.79 10,515 6.28
Forfeited or cancelled 132 3.90 17,031 12.09
------- -------
Outstanding at end of year 89,283 9.34 120,207 8.00
======= =======
Options exercisable
at year-end 85,508 9.28 114,544 7.87
Weighted-average fair value
of options granted during
the year -- -- -- 8.49
OPTIONS OUTSTANDING OPTIONS EXERCISABLE
------------------------------------------------- ----------------------------------------
Weighted Average Weighted-Average
Exercise Number Outstanding Remaining Number Exercisable Exercise
Price 12/31/96 Contractual Life 12/31/96 Price
-------- ------------------ ---------------- ------------------ ----------------
$3.90 3,695 0.8 years 3,695 $3.90
6.76 24,367 3.0 24,367 6.76
10.69 61,221 8.0 57,446 10.69
----------- -----------
89,283 85,508
=========== ===========
All share and dollar amounts are reflected at amounts giving effect to the
5% stock dividends declared through January 1997.
37
12. EMPLOYEE STOCK OWNERSHIP PLAN
In December 1989, the Board of Directors of the Bank approved the adoption
of an Employee Stock Ownership Plan (ESOP) that will acquire 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, all shares held by the ESOP are treated as outstanding in
computing earnings per share. In addition, dividends on ESOP shares are
recorded as a reduction of retained earnings. The ESOP may acquire in the
open market up to 187,700 shares. At December 31, 1996, the Plan owns
46,498 shares. All employees who meet length-of-service and age
requirements are covered under this defined contribution plan. Employee
contributions to this plan under a deferred compensation arrangement
(401k) are matched by the Bank, subject to a maximum of one-half of an
employee's 4% elective deferral. Additional contributions are determined
at the discretion of management and the Board of Directors. For the years
ended December 31, 1996, 1995, and 1994, the Company charged $46,000,
$159,000, and $100,000 against earnings to fund the Plan.
13. STOCK DIVIDENDS
On January 27, 1994, the Board of Directors declared a 5% stock dividend
and a $.10 per share cash dividend that was distributed to holders of
record on March 4, 1994. The stock distribution increased the
Corporation's issued stock by approximately 30,000 shares.
On January 31, 1995, the Board of Directors declared a 5% stock dividend
and a $.10 per share cash dividend that was distributed to holders of
record on March 3, 1995. The stock distribution increased the
Corporation's issued stock by approximately 32,000 shares.
On January 24, 1996, the Board of Directors declared a 5% stock dividend
and a $.10 per share cash dividend to be distributed to holders of record
on March 4, 1996. The stock distribution increased the Corporation's
issued stock by approximately 35,000 shares.
On January 24, 1997, the Board of Directors declared a 5% stock dividend
that was distributed to holders of record on March 7, 1997. The stock
distribution increased the Corporation's issued stock by approximately
37,500 shares.
14. REGULATORY MATTERS
The Bank is 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 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 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, 1996, that the Bank meets all capital adequacy requirements
to which it is subject.
38
As of December 31, 1996, the most recent notification from the Office of
Thrift Supervision 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 tangible, core and
risk-based ratios as set forth in the table. There are no conditions or
events since that notification that management believes have changed the
Bank's category.
The Bank's actual capital amounts and ratios for 1996 and 1995 are
presented in the tables below:
To be Considered
Well Capitalized
Required for Under Prompt
Capital Adequacy Corrective Action
Actual Purposes Provisions
----------------- -------------------- --------------------
Amount Ratio Amount Ratio Amount Ratio
------ ----- ------ ----- ------- -----
At December 31, 1996:
Tangible $16,447 9.3 % $ 2,661 1.5 % N/A N/A
Core (Leverage) 16,447 9.3 5,322 3.0 $ 8,870 5.0 %
Tier 1 risk-based 16,447 15.7 N/A N/A 6,303 6.0
Total risk-based 17,567 16.7 8,404 8.0 10,505 10.0
To be Considered
Well Capitalized
Required for Under Prompt
Capital Adequacy Corrective Action
Actual Purposes Provisions
----------------- -------------------- --------------------
Amount Ratio Amount Ratio Amount Ratio
------ ----- ------ ----- ------- -----
At December 31, 1995:
Tangible $15,112 9.2 % $2,450 1.5 % N/A N/A
Core (Leverage) 15,112 9.2 4,901 3.0 $ 8,169 5.0 %
Tier 1 risk-based 15,112 15.6 N/A N/A 5,789 6.0
Total risk-based 15,846 16.4 7,719 8.0 9,649 10.0
Charter Conversion - As a result of the enactment of the Small Business
Job Protection Act that was signed into law on August 20, 1996, all
savings banks and savings associations will be able to change to a
commercial bank charter without having to recapture any of their pre-1988
bad debt reserve accumulations. Prior to the passage of this law, when
Tri-County evaluated the benefits of changing to a commercial bank
charter, the recapture tax on these bad debt reserves represented a
material cost to be considered. With this significant obstacle removed,
the opportunity to change the Bank's model of operations was revisited.
On October 30, 1996, the Board of Directors of the Savings Bank
unanimously adopted a Plan of Conversion whereby the Savings Bank will
convert to a Maryland-chartered commercial bank to be known as "Community
Bank of Tri-County." On January 24, 1997, the Maryland Commissioner of
Financial Regulation granted preliminary approval of the Charter
Conversion and on March 7, 1997, the Bank's Federal Reserve Membership
Application and the Corporation's Bank Holding Company application were
approved. Following the charter Conversion, both the Bank and the
Corporation will be regulated by the Federal Reserve Bank. The Charter
Conversion will allow the Bank more flexibility in the types of loans it
is permitted to make as it will no longer be required to meet the
Qualified Thrift Lender Test. Specifically, the Bank will be permitted to
increase its consumer and commercial lending and will be better able to
offer products to its small business and retail customers.
39
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 cash flows. Furthermore, the fair values disclosed should not be
interpreted as the aggregate current value of the Company.
December 31, 1996 December 31, 1995
------------------------------------------------------------------------
Estimated Estimated
Carrying Fair Carrying Fair
Amount Value Amount Value
------ ----- ------ -----
Assets:
Cash and cash equivalents $ 3,903,612 $ 3,903,612 $ 4,050,219 $ 4,050,219
Investment securities
and FHLB stock 13,429,115 13,429,115 15,785,398 15,785,398
Mortgage-backed securities 43,354,206 43,389,668 31,954,354 31,954,354
Loans receivable, net 111,024,921 117,708,731 107,340,325 113,085,292
Loans held for sale 1,011,930 1,011,930 476,750 476,750
Liabilities:
Savings, NOW and money
market accounts 57,614,810 57,614,810 58,198,391 58,198,391
Time certificates 77,204,182 77,421,687 71,149,885 71,767,932
FHLB advances 24,000,000 24,000,000 13,250,000 13,250,000
Notes Payable and other Borrowings 733,466 733,466 4,302,845 4,302,845
At December 31, 1996 and 1995, the Company had outstanding loan
commitments and standby letters of credit of $5.3 million and $5.7
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.
40
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.
FHLB Advances - These were valued using the discounted cash flow method.
The discount rate was equal to the rate currently offered on similar
borrowings.
Notes Payable and Other Borrowings - These were valued using the
discounted cash flow method. The discount rate was equal to the rate
currently offered on similar borrowings.
The fair value estimates presented herein are based on pertinent
information available to management as of December 31, 1996 and 1995.
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 statement since
that date and, therefore, current estimates of fair value may differ
significantly from the amounts presented herein.
16. SAIF RECAPITALIZATION
The Federal Deposit Insurance Corporation administers two separate deposit
insurance funds, the Banking Insurance Fund (BIF) and Savings Association
Insurance Fund (SAIF). Congress passed legislation in August 1996, that
recapitalized the SAIF fund through a special assessment on FDIC-insured
institutions with SAIF deposits. This deposit assessment resulted in an
after-tax expense to the Company of approximately $504,000 for the year
ended December 31, 1996.
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17. CONDENSED FINANCIAL STATEMENTS - PARENT COMPANY ONLY
Condensed Statements of Financial Condition:
December 31,
--------------------------
ASSETS 1996 1995
Cash $ 131,782 $ 120,838
Accounts receivable 1,383 1,383
Investment securities available for sale 447,565 421,781
Investment in loans 174,231 153,261
Investment in wholly owned subsidiary 16,536,386 15,344,485
----------- -----------
TOTAL ASSETS $17,291,347 $16,041,748
=========== ===========
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities $ 39,664 $ 70,600
Stockholders' equity:
Common stock 7,510 6,851
Capital in excess of par 5,724,729 5,021,350
Retained earnings 11,430,666 10,710,824
Net unrealized gain (loss) on investment
and mortgage-backed securities 88,778 232,123
----------- -----------
TOTAL LIABILITIES AND STOCKHOLDERS'
EQUITY $17,291,347 $16,041,748
=========== ===========
Condensed Statements of Income:
Year Ended December 31,
------------------------------------------------------
1996 1995 1994
Interest revenues $ 38,463 $ 35,790 $ 24,032
Amortization and miscellaneous expenses 53,981 48,364 52,337
------------ ------------- ------------
Income (loss) before income
taxes and equity in
undistributed
net income of subsidiary (15,518) (12,574) (28,305)
Federal and state income taxes - - (2,174)
Equity in undistributed net income of subsidiary 1,335,245 2,040,388 1,613,536
------------ ------------ ------------
NET INCOME $ 1,319,727 $ 2,027,814 $ 1,583,057
============ ============ ============
42
Condensed Statements of Cash Flows:
Year Ended December 31,
---------------------------------------------------
1996 1995 1994
CASH FLOWS FROM:
Operating activities $ (70,641) $ (1,866) $ 16,673
Investing activities:
Loans originated (114,600) (138,223) (42,908)
Principal collected on loans 93,630 84,620 17,000
Purchase of investment securities
available for sale (431,598) (504,469) (291,447)
Maturities of investment securities
available for sale 430,000 400,000
Financing activities:
Dividends paid (74,045) (69,013) (66,003)
Exercise of stock options 178,198 66,006 42,715
------------- ------------ ------------
INCREASE (DECREASE) IN CASH $ 10,944 $ (162,945) $ (323,970)
============== ============ ============
* * * * * *
43