U.S. SECURITIES AND EXCHANGE COMMISSION
Washington, DC 20549
FORM 10-K
|X| Annual report pursuant to Section 13 or 15(d) of the Securities
Exchange Act of 1934
For the fiscal year ended December 31, 2005
|_| Transition report pursuant to Section 13 or 15(d) of the Securities
Exchange Act of 1934
For the transition period from __________ to_________
Commission file number: 000-32641
James Monroe Bancorp, Inc.
(Exact name of Registrant as specified in its charter)
Virginia 54-1941875
(State or other jurisdiction (I.R.S. Employer Identification No.)
of incorporation or organization)
3033 Wilson Boulevard, Arlington, Virginia 22201
(Address of principal executive offices) (Zip Code)
Registrant's telephone number: 703.524.8100
Securities registered pursuant to Section 12(b) of the Exchange Act: None
Securities registered pursuant to Section 12(g) of the Exchange Act:
Common Stock, $1.00 par value
Indicate by check mark if the registrant is a well-known seasoned issuer, as
defined in Section 405 of the Securities Act. Yes |_| No |X|
Indicate by check mark if the registrant is not required to file reports
pursuant to Section 13 or Section 15(d) of the Act. Yes |_| No |X|
Indicate by check mark whether the registrant; (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports); and (2) has been subject to such
filing requirements for the past 90 days. Yes |X| No |_|
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405
of Regulation S-K is not contained in this form, and will not be contained, to
the best of registrant's knowledge, in definitive proxy or information
statements incorporated by reference in Part III of this Form 10-K or any
amendment to this Form 10-K. |_|
Indicate by check mark whether the registrant is a large accelerated filer, an
accelerated filer or a non-accelerated filer. See definition of "accelerated
filer and large accelerated filer" in Rule 12b-2 of the Exchange Act.
Large accelerated filer |_| Accelerated filer |_| Non-accelerated filer |X|
Indicate by check mark whether the registrant is a shell company (as defined in
Rule 12b-2 of the Exchange Act). Yes |_| No |X|
The aggregate market value of the outstanding Common Stock held by nonaffiliates
as of June 30, 2005 was approximately $68.05 million.
As of February 28, 2006, the number of outstanding shares of the Common Stock,
$1.00 par value, of James Monroe Bancorp, Inc. was 5,628,833.
DOCUMENTS INCORPORATED BY REFERENCE
Portions of the registrant's definitive Proxy Statement for the 2006 Annual
Meeting of Shareholders, expected to be filed on or before May 1, 2006, are
incorporated by reference in part III hereof.
PART I
ITEM 1. BUSINESS.
GENERAL
James Monroe Bancorp (the "Company") was incorporated under the laws of
the Commonwealth of Virginia on April 9, 1999 to be the holding company for
James Monroe Bank (the "Bank"). The Company acquired all of the shares of the
Bank on July 1, 1999 in a mandatory share exchange under which each outstanding
share of common stock of the Bank was exchanged for one share of the Company
common stock. The Bank, a Virginia chartered commercial bank, which is a member
of the Federal Reserve System, is the Company's sole operating subsidiary. The
Bank commenced banking operations on June 8, 1998, and currently operates out of
its main office, five full service branch offices, one drive-up/walk through
limited service branch, one loan production office and a mortgage loan
production office. The Bank seeks to provide a high level of personal service
and a sophisticated menu of products to individuals and small to medium sized
businesses. While the Bank offers a full range of services to a wide array of
depositors and borrowers, it has chosen small to medium sized businesses,
professionals and the individual retail customer as its primary target market.
The Bank believes that as financial institutions grow and are merged with or
acquired by larger institutions with headquarters that are far away from the
local customer base, the local business and individual is further removed from
the point of decision-making. The Bank attempts to place the customer contact
and the ultimate decision on products and credits as close together as possible.
LENDING ACTIVITIES
The Bank offers a wide array of lending services to its customers,
including commercial loans, lines of credit, personal loans, auto loans and
financing arrangements for personal equipment and business equipment. Loan
terms, including interest rates, loan to value ratios, and maturities, are
tailored as much as possible to meet the needs of the borrower. A special effort
is made to keep loan products as flexible as possible within the guidelines of
prudent banking practices in terms of interest rate risk and credit risk.
When considering loan requests, the primary factors taken into
consideration are the cash flow and financial condition of the borrower, the
value of the underlying collateral, if applicable, and the character and
integrity of the borrower. These factors are evaluated in a number of ways
including an analysis of financial statements, credit reviews, trade reviews,
and visits to the borrower's place of business. We have implemented a
comprehensive loan policy and procedures manual to provide our loan officers
with term, collateral, loan-to-value and pricing guidelines. The policy manual
and sound credit analysis, together with thorough review by the Asset-Liability
Committee, have resulted in a profitable loan portfolio with minimal
delinquencies or problem loans.
Our aim is to build and maintain a commercial loan portfolio consisting
of term loans, demand loans, lines of credit and commercial real estate loans
provided to primarily locally-based borrowers. These types of loans are
generally considered to have a higher degree of risk of default or loss than
other types of loans, such as residential real estate loans, because repayment
may be affected by general economic conditions, interest rates, the quality of
management of the business, and other factors which may cause a borrower to be
unable to repay its obligations. Traditional installment loans and personal
lines of credit will be available on a selective basis. General economic
conditions can directly affect the quality of a small and mid-sized business
loan portfolio. We attempt to manage the loan portfolio to avoid high
concentrations of similar industry and/or collateral pools, although this cannot
be assured.
Loan business is generated primarily through referrals and
direct-calling efforts. Referrals of loan business come from directors,
shareholders, current customers and professionals such as lawyers, accountants
and financial intermediaries.
At December 31, 2005, the Bank's statutory lending limit to any single
borrower was $7.42 million, subject to certain exceptions provided under
applicable law. As of December 31, 2005, the Bank's credit exposure to its
largest borrower was $5,032,894.
Commercial Loans. Commercial loans are written for any prudent business
purpose, including the financing of plant and equipment, the carrying of
accounts receivable, contract administration, and the acquisition and
construction of real estate projects. Special attention is paid to the
commercial real estate market, which is particularly active in the Northern
Virginia
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market area. The Bank's commercial loan portfolio reflects a diverse group of
borrowers with no concentration in any borrower, or group of borrowers.
The lending activities in which we engage carry the risk that the
borrowers will be unable to perform on their obligations. As such, interest rate
policies of the Federal Reserve Board and general economic conditions,
nationally and in our primary market area will have a significant impact on our
results of operations. To the extent that economic conditions deteriorate,
business and individual borrowers may be less able to meet their obligations to
the Bank in full, in a timely manner, resulting in decreased earnings or losses
to the Bank. To the extent that loans are secured by real estate, adverse
conditions in the real estate market may reduce the ability of the borrower to
generate the necessary cash flow for repayment of the loan, and reduce our
ability to collect the full amount of the loan upon a default. To the extent
that the Bank makes fixed rate loans, general increases in interest rates will
tend to reduce our spread as the interest rates we must pay for deposits
increase while interest income is flat. Economic conditions and interest rates
may also adversely affect the value of property pledged as security for loans.
We constantly strive to mitigate risks in the event of unforeseen
threats to the loan portfolio as a result of an economic downturn or other
negative influences. Plans for mitigating inherent risks in managing loan assets
include carefully enforcing loan policies and procedures, evaluating each
borrower's industry and business plan during the underwriting process,
identifying and monitoring primary and alternative sources for repayment and
obtaining collateral that is margined to minimize loss in the event of
liquidation.
Commercial real estate loans will generally be owner occupied or
managed transactions with a principal reliance on the borrower's ability to
repay, as well as prudent guidelines for assessing real estate values. Risks
inherent in managing a commercial real estate portfolio relate to either sudden
or gradual drops in property values as a result of a general or local economic
downturn. A decline in real estate values can cause loan to value margins to
increase and diminish the bank's equity cushion on both an individual and
portfolio basis. The Bank attempts to mitigate commercial real estate lending
risks by carefully underwriting each loan of this type to address the perceived
risks in the individual transaction. Generally, the Bank requires a loan to
value ratio of 75% of the lower of an appraisal or cost. A borrower's ability to
repay is carefully analyzed and policy calls for an ongoing cash flow to debt
service requirement of 1.1:1.0. An approved list of commercial real estate
appraisers selected on the basis of rigorous standards has been established.
Each appraisal is scrutinized in an effort to insure current comparable market
values.
As noted above, commercial real estates loans are generally made on
owner occupied or managed properties where there is both a reliance on the
borrower's financial health and the ability of the borrower and the business to
repay. Whenever appropriate and available, the Bank seeks Federal and State loan
guarantees, such as the Small Business Administration's "7A" and "504" loan
programs, to reduce risks. The Bank generally requires personal guarantees on
all loans as a matter of policy; exceptions to policy are documented. All
borrowers will be required to forward annual corporate, partnership and personal
financial statements to comply with bank policy and enforced through the loan
covenants documentation for each transaction. Interest rate risks to the Bank
are mitigated by using either floating interest rates or by fixing rates for a
short period of time, generally less than five years. While loan amortizations
may be approved for up to 360 months, loans generally have a call provision
(maturity date) of 5-10 years or less. Specific and non-specific provisions for
loan loss reserves are generally set based upon a methodology developed by
management and approved by the board of directors and described more fully in
the Company's Critical Accounting Policies included herein.
Commercial term loans are used to provide funds for equipment and
general corporate needs. This loan category is designed to support borrowers who
have a proven ability to service debt over a term generally not to exceed 60
months. The Bank generally requires a first lien position on all collateral and
guarantees from owners having at least a 20% interest in the involved business.
Interest rates on commercial term loans are generally floating, adjust within 3
to 5 years, or are fixed for a term not to exceed five years. Management
carefully monitors industry and collateral concentrations to avoid loan
exposures to a large group of similar industries and/or similar collateral.
Commercial loans are evaluated for historical and projected cash flow
attributes, balance sheet strength, and primary and alternate resources of
personal guarantors. Commercial term loan documents require borrowers to forward
regular financial information on both the business and on personal guarantors.
Loan covenants require at least annual submission of complete financial
information and in certain cases this information is required more frequently,
depending on the degree to which lenders desire information resources for
monitoring a borrower's financial condition and compliance with loan covenants.
Examples of properly margined collateral for loans, as required by bank policy,
would be a 75% advance on the lesser of appraisal or recent sales price on
commercial property, 80%
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or less advance on eligible receivables, 50% or less advance on eligible
inventory and an 80% advance on appraised residential property. Collateral
borrowing certificates may be required to monitor certain collateral categories
on a monthly or quarterly basis. Key person life insurance is required as
appropriate and as necessary to mitigate the risk loss of a primary owner or
manager.
The Bank attempts to further mitigate commercial term loan loss by
using Federal and State loan guarantee programs such as offered by the United
States Small Business Administration. The loan loss reserve of approximately
1.04% of the entire portfolio in this group, exclusive of the government
guaranteed portion, has been established. Specific loan reserves will be used to
increase overall reserves based on increased credit and/or collateral risks on
an individual loan basis. At December 31, 2005, specific reserves have been
assigned or made for specific credits. A risk rating system is used to
proactively determine loss exposure and provide a measurement system for setting
general and specific reserve allocations.
Commercial lines of credit are used to finance a business borrower's
short-term credit needs and/or to finance a percentage of eligible receivables
and inventory. In addition to the risks inherent in term loan facilities, line
of credit borrowers typically require additional monitoring to protect the
lender against increasing loan volumes and diminishing collateral values.
Commercial lines of credit are generally revolving in nature and require close
scrutiny. The Bank generally requires at least an annual out of debt period (for
seasonal borrowers) or regular financial information (monthly or quarterly
financial statements, borrowing base certificates, etc.) for borrowers with more
growth and greater permanent working capital financing needs. Advances against
collateral are generally in the same percentages as in term loan lending. Lines
of credit and term loans to the same borrowers are generally cross-defaulted and
cross-collateralized. Industry and collateral concentration, general and
specific reserve allocation and risk rating disciplines are the same as those
used in managing the commercial term loan portfolio. Interest rate charges on
this group of loans generally float at a factor at or above the prime lending
rate. Generally, personal guarantees are required on these loans.
As part of its internal loan review process management reviews all
loans 30-days delinquent, loans on the Watch List, loans rated special mention,
substandard, or doubtful, and other loans of concern at least quarterly. Loan
reviews are reported to the board of directors with any adversely rated changes
specifically mentioned. All other loans with their respective risk ratings are
reported monthly to the Bank's Board of Directors. The Audit Committee
coordinates periodic documentation and internal control reviews by outside
vendors to complement loan reviews.
Mortgage Lending. In the first quarter of 2003, the Company established
a mortgage lending operation as a division of the Bank, which originates
conforming, 1-4 family residential mortgage loans, on a pre-sold basis, for sale
to secondary market purchasers, servicing released. Under the program, loans are
originated and funded by the Bank in conformity to the standards of the
secondary market purchasers, and which the secondary market purchasers will
agree to purchase prior to funding by the bank. While the Bank is subject to
repurchasing certain loans which are ultimately determined not to meet the
purchaser's standards, including as a result of inaccuracies or fraud in
borrower's documentation, the Company's risk related to the borrower's credit in
respect of these loans is minimal. Activity in the residential mortgage loan
market is highly sensitive to changes in interest rates. There is no assurance
that the Company will be able to successfully maintain the mortgage loan
operation, that it will continue to be profitable, or that the Company will not
be subject to borrower credit risks in respect of these loans.
Other Loans. Loans are considered for any worthwhile personal or
business purpose on a case-by-case basis, such as the financing of equipment,
receivables, contract administration expenses, land acquisition and development,
and automobile financing. Consumer credit facilities are underwritten to focus
on the borrower's credit record, length of employment and cash flow to debt
service. Car, residential real estate and similar loans require advances of the
lesser of 80% loan to collateral value or cost. Loan loss reserves for this
group of loans are generally set at approximately 1.04% subject to adjustments
as required by national or local economic conditions.
INVESTMENT ACTIVITIES
The investment policy of the Bank is an integral part of its overall
asset/liability management program. The investment policy is to establish a
portfolio which will provide liquidity necessary to facilitate funding of loans
and to cover deposit fluctuations while at the same time achieving a
satisfactory return on the funds invested. The Bank seeks to maximize earnings
from its investment portfolio consistent with the safety and liquidity of those
investment assets.
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The securities in which the Bank may invest are subject to regulation
and are limited to securities which are considered investment grade securities.
In addition, the Bank's internal investment policy restricts investments to the
following categories: U.S. Treasury securities; obligations of U.S. government
agencies; investment grade obligations of U.S. private corporations;
mortgage-backed securities, including securities issued by Federal National
Mortgage Association and the Federal Home Loan Mortgage Corporation; or
securities of states and political subdivisions.
SOURCES OF FUNDS
Deposits. Deposits obtained through bank offices have traditionally
been the principal source of the Bank's funds for use in lending and for other
general business purposes. In order to better serve the needs of its customers,
the Bank offers several types of deposit accounts in addition to standard
savings, checking, and NOW accounts. Special deposit accounts include the
Clarendon, Loudoun, Fairfax, Dulles, and Manassas Money Market Accounts which
pay a higher rate of interest but require a larger minimum deposit. Personal
checking requires a $300 minimum balance and may have no monthly fee, per check
charge, or activity limit. Small Business Checking allows a small business to
pay no monthly service charge with a minimum balance of $1,000 but limits the
number of checks and deposits per month. If the minimums are exceeded in this
account, the small business may move to another account with a minimum balance
of $2,500 and would be entitled to a higher minimum number of checks and
deposits without incurring a monthly fee. If the small business grows and
exceeds these minimums, the regular commercial analysis account is available
where adequate balance can offset the cost of activity. Therefore, the bank
offers a range of accounts to meet the needs of the customer without the
customer incurring charges or fees.
Bills have been introduced in each of the last several Congresses which
would permit banks to pay interest on checking and demand deposit accounts
established by businesses, a practice which is currently prohibited by
regulation. If the legislation effectively permitting the payment of interest on
business demand deposits is enacted, of which there can be no assurance, it is
likely that we may be required to pay interest on some portion of our
noninterest bearing deposits in order to compete against other banks. As a
significant portion of our deposits are non-interest bearing demand deposits
established by businesses, payment of interest on these deposits could have a
significant negative impact on our net income, net interest income, interest
margin, return on assets and equity, and other indices of financial performance.
We expect that other banks would be faced with similar negative impacts. We also
expect that the primary focus of competition would continue to be based on other
factors, such as quality of service.
Borrowing. While the Company has not placed significant reliance on
borrowings as a source of liquidity, we have established various borrowing
arrangements in order to provide management with additional sources of liquidity
and funding, thereby increasing flexibility. Management believes that the
Company currently has adequate liquidity available to respond to current
liquidity demands.
COMMUNITY REINVESTMENT ACT
The Bank is committed to serving the banking needs of the entire
community, including low and moderate income areas, and is a supporter of the
Community Reinvestment Act ("CRA"). There are several ways in which the Bank
attempts to fulfill this commitment, including working with economic development
agencies, undertaking special projects, and becoming involved with neighborhood
outreach programs.
The Bank has contacts with state and city agencies that assist in the
financing of affordable housing developments as well as with groups which
promote the economic development of low and moderate income individuals. The
Bank has computer software to geographically code all types of accounts to track
business development and performance by census tract and to assess market
penetration in low and moderate income neighborhoods within the primary service
area. The Bank is a registered Small Business Administration lender.
The Company encourages its directors and officers to participate in
community, civic and charitable organizations. Management and members of the
Board of Directors periodically review the various CRA activities of the Bank,
including the advertising program and geo-coding of real estate loans by census
tract data which specifically focuses on low income neighborhoods, its credit
granting process with respect to business prospects generated in these areas,
and its involvement with community leaders on a personal level.
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COMPETITION
In attracting deposits and making loans, we encounter competition from
other institutions, including larger commercial banking organizations, savings
banks, credit unions, other financial institutions and non-bank financial
service companies serving our market area. Financial and non-financial
institutions not located in the market are also able to reach persons and
entities based in the market through mass marketing, the internet,
telemarketing, and other means. The principal methods of competition include the
level of loan interest rates, interest rates paid on deposits, efforts to obtain
deposits, range of services provided and the quality of these services. Our
competitors include a number of major financial companies whose substantially
greater resources may afford them a marketplace advantage by enabling them to
maintain numerous banking locations and mount extensive promotional and
advertising campaigns. In light of the deregulation of the financial service
industry and the absence of interest rate controls on deposits, we anticipate
continuing competition from all of these institutions in the future.
Additionally, as a result of legislation which reduced restrictions on
interstate banking and widened the array of companies that may own banks, we may
face additional competition from institutions outside our market and outside the
traditional range of bank holding companies which may take advantage of such
legislation to acquire or establish banks or branches in our market. There can
be no assurance that we will be able to successfully meet these competitive
challenges.
In addition to offering competitive rates for its banking products and
services, our strategy for meeting competition has been to concentrate on
specific segments of the market for financial services, particularly small
business and individuals, by offering such customers customized and personalized
banking services.
We believe that active participation in civic and community affairs is
an important factor in building our reputation and, thereby, attracting
customers.
EMPLOYEES
As of December 31, 2005, the Bank had 111 full time equivalent
employees. The Company has no employees who are not also employees of the Bank.
Our employees are not represented by any collective bargaining unit, and we
believe our employee relations are good. The Bank maintains a benefit program,
which includes health and dental insurance, life, short-term and long-term
disability insurance, and a 401(k) plan for substantially all employees.
SUPERVISION AND REGULATION
JAMES MONROE BANCORP
Bancorp is a bank holding company registered under the Bank Holding
Company Act of 1956, as amended, (the "Act") and is subject to supervision by
the Federal Reserve Board. As a bank holding company, Bancorp is required to
file with the Federal Reserve Board an annual report and such other additional
information as the Federal Reserve Board may require pursuant to the Act. The
Federal Reserve Board may also make examinations of Bancorp and each of its
subsidiaries.
The Act requires approval of the Federal Reserve Board for, among other
things, the acquisition by a proposed bank holding company of control of more
than five percent (5%) of the voting shares, or substantially all the assets, of
any bank or the merger or consolidation by a bank holding company with another
bank holding company. The Act also generally permits the acquisition by a bank
holding company of control, or substantially all the assets, of any bank located
in a state other than the home state of the bank holding company, except where
the bank has not been in existence for the minimum period of time required by
state law, but if the bank is at least 5 years old, the Federal Reserve Board
may approve the acquisition.
Under current law, with certain limited exceptions, a bank holding
company is prohibited from acquiring control of any voting shares of any company
which is not a bank or bank holding company and from engaging directly or
indirectly in any activity other than banking or managing or controlling banks
or furnishing services to or performing service for its authorized subsidiaries.
A bank holding company may, however, engage in or acquire an interest in, a
company that engages in activities which the Federal Reserve Board has
determined by order or regulation to be so closely related to banking or
managing or controlling banks as to be properly incident thereto. In making such
a determination, the Federal Reserve Board is required to consider whether the
performance of such activities can reasonably be expected to produce benefits to
the public, such as convenience, increased competition or gains in efficiency,
which outweigh possible adverse effects, such as undue concentration of
resources, decreased or unfair competition, conflicts of interest or unsound
banking practices. The Federal
6
Reserve Board is also empowered to differentiate between activities commenced de
novo and activities commenced by the acquisition, in whole or in part, of a
going concern. Some of the activities that the Federal Reserve Board has
determined by regulation to be closely related to banking include making or
servicing loans, performing certain data processing services, acting as a
fiduciary or investment or financial advisor, and making investments in
corporations or projects designed primarily to promote community welfare.
Effective on March 11, 2001, the Gramm Leach Bliley Act (the "GLB Act")
allows a bank holding company or other company to certify status as a financial
holding company, which will allow such company to engage in activities that are
financial in nature, that are incidental to such activities, or are
complementary to such activities. The GLB Act enumerates certain activities that
are deemed financial in nature, such as underwriting insurance or acting as an
insurance principal, agent or broker, underwriting, dealing in or making markets
in securities, and engaging in merchant banking under certain restrictions. It
also authorizes the Federal Reserve Board to determine by regulation what other
activities are financial in nature, or incidental or complementary thereto.
Subsidiary banks of a bank holding company are subject to certain
restrictions imposed by the Federal Reserve Act on any extensions of credit to
the bank company or any of its subsidiaries, or investments in the stock or
other securities thereof, and on the taking of such stock or securities as
collateral for loans to any borrower. Further, a holding company and any
subsidiary bank are prohibited from engaging in certain tie-in arrangements in
connection with the extension of credit. A subsidiary bank may not extend
credit, lease or sell property, or furnish any services, or fix or vary the
consideration for any of the foregoing, on the condition that: (i) the customer
obtain or provide some additional credit, property or services from or to such
bank other than a loan, discount, deposit or trust service; (ii) the customer
obtain or provide some additional credit, property or service from or to Bancorp
or any other subsidiary of Bancorp; or (iii) the customer not obtain some other
credit, property or service from competitors, except for reasonable requirements
to assure the soundness of credit extended.
The Federal Reserve has also adopted capital guidelines for bank
holding companies that are substantially the same as those applying to state
member banks, although these requirements are not currently applicable to
Bancorp.
JAMES MONROE BANK
The Bank is a Virginia chartered commercial bank and a member of the
Federal Reserve System. Its deposit accounts are insured by the Bank Insurance
Fund of the FDIC up to the maximum legal limits of the FDIC and it is subject to
regulation, supervision and regular examination by the Virginia Bureau of
Financial Institutions and the Federal Reserve. The regulations of these various
agencies govern most aspects of James Monroe Bank's business, including required
reserves against deposits, loans, investments, mergers and acquisitions,
borrowings, dividends and location and number of branch offices. The laws and
regulations governing the Bank generally have been promulgated to protect
depositors and the deposit insurance funds, and not for the purpose of
protecting stockholders.
Banking is a business which depends on interest rate differentials. In
general, the differences between the interest paid by a bank on its deposits and
its other borrowings and the interest received by a bank on loans extended to
its customers and securities held in its investment portfolio constitute the
major portion of the Bank's earnings. Thus, the earnings and growth of the Bank
will be subject to the influence of economic conditions generally, both domestic
and foreign, and also to the monetary and fiscal policies of the United States
and its agencies, particularly the Federal Reserve Board, which regulates the
supply of money through various means including open market dealings in United
States government securities. The nature and timing of changes in such policies
and their impact on the Bank cannot be predicted.
Branching and Interstate Banking. The federal banking agencies are
authorized to approve interstate bank merger transactions without regard to
whether such transaction is prohibited by the law of any state, unless the home
state of one of the banks has opted out of the interstate bank merger provisions
of the Riegle-Neal Interstate Banking and Branching Efficiency Act of 1994 (the
"Riegle-Neal Act") by adopting a law after the date of enactment of the
Riegle-Neal Act and prior to June 1, 1997, which applies equally to all
out-of-state banks and expressly prohibits merger transactions involving
out-of-state banks. Interstate acquisitions of branches are permitted only if
the law of the state in which the branch is located permits such acquisitions.
Such interstate bank mergers and branch acquisitions are also subject to the
nationwide and statewide insured deposit concentration limitations described in
the Riegle-Neal Act.
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The Riegle-Neal Act authorizes the federal banking agencies to approve
interstate branching de novo by national and state banks in states which
specifically allow for such branching. Virginia has enacted laws which permit
interstate acquisitions of banks and bank branches and permit out-of-state banks
to establish de novo branches.
USA Patriot Act. Under the Uniting and Strengthening America by
Providing Appropriate Tools Required to Intercept and Obstruct Terrorism Act,
commonly referred to as the "USA Patriot Act" or the "Patriot Act", financial
institutions are subject to prohibitions against specified financial
transactions and account relationships, as well as enhanced due diligence
standards intended to detect, and prevent, the use of the United States
financial system for money laundering and terrorist financing activities. The
Patriot Act requires financial institutions, including banks, to establish
anti-money laundering programs, including employee training and independent
audit requirements, meet minimum standards specified by the act, follow minimum
standards for customer identification and maintenance of customer identification
records, and regularly compare customer lists against lists of suspected
terrorists, terrorist organizations and money launderers. The costs or other
effects of the compliance burdens imposed by the Patriot Act or future
anti-terrorist, homeland security or anti-money laundering legislation or
regulations cannot be predicted with certainty.
Capital Adequacy Guidelines. The Federal Reserve Board has adopted
risk-based capital adequacy guidelines pursuant to which they assess the
adequacy of capital in examining and supervising banks and bank holding
companies and in analyzing bank regulatory applications. Risk-based capital
requirements determine the adequacy of capital based on the risk inherent in
various classes of assets and off-balance sheet items.
State member banks are expected to meet a minimum ratio of total
qualifying capital (the sum of core capital (Tier 1) and supplementary capital
(Tier 2)) to risk weighted assets of 8%. At least half of this amount (4%)
should be in the form of core capital.
Tier 1 Capital generally consists of the sum of common stockholders'
equity and perpetual preferred stock (subject in the case of the latter to
limitations on the kind and amount of such stock which may be included as Tier 1
Capital), less goodwill, without adjustment for changes in the market value of
securities classified as "available for sale" in accordance with FAS 115. Tier 2
Capital consists of the following: hybrid capital instruments; perpetual
preferred stock which is not otherwise eligible to be included as Tier 1
Capital; term subordinated debt and intermediate-term preferred stock; and,
subject to limitations, general allowances for loan losses. Assets are adjusted
under the risk-based guidelines to take into account different risk
characteristics, with the categories ranging from 0% (requiring no risk-based
capital) for assets such as cash and certain U.S. government and agency
securities, to 100% for the bulk of assets which are typically held by a bank
holding company, including certain multi-family residential and commercial real
estate loans, commercial business loans and consumer loans. Residential first
mortgage loans on one to four family residential real estate and certain
seasoned multi-family residential real estate loans, which are not 90 days or
more past-due or non-performing and which have been made in accordance with
prudent underwriting standards are assigned a 50% level in the risk-weighing
system, as are certain privately-issued mortgage-backed securities representing
indirect ownership of such loans. Off-balance sheet items also are adjusted to
take into account certain risk characteristics.
In addition to the risk-based capital requirements, the Federal Reserve
Board has established a minimum 4.0% Leverage Capital Ratio (Tier 1 Capital to
total adjusted assets) requirement for the most highly-rated banks, with an
additional cushion of at least 100 to 200 basis points for all other banks,
which effectively increases the minimum Leverage Capital Ratio for such other
banks to 4.0% - 6.0% or more. The highest-rated banks are those that are not
anticipating or experiencing significant growth and have well diversified risk,
including no undue interest rate risk exposure, excellent asset quality, high
liquidity, good earnings and, in general, those which are considered a strong
banking organization. A bank having less than the minimum Leverage Capital Ratio
requirement shall, within 60 days of the date as of which it fails to comply
with such requirement, submit a reasonable plan describing the means and timing
by which a bank shall achieve its minimum Leverage Capital Ratio requirement. A
bank that fails to file such plan is deemed to be operating in an unsafe and
unsound manner, and could subject that bank to a cease-and-desist order. Any
insured depository institution with a Leverage Capital Ratio that is less than
2.0% is deemed to be operating in an unsafe or unsound condition pursuant to
Section 8(a) of the Federal Deposit Insurance Act (the "FDIA") and is subject to
potential termination of deposit insurance. However, such an institution will
not be subject to an enforcement proceeding solely on account of its capital
ratios, if it has entered into and is in compliance with a written agreement to
increase its Leverage Capital Ratio and to take such other action as may be
necessary for the institution to be operated in a safe and sound manner. The
capital regulations also provide, among other things, for the issuance of a
capital directive, which is a final order issued to a bank that fails to
maintain minimum capital or to restore its capital to the minimum
8
capital requirement within a specified time period. Such directive is
enforceable in the same manner as a final cease-and-desist order.
Prompt Corrective Action. Under Section 38 of the FDIA, each federal
banking agency is required to implement a system of prompt corrective action for
institutions which it regulates. The federal banking agencies have promulgated
substantially similar regulations to implement the system of prompt corrective
action established by Section 38 of the FDIA. Under the regulations, a bank
shall be deemed to be: (i) "well capitalized" if it has a Total Risk Based
Capital Ratio of 10.0% or more, a Tier 1 Risk Based Capital Ratio of 6.0% or
more, a Leverage Capital Ratio of 5.0% or more and is not subject to any written
capital order or directive; (ii) "adequately capitalized" if it has a Total Risk
Based Capital Ratio of 8.0% or more, a Tier 1 Risk Based Capital Ratio of 4.0%
or more and a Tier 1 Leverage Capital Ratio of 4.0% or more (3.0% under certain
circumstances) and does not meet the definition of "well capitalized;" (iii)
"undercapitalized" if it has a Total Risk Based Capital Ratio that is less than
8.0%, a Tier 1 Risk based Capital Ratio that is less than 4.0% or a Leverage
Capital Ratio that is less than 4.0% (3.0% under certain circumstances); (iv)
"significantly undercapitalized" if it has a Total Risk Based Capital Ratio that
is less than 6.0%, a Tier 1 Risk Based Capital Ratio that is less than 3.0% or a
Leverage Capital Ratio that is less than 3.0%; and (v) "critically
undercapitalized" if it has a ratio of tangible equity to total assets that is
equal to or less than 2.0%.
An institution generally must file a written capital restoration plan
which meets specified requirements with an appropriate federal banking agency
within 45 days of the date the institution receives notice or is deemed to have
notice that it is undercapitalized, significantly undercapitalized or critically
undercapitalized. A federal banking agency must provide the institution with
written notice of approval or disapproval within 60 days after receiving a
capital restoration plan, subject to extensions by the applicable agency.
An institution which is required to submit a capital restoration plan
must concurrently submit a performance guaranty by each company that controls
the institution. Such guaranty shall be limited to the lesser of (i) an amount
equal to 5.0% of the institution's total assets at the time the institution was
notified or deemed to have notice that it was undercapitalized or (ii) the
amount necessary at such time to restore the relevant capital measures of the
institution to the levels required for the institution to be classified as
adequately capitalized. Such a guaranty shall expire after the federal banking
agency notifies the institution that it has remained adequately capitalized for
each of four consecutive calendar quarters. An institution which fails to submit
a written capital restoration plan within the requisite period, including any
required performance guaranty, or fails in any material respect to implement a
capital restoration plan, shall be subject to the restrictions in Section 38 of
the FDIA which are applicable to significantly undercapitalized institutions.
A "critically undercapitalized institution" is to be placed in
conservatorship or receivership within 90 days unless the FDIC formally
determines that forbearance from such action would better protect the deposit
insurance fund. Unless the FDIC or other appropriate federal banking regulatory
agency makes specific further findings and certifies that the institution is
viable and is not expected to fail, an institution that remains critically
undercapitalized on average during the fourth calendar quarter after the date it
becomes critically undercapitalized must be placed in receivership. The general
rule is that the FDIC will be appointed as receiver within 90 days after a bank
becomes critically undercapitalized unless extremely good cause is shown and an
extension is agreed-to by the federal regulators. In general, good cause is
defined as capital, which has been raised and is imminently available for
infusion into a bank except for certain technical requirements which may delay
the infusion for a period of time beyond the 90 day time period.
Immediately upon becoming undercapitalized, an institution shall become
subject to the provisions of Section 38 of the FDIA, which (i) restrict payment
of capital distributions and management fees; (ii) require that the appropriate
federal banking agency monitor the condition of the institution and its efforts
to restore its capital; (iii) require submission of a capital restoration plan;
(iv) restrict the growth of the institution's assets; and (v) require prior
approval of certain expansion proposals. The appropriate federal banking agency
for an undercapitalized institution also may take any number of discretionary
supervisory actions if the agency determines that any of these actions is
necessary to resolve the problems of the institution at the least possible
long-term cost to the deposit insurance fund, subject in certain cases to
specified procedures. These discretionary supervisory actions include: requiring
the institution to raise additional capital; restricting transactions with
affiliates; requiring divestiture of the institution or the sale of the
institution to a willing purchaser; and any other supervisory action that the
agency deems appropriate. These and additional mandatory and permissive
supervisory actions may be taken with respect to significantly undercapitalized
and critically undercapitalized institutions.
9
Additionally, under Section 11(c)(5) of the FDIA, a conservator or
receiver may be appointed for an institution where: (i) an institution's
obligations exceed its assets; (ii) there is substantial dissipation of the
institution's assets or earnings as a result of any violation of law or any
unsafe or unsound practice; (iii) the institution is in an unsafe or unsound
condition; (iv) there is a willful violation of a cease-and-desist order; (v)
the institution is unable to pay its obligations in the ordinary course of
business; (vi) losses or threatened losses deplete all or substantially all of
an institution's capital, and there is no reasonable prospect of becoming
"adequately capitalized" without assistance; (vii) there is any violation of law
or unsafe or unsound practice or condition that is likely to cause insolvency or
substantial dissipation of assets or earnings, weaken the institution's
condition, or otherwise seriously prejudice the interests of depositors or the
insurance fund; (viii) an institution ceases to be insured; (ix) the institution
is undercapitalized and has no reasonable prospect that it will become
adequately capitalized, fails to become adequately capitalized when required to
do so, or fails to submit or materially implement a capital restoration plan; or
(x) the institution is critically undercapitalized or otherwise has
substantially insufficient capital.
Regulatory Enforcement Authority. Federal banking law grants
substantial enforcement powers to federal banking regulators. This enforcement
authority includes, among other things, the ability to assess civil money
penalties, to issue cease-and-desist or removal orders and to initiate
injunctive actions against banking organizations and institution-affiliated
parties. In general, these enforcement actions may be initiated for violations
of laws and regulations and unsafe or unsound practices. Other actions or
inactions may provide the basis for enforcement action, including misleading or
untimely reports filed with regulatory authorities.
Deposit Insurance Premiums. The FDIA establishes a risk based deposit
insurance assessment system. Under applicable regulations, deposit premium
assessments are determined based upon a matrix formed utilizing capital
categories - well capitalized, adequately capitalized and undercapitalized -
defined in the same manner as those categories are defined for purposes of
Section 38 of the FDIA. Each of these groups is then divided into three
subgroups which reflect varying levels of supervisory concern, from those which
are considered healthy to those which are considered to be of substantial
supervisory concern. The matrix so created results in nine assessment risk
classifications, with rates ranging from 0.00% of insured deposits for well
capitalized institutions having the lowest level of supervisory concern, to
0.27% of insured deposits for undercapitalized institutions having the highest
level of supervisory concern. In general, while the Bank Insurance Fund of the
FDIC ("BIF") maintains a reserve ratio of 1.25% or greater, no deposit insurance
premiums are required. When the BIF reserve ratio falls below that level, all
insured banks would be required to pay premiums. Payment of deposit premiums,
either under current law or as the deposit insurance system may be reformed,
will have an adverse impact on earnings.
ITEM 1A. RISK FACTORS.
An investment in our common stock involves various risks. The following
is a summary of certain risks identified by us as affecting our business. You
should carefully consider the risk factors listed below, as well as other
cautionary statements made in this Annual Report, and risks and uncertainties
which we may identify in our other reports and documents filed with the
Securities and Exchange Commission or other public announcements. These risk
factors may cause our future earnings to be lower or our financial condition to
be less favorable than we expect. In addition, other risks of which we are not
aware, which relate to the banking and financial services industries in general,
or which we do not believe are material, may cause earnings to be lower, or hurt
our future financial condition. You should read this section together with the
other information in this Annual Report.
OUR LEVEL OF ASSETS AND EARNINGS MAY NOT CONTINUE TO GROW AS RAPIDLY AS
THEY HAVE IN THE PAST FEW YEARS.
Since opening for business in 1998, our asset level has increased
rapidly, including an 17.6% increase in 2005. Since 1999, the first full year
for which we achieved profitability, our earnings have increased at least 15%
annually. We cannot assure you that we will continue to achieve comparable
results in future years. As our asset size and earnings increase, it may become
more difficult to achieve high rates of increase in assets and earnings.
Additionally, it may become more difficult to achieve continued improvements in
our expense levels and efficiency ratio. Declines in the rate of growth of
income or assets, and increases in operating expenses or nonperforming assets
may have an adverse impact on the value of our common stock.
WE MAY NOT BE ABLE TO SUCCESSFULLY MANAGE CONTINUED GROWTH.
We expect that we will seek further growth in the level of our assets
and deposits and the number of our branches. As our capital base grows, through
earnings or otherwise, so does our legal lending limit. We cannot be certain as
to our ability to manage increased levels of assets and liabilities, or to
successfully make and supervise higher balance loans.
10
Further, we may not be able to maintain the relatively low levels of
nonperforming loans that we have experienced. We may be required to make
additional investments in equipment and personnel to manage higher asset levels
and loan balances, which may adversely impact earnings, shareholder returns and
our efficiency ratio. We cannot be certain as to out ability to obtain deposits
or other liquidity sources to fund additional loans at interest rates that will
permit an increase in our net interest margin. Increases in operating expenses
or nonperforming assets may have an adverse impact on the value of our common
stock. To the extent growth involves establishment of additional branch
facilities, it can act to reduce or impede the growth of earning until the time,
if ever, that the new branch facilities achieve profitability.
TRADING IN OUR COMMON STOCK HAS BEEN SPORADIC AND VOLUME HAS BEEN
LIGHT. AS A RESULT, SHAREHOLDERS MAY NOT BE ABLE TO QUICKLY AND EASILY SELL
THEIR COMMON STOCK.
Although our common stock is listed for trading on the Nasdaq Capital
Market, and a number of brokers offer to make a market in the common stock on a
regular basis, trading volume to date has been limited, averaging only
approximately 3,016 shares per day over the twelve months ended February 28,
2006, and there can be no assurance that a more active and liquid market for the
common stock will develop, or if developed that it can be maintained.
Accordingly, shareholders may find it difficult to sell a significant number of
shares at the prevailing market price.
WE HAVE NO CURRENT PLANS TO PAY CASH DIVIDENDS.
James Monroe Bank is our principal revenue producing operation. As a
result, the ability to pay cash dividends to shareholders largely depends on
receiving dividends from James Monroe Bank. The amount of dividends that a bank
may pay is limited by state and federal laws and regulations. Even if we have
earnings in an amount sufficient to pay cash dividends, our Board of Directors
currently intends to retain earnings for the purpose of financing growth.
OUR DIRECTORS AND EXECUTIVE OFFICERS OWN 19.5% OF THE OUTSTANDING
SHARES OF COMMON STOCK COMMON. AS A RESULT OF THEIR COMBINED OWNERSHIP, THEY
COULD MAKE IT MORE DIFFICULT TO OBTAIN APPROVAL FOR SOME MATTERS SUBMITTED TO
SHAREHOLDER VOTE, INCLUDING MERGERS AND ACQUISITIONS. THE RESULTS OF THE VOTE
MAY BE CONTRARY TO THE DESIRES OR INTERESTS OF THE PUBLIC SHAREHOLDERS.
Our directors and executive officers and their affiliates own
approximately 19.5% of the outstanding common stock, and are deemed to
beneficially own approximately 26.0% of the common stock, including options to
purchase shares of common stock. By voting against a proposal submitted to
shareholders, the directors and officers, as a group, may be able to make
approval more difficult for proposals requiring the vote of shareholders, such
as some mergers, share exchanges, asset sales, and amendments to the Articles of
Incorporation.
THE LOSS OF THE SERVICES OF ANY KEY EMPLOYEES COULD ADVERSELY AFFECT
INVESTOR RETURNS.
Our business is service oriented, and our success depends to a large
extent upon the services of John R. Maxwell, our President and Chief Executive
Officer, and other senior officers. The loss of the services of Mr. Maxwell or
other senior officers could adversely affect our business. Although we have $1
million in key man insurance on Mr. Maxwell, the proceeds of this policy are not
intended to fully compensate us for the loss of Mr. Maxwell's services.
A SUBSTANTIAL PORTION OF OUR LOANS ARE REAL ESTATE RELATED LOANS IN THE
NORTHERN VIRGINIA/WASHINGTON DC METROPOLITAN AREA, AND SUBSTANTIALLY ALL OF OUR
LOANS ARE MADE TO BORROWERS IN THAT AREA. ADVERSE CHANGES IN THE REAL ESTATE
MARKET OR ECONOMY IN THIS AREA COULD LEAD TO HIGHER LEVELS OF PROBLEM LOANS AND
CHARGE OFFS, AND ADVERSELY AFFECT OUR EARNINGS AND FINANCIAL CONDITION.
We have a substantial amount of loans secured by real estate in the
Northern Virginia/Washington DC metropolitan area as collateral, and
substantially all of our loans are to borrowers in that area. At December 31,
2005, 71.2% of our loans were commercial real estate loans and 11.6% were
construction and land development loans. An additional 12.5% were commercial and
industrial loans which are not secured by real estate. These loans have a higher
risk of default than other types of loans, such as single family residential
mortgage loans. In addition, the repayments of these loans often depends on the
successful operation of a business or the sale or development of the underlying
property, and as a result are more likely to be adversely affected by adverse
conditions in the real estate market or the economy in general. These
concentrations expose us to the risk that adverse developments in the real
estate market, or in the general economic conditions in the Northern
11
Virginia/Washington DC metropolitan area, could increase the levels of
nonperforming loans and charge offs, and reduce loan demand and deposit growth.
In that event, we would likely experience lower earnings or losses.
Additionally, if economic conditions in the area deteriorate, or there is
significant volatility or weakness in the economy or any significant sector of
the area's economy, our ability to develop our business relationships may be
diminished, the quality and collectibility of our loans may be adversely
affected, the value of collateral may decline and loan demand may be reduced.
Commercial and commercial real estate and construction loans also
generally have larger balances than single family mortgages loans and other
consumer loans. Because the loan portfolio contains a significant number of
commercial and commercial real estate and construction loans with relatively
large balances, the deterioration of one or a few of these loans may cause a
significant increase in nonperforming assets. An increase in nonperforming loans
could result in: a loss of earnings from these loans, an increase in the
provision for loan losses, or an increase in loan charge-offs, which could have
an adverse impact on our results of operations and financial condition.
OUR FINANCIAL CONDITION AND RESULTS OF OPERATIONS WOULD BE ADVERSELY
AFFECTED IF OUR ALLOWANCE FOR LOAN LOSSES IS NOT SUFFICIENT TO ABSORB ACTUAL
LOSSES OR IF WE ARE REQUIRED TO INCREASE OUR ALLOWANCE FOR LOAN LOSSES.
Experience in the banking industry indicates that a portion of our
loans will become delinquent, and that some may only be partially repaid or may
never be repaid at all. Despite our underwriting criteria, we may experience
losses for reasons beyond our control, such as general economic conditions. We
may be particularly susceptible to losses due to: (1) the geographic
concentration of our loans, (2) the concentration of higher risk loans, such as
commercial real estate, construction and commercial and industrial loans, and
(3) the relative lack of seasoning of certain of our loans. Although we believe
that our allowance for loan losses is maintained at a level adequate to absorb
any inherent losses in our loan portfolio, these estimates of loan losses are
necessarily subjective and their accuracy depends on the outcome of future
events. As a result, there can be no assurance that we will be able to maintain
our relatively low levels of non-performing assets and charge-offs. If we need
to make significant and unanticipated increases in our loss allowance in the
future, our results of operations would be materially adversely affected at that
time.
While we strive to carefully monitor credit quality and to identify
loans that may become nonperforming, at any time there are loans included in the
portfolio that will result in losses, but that have not been identified as
nonperforming or potential problem loans. We cannot be sure that we will be able
to identify deteriorating loans before they become nonperforming assets, or that
we will be able to limit losses on those loans that are identified. As a result,
future additions to the allowance may be necessary.
OUR BANK REGULATORS MAY REQUIRE US TO INCREASE OUR ALLOWANCE FOR LOAN
LOSSES, WHICH COULD HAVE A NEGATIVE EFFECT ON OUR FINANCIAL CONDITION AND
RESULTS OF OPERATIONS.
Federal and state regulators, as an integral part of their supervisory
function, periodically review our allowance for loan losses. These regulatory
agencies may require us to increase our provision for loan losses or to
recognize further loan charge offs based upon their judgments, which may be
different from ours. Any increase in the allowance for loan losses required by
these regulatory agencies could have a negative effect on our financial
condition and results of operations.
LACK OF SEASONING OF OUR LOAN PORTFOLIO MAY INCREASE THE RISK OF CREDIT
DEFAULTS IN THE FUTURE.
Most of the loans in our loan portfolio were originated within the past
four years, and as of December 31, 2005, approximately 46% of loans outstanding
were either originated or renewed within 2005. In general, loans do not begin to
show signs of credit deterioration or default until they have been outstanding
for some period of time, a process referred to as "seasoning." As a result, a
portfolio of older loans will usually behave more predictably than a newer
portfolio. Because our loan portfolio is relatively new, the current level of
delinquencies and defaults may not be representative of the level that will
prevail when the portfolio becomes more seasoned, which may be somewhat higher
than current levels.
THERE IS NO ASSURANCE THAT WE WILL BE ABLE TO SUCCESSFULLY COMPETE WITH
OTHERS FOR BUSINESS.
The Northern Virginia/Washington DC metropolitan area in which we
operate is considered highly attractive from an economic and demographic
viewpoint, and is therefore a highly competitive banking market. We compete for
loans, deposits, and investment dollars with numerous large, regional and
national banks and other community banking institutions, as well as other kinds
of financial institutions and enterprises, such as the online divisions of
out-of market banks, securities firms,
12
insurance companies, savings associations, credit unions, mortgage brokers, and
private lenders. Many competitors have substantially greater resources than us,
and operate under less stringent regulatory regimens. The differences in
resources and regulations may make it harder for us to compete profitably,
reduce the rates that we can earn on loans and investments, increase the rates
we must offer on deposits and other funds, and adversely affect our overall
financial condition and earnings.
CHANGES IN INTEREST RATES AND OTHER FACTORS BEYOND OUR CONTROL COULD
HAVE AN ADVERSE IMPACT ON OUR EARNINGS.
Our operating income and net income depend to a great extent on our net
interest margin i.e., the difference between the interest yields we receive on
loans, securities and other interest bearing assets and the interest rates we
pay on interest bearing deposits and other liabilities. These rates are highly
sensitive to many factors which are beyond our control, including competition,
general economic conditions and monetary and fiscal policies of various
governmental and regulatory authorities, including the Board of Governors of the
Federal Reserve System. As discussed in Item 7 of this report, "Management's
Discussion and Analysis of Financial Condition and Results of Operations", under
the caption "Liquidity and Interest Rate Sensitivity Management", the Company
manages its exposure to possible changes in interest rates by simulation
modeling or "what if" scenarios to quantify the potential financial implications
of changes in interest rates. At December 31, 2005, the Company's modeling
indicated that continued declines in market interest rates could reduce net
interest income up to 5.5%. Increases in market rates would likely have an
adverse impact on our noninterest income, as a result of reduced demand for
mortgage loans, which we make on a pre-sold basis.
Adverse changes in the real estate market in our market area could also
have an adverse affect on our cost of funds and net interest margin, as we
typically have a large amount of noninterest bearing deposits related to real
estate sales and development. While we expect that we would be able to replace
the liquidity provided by these deposits, the replacement funds would likely be
more costly, negatively impacting earnings.
Additionally, changes in applicable law, if enacted, including those
that would permit banks to pay interest on checking and demand deposit accounts
established by businesses, could have a significant negative effect on net
interest income, net income, net interest margin, return on assets and return on
equity. A significant portion of our deposits, 22.7% at December 31, 2005, are
noninterest bearing demand deposits.
Government policy relating to the deposit insurance funds may also
adversely affect our results of operations. Under current law and regulation, if
the reserve ratio of the Bank Insurance Fund falls below 1.25%, all insured
banks will be required to pay deposit insurance premiums. We do not currently
pay any deposit insurance premiums. Payment of deposit insurance premiums will
have an adverse effect on our earnings. These changes or other legislative or
regulatory developments could have a significant negative effect on our net
interest income, net income, net interest margin, return on assets and return on
equity.
SUBSTANTIAL REGULATORY LIMITATIONS ON CHANGES OF CONTROL AND
ANTI-TAKEOVER PROVISIONS OF VIRGINIA LAW MAY MAKE IT MORE DIFFICULT FOR YOU TO
RECEIVE A CHANGE IN CONTROL PREMIUM.
With certain limited exceptions, federal regulations prohibit a person
or company or a group of persons deemed to be "acting in concert" from, directly
or indirectly, acquiring more than 10% (5% if the acquiror is a bank holding
company) of any class of our voting stock or obtaining the ability to control in
any manner the election of a majority of our directors or otherwise direct the
management or policies of our company without prior notice or application to and
the approval of the Federal Reserve. There are comparable prior approval
requirements for changes in control under Virginia law. Also, Virginia corporate
law contains several provisions that may make it more difficult for a third
party to acquire control of us without the approval of our Board of Directors,
and may make it more difficult or expensive for a third party to acquire a
majority of our outstanding common stock.
ITEM 1B. UNRESOLVED STAFF COMMENTS. NONE.
13
ITEM 2. PROPERTIES.
We currently maintain seven banking offices in the Northern Virginia
market. All of our properties are occupied under leases which have terms
extending until at least 2006 and more renewal options. We have also leased
14,107 square feet in a new building in Chantilly, Virginia which houses our
Chantilly branch and certain administrative and operations functions.
ADDRESS TYPE OF FACILITY
------- ----------------
3033 Wilson Boulevard Main banking office, executive office
Arlington, Virginia
3914 Centreville Road Full service branch, administrative
Chantilly, Virginia offices, back office operations
7023 Little River Turnpike Full service branch
Annandale, Virginia
10509 Judicial Drive Full service branch
Fairfax, Virginia
606 South King Street Full service branch
Leesburg, Virginia
10 W. Market Street Drive through/walk through limited
Leesburg, Virginia service branch
7900 Sudley Road Full service branch
Manassas, Virginia
12165 Darnestown Road Loan production center
Gaithersburg, Maryland
4211 Pleasant Valley Road Mortgage lending division office
Chantilly, Virginia
Management believes the existing facilities are adequate to conduct the
Company's business.
ITEM 3. LEGAL PROCEEDINGS.
From time to time the Company is a participant in various legal
proceedings incidental to its business. In the opinion of management, the
liabilities (if any) resulting from such legal proceeding will not have a
material effect on the financial position of the Company.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.
No matters were submitted for the vote of shareholders during the
quarter ended December 31, 2005.
14
PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY, RELATED STOCKHOLDER MATTERS.
Market for Common Stock and Dividends. Since August 27, 2002, our
common stock has been trading on the Nasdaq Capital Market under the symbol
"JMBI." Prior to that date and since January 19, 2001, the common stock was
traded on the OTC Bulletin Board. As of December 31, 2005, there were 5,574,710
shares of common stock outstanding, held by approximately 436 shareholders of
record. At that date, there were also outstanding options to purchase 731,363
shares of common stock, 731,259 of which were exercisable.
Set forth below is our share price history for the each quarter since
January 1, 2003 through December 31, 2005. Information provided represents high
and low bid prices, which reflect inter-dealer prices without retail mark-up,
mark-down or commission, and may not represent actual trades. To date, trading
in the common stock has been relatively light. No assurance can be given that an
active trading market will develop, or if one develops, can be maintained.
Information has been adjusted to reflect the three-for-two stock split in the
form of a 50% stock dividend paid on July 25, 2002, the five-for-four stock
split in the form of a 25% stock dividend paid on May 16, 2003, the
three-for-two stock split in the form of a 50% stock dividend paid on June 1,
2004, and the five-for-four stock split in the form a 25% stock dividend paid on
December 28, 2005.
2005 2004 2003
-------------- -------------- --------------
Period Ended High Low High Low High Low
------ ------ ------ ------ ------ ------
March 31, $16.10 $14.44 $15.31 $13.15 $9.49 $6.98
June 30, $16.60 $14.04 $15.48 $14.01 $12.70 $8.96
September 30, $18.80 $14.80 $15.40 $14.40 $14.08 $11.60
December 31, $20.00 $17.48 $15.92 $14.12 $14.24 $11.84
Dividends. Holders of the common stock are entitled to receive
dividends as and when declared by the Board of Directors. On July 25, 2002, the
Company effected a three-for-two stock split in the form of a 50% stock
dividend. On May 16, 2003, we paid a five-for-four stock split in the form of a
25% stock dividend. On June 1, 2004 the Company effected a three-for-two stock
split in the form of a 50% stock dividend. On December 28, 2005 we paid a
five-for-four stock split in the form of a 25% stock dividend. The Company has
not paid cash dividends since it became the holding company for the Bank, and
prior to that time the Bank did not pay any cash dividends, each electing to
retain earnings to support growth. We currently intend to continue the policy of
retaining earnings to support growth for the immediate future. Future dividends
will depend primarily upon the Bank's earnings, financial condition, and need
for funds and capital, as well as applicable governmental policies and
regulations. There can be no assurance that we will have earnings at a level
sufficient to support the payment of dividends, or that we will in the future
elect to pay dividends.
Regulations of the Federal Reserve and Virginia law place a limit on
the amount of dividends the Bank may pay without prior approval. Prior
regulatory approval is required to pay dividends which exceed the Bank's net
profits for the current year plus its retained net profits for the preceding two
calendar years, less required transfers to surplus. At December 31, 2005,
$10,163,000 was available for the payment of dividends by the Bank without prior
regulatory approval. State and federal regulatory authorities also have
authority to prohibit a bank from paying dividends if they deem payment to be an
unsafe or unsound practice.
The Federal Reserve has established guidelines with respect to the
maintenance of appropriate levels of capital by registered bank holding
companies. Compliance with such standards, as presently in effect, or as they
may be amended from time to time, could possibly limit the amount of dividends
that the Company may pay in the future. In 1985, the Federal Reserve issued a
policy statement on the payment of cash dividends by bank holding companies. In
the statement, the Federal Reserve expressed its view that a holding company
experiencing earnings weaknesses should not pay cash dividends exceeding its net
income, or which could only be funded in ways that weakened the holding
company's financial health, such as by borrowing.
As a depository institution, the deposits of which are insured by the
FDIC, the Bank may not pay dividends or distribute any of its capital assets
while it remains in default on any assessment due the FDIC. The Bank is not
currently in default under any of its obligations to the FDIC.
15
Recent Sales of Unregistered Shares. None.
Use of Proceeds: Not Applicable.
Securities Authorized for Issuance Under Equity Compensation Plans. The
following table sets forth information regarding options issuable and issued
under our plans under which stock options or other equity based compensation may
be granted.
Equity Compensation Plan Information
Number of securities
remaining available for
Number of securities to be future issuance under
issued upon exercise Weighted average exercise equity compensation plans
of outstanding price of outstanding options, (excluding securities
Plan category options, warrants and rights warrants and rights reflected in column (a))
- ------------------------------------------------------------------------------------------------------------------------------
(a) (b) (c)
Equity compensation plans
approved by security holders (1) 731,363 $8.92 295,527
Equity compensation plans not
approved by security holders 0 N/A 0
--------------------------------------------------------------------------------------------
Total 731,363 $8.92 295,527
(1) Consists of the 1998 Management Incentive Stock Option Plan, 1999
Director's Stock Option Plan and 2003 Equity Compensation Plan described
further in Note 8 to the consolidated financial statements, and in response
to Item 10 hereof. Certain expired employment arrangements of the Company,
which were not individually approved by shareholders, and which are
disclosed in response to Item 11 hereof, called for the issuance of options
to purchase common stock under the stock option plan which have been
approved by shareholders.
Issuer Repurchases of Common Stock. No shares of the Company's common
stock were repurchased by or on behalf of the Company during the fourth quarter
of 2005.
16
ITEM 6. SELECTED FINANCIAL DATA.
YEAR ENDED DECEMBER 31,
------------------------------------------------------------------
(DOLLARS IN THOUSANDS EXCEPT SHARE DATA) 2005 2004 2003 2002 2001
---------- ---------- ---------- ---------- ----------
BALANCE SHEET HIGHLIGHTS:
Total assets $ 529,921 $ 450,770 $ 305,651 $ 238,793 $ 126,658
Total loans 378,491 249,996 169,047 121,047 86,139
Total liabilities 490,276 413,869 271,760 219,598 114,691
Total stockholders' equity 39,645 36,901 33,891 19,195 11,967
- ----------------------------------------- ---------- ---------- ---------- ---------- ----------
RESULTS OF OPERATIONS:
Total interest income $ 27,343 $ 17,462 $ 13,026 $ 10,091 $ 7,548
Total interest expense 9,512 4,833 3,618 3,609 2,918
Net interest income 17,831 12,629 9,408 6,482 4,630
Provision for loan losses 1,167 990 662 483 450
Other income 1,627 1,175 1,147 760 554
Noninterest expense 11,883 8,287 5,964 4,394 3,033
Income before taxes 6,408 4,527 3,929 2,365 1,701
Net income 4,217 2,970 2,601 1,553 1,112
- ----------------------------------------- ---------- ---------- ---------- ---------- ----------
PER SHARE DATA(1):
Earnings per share, basic $ 0.76 $ 0.54 $ 0.58 $ 0.40 $ 0.33
Earnings per share, diluted $ 0.72 $ 0.51 $ 0.54 $ 0.38 $ 0.32
Weighted average shares
outstanding--basic 5,563,758 5,544,881 4,487,414 3,852,833 3,375,349
Weighted average shares
outstanding--diluted 5,897,085 5,843,964 4,787,377 4,051,011 3,499,524
Book value (at period-end) $ 7.11 $ 6.64 $ 6.14 $ 4.45 $ 3.54
Shares outstanding 5,574,710 5,556,530 5,519,629 4,314,086 3,376,643
- ----------------------------------------- ---------- ---------- ---------- ---------- ----------
PERFORMANCE RATIOS:
Return on average assets 0.86% 0.83% 0.97% 0.88% 1.02%
Return on average equity 11.04% 8.35% 11.94% 10.15% 9.65%
Net interest margin 3.79% 3.72% 3.73% 3.90% 4.56%
Efficiency Ratio (2) 61.07% 60.03% 56.50% 60.67% 58.51%
- ----------------------------------------- ---------- ---------- ---------- ---------- ----------
OTHER RATIOS:
Allowance for loan losses to total loans 1.04% 1.12% 1.16% 1.15% 1.20%
Equity to assets 7.48% 8.19% 11.09% 8.04% 9.45%
Nonperforming loans to total loans 0.07% 0.14% 0.30% 0.24% 0.31%
Net charge-offs to average loans 0.01% 0.07% 0.07% 0.12% 0.03%
Risk-Adjusted Capital Ratios:
Tier 1 14.0% 16.2% 21.9% 15.4% 11.9%
Total 15.9% 17.1% 22.9% 16.4% 13.0%
Leverage Ratio 10.6% 10.7% 14.3% 10.5% 9.5%
(1) Information has been adjusted to reflect the 5-for-4 stock split paid on
December 28, 2005, the 3-for-2 stock split paid on June 1, 2004, the 5-for-4
stock split paid on May 16, 2003 and the 3-for-2 stock split paid on July 25,
2002.
(2) Computed by dividing noninterest expense by the sum of net interest income
on a tax equivalent basis and noninterest income, including securities gains or
losses and gains or losses on the sale of loans. This is a non-GAAP financial
measure, which we believe provides investors with important information
regarding our operational efficiency. Comparison of our efficiency ratio with
those of other companies may not be possible, because other companies may
calculate the efficiency ratio differently.
17
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS.
FORWARD LOOKING STATEMENTS
This Management's Discussion and Analysis and other portions of this
report contain forward looking statements within the meaning of the Securities
Exchange Act of 1934, as amended, including statements of goals, intentions, and
expectations as to future trends, plans, events or results of Company operations
and policies and regarding general economic conditions. In some cases, forward
looking statements can be identified by use of such words as "may," "will,"
"anticipate," "believes," "expects," "plans," "estimates," "potential,"
"continue," "should," and similar words or phases. These statements are based
upon current and anticipated economic conditions, nationally and in the
Company's market, interest rates and interest rate policies, competitive
factors, government agencies and other third parties, which by their nature are
not susceptible to accurate forecast, and are subject to significant
uncertainty. Because of these uncertainties and the assumptions on which this
discussion and the forward looking statements are based, actual future
operations and results in the future may differ materially from those indicated
herein. Readers are cautioned against placing undue reliance on any such forward
looking statement.
INTRODUCTION
This Management's Discussion and Analysis reviews the financial
condition and results of operations of the Company and its subsidiaries as of
and for the years ended December 31, 2005, 2004 and 2003. Some tables cover more
than these periods to comply with Securities and Exchange Commission disclosure
requirements or to illustrate trends over a period of time. When reading this
discussion, reference should be made to the consolidated financial statements
and related notes that appear herein and to our consolidated financial
statements and footnotes thereto for the year ended December 31, 2005.
CRITICAL ACCOUNTING POLICIES
There were no changes to the Company's critical accounting policies in
the fourth quarter of 2005. Critical accounting policies are those applications
of accounting principles or practices that require considerable judgment,
estimation, or sensitivity analysis by management. In the financial service
industry, examples, albeit not an all inclusive list, of disclosures that may
fall within this definition are the determination of the adequacy of the
allowance for loan losses, valuation of mortgage servicing rights, valuation of
derivatives or securities without a readily determinable market value, and the
valuation of the fair value of intangibles and goodwill. Except for the
determination of the adequacy of the allowance for loan losses, the Company does
not believe there are other practices or policies that require significant
sensitivity analysis, judgments, or estimations.
Allowance for Loan Losses. The Company has developed a methodology to
determine, on a quarterly basis, an allowance to absorb probable loan losses
inherent in the portfolio based on evaluations of the collectibility of loans,
historical loss experience, peer bank loss experience, delinquency trends,
economic conditions, portfolio composition, and specific loss estimates for
loans considered substandard or doubtful. All commercial and commercial real
estate loans that exhibit probable or observed credit weaknesses are subject to
individual review. If necessary, reserves would be allocated to individual loans
based on management's estimate of the borrower's ability to repay the loan given
the availability of collateral and other sources of cash flow. Any reserves for
impaired loans are measured based on the present rate or fair value of the
underlying collateral. The Company evaluates the collectibility of both
principal and interest when assessing the need for a loss accrual. A composite
allowance factor that considers the Company's and other peer bank loss
experience ratios, delinquency trends, economic conditions, and portfolio
composition are applied to the total of commercial and commercial real estate
loans not specifically evaluated. A percentage of this composite allowance
factor is also applied to the aggregate of unused commercial lines of credit
which the Company has an obligation to honor but where the borrower has not
elected to draw on their lines of credit.
Homogeneous loans, such as consumer installment, residential mortgage
loans, home equity loans, and smaller consumer loans are not individually risk
graded. Reserves are established for each homogeneous pool of loans based on the
expected net charge offs from a current trend in delinquencies, losses or
historical experience and general economic conditions. The Company has no
material delinquencies in these types of loans, and has not, since inception,
had a trend or an indication of a trend that would guide the Company in expected
material losses in these types of homogeneous pools of loans.
18
The Company's allowance for loan losses is determined based upon a
methodology developed by management as described above and is approved by the
board of directors each quarter.
COMPANY HIGHLIGHTS SINCE DECEMBER 31, 2004 ARE:
o Average assets grew $131.4 million (37%).
o Average loans grew $115.3 million (55%).
o Average deposits grew $115 million (37%).
o Net interest margin was 3.79% for the full year 2005 compared to 3.72%
for the full year 2004.
o Asset quality remained strong as the dollar value of total
nonperforming loans at December 31, 2005 declined $92,000, from
$349,000 at December 31, 2004 to $257,000 at December 31, 2005. More
importantly, the percentage of total loans represented by such
nonperforming loans has declined significantly from 0.14% at December
31, 2004 to 0.07% at December 31, 2005. The allowance for loan losses
totaled 1.04% of total loans outstanding at December 31, 2005.
o The Company ended the year with excellent liquidity and adequate
capital to support further growth.
o The Company opened a loan production office in Gaithersburg, Maryland
in July 2005. The Bank has hired two lenders who have spent a
significant part of their banking careers working in the Montgomery
County market.
o The Company effected a five-for-four stock split for shareholders of
record on November 28, 2005, paid on December 28, 2005.
BALANCE SHEET
Year Ended December 31, 2005 vs. Year Ended December 31, 2004. Total
assets increased by $79.2 million from December 31, 2004 to December 31, 2005,
ending the year at $529.9 million. During this period, loans grew $128.5 million
and deposits increased $67.2 million. The securities portfolio ended the year at
$119.0 million, a decrease of $27.8 million, as cash flow from maturing and
called securities were reinvested in higher yielding loans. Similarly, overnight
investments decreased $29.8 million to $6.0 million as funds were deployed into
loans. Stockholders' equity increased $2.7 million as a result of the $4.2
million of earnings retention for the year 2004, and $192,000 in proceeds from
the issuance of shares upon the exercise of options and the sale of shares in
the Company's KSOP plan, offset by a $1.7 million increase in the unrealized
loss on securities available for sale.
Year Ended December 31, 2004 vs. Year Ended December 31, 2003. Total
assets increased by $144.8 million from December 31, 2003 to December 31, 2004,
ending the period at $450.8 million. During this period, the Company emphasized
the importance of becoming the primary banker for our customers with the goal of
providing both lending and deposit services. These efforts resulted in deposit
growth of $148.9 million and loan growth of $80.9 million. The securities
portfolio grew during the year by $24.5 million, ending the period at $146.8
million. The Company's liquidity position improved by $42.6 million as overnight
investments totaled $35.8 million at year end. Stockholders' equity increased
$3.0 million as a result of the $2.970 million of earnings retention for the
year 2004, and $401,000 in proceeds from the issuance of shares upon the
exercise of options and the sale of shares in the Company's KSOP plan, offset by
a $358,000 decrease in the unrealized gains on securities available for sale.
19
RESULTS OF OPERATIONS
For the year ended December 31, 2005, the Company earned $4.217
million, or $.76 per basic share and $.72 per diluted share, compared with
$2.970 million, or $.54 per basic share and $.51 per diluted share, for the year
ended December 31, 2004 and $2.601 million, or $.58 per basic share and $.54 per
diluted share, for the year ended December 31, 2003. Return on average assets
was .86% and return on average equity was 11.04% for the year ended December 31,
2005 compared to a .83% return on average assets and 8.35% return on average
equity for the year ended December 31, 2004 and a .97% return on average assets
and a 11.94% return on average equity for the year ended December 31, 2003.
During 2005, the Company continued to focus on managing its net
interest margin, especially in light of the low, but rising, interest rate
environment. Beginning in 2001 through June 2003, the Federal Reserve reduced
the federal funds target rate an aggregate of 550 basis points. These dramatic
reductions over a relatively short period impacted the loan and investment
portfolios in 2003 and 2004, as loans repriced on a delayed basis or renewed at
lower interest rates, and as investment securities matured or were called, and
were reinvested at lower rates. This was partially offset by continued repricing
upon renewal of certificates of deposit. While the Federal Reserve began to
reverse the rate reductions, through a series of thirteen increases aggregating
325 basis points, beginning on June 30, 2004 through December 13, 2005, the rate
reductions and continuing low rate environment caused a reduction in the net
interest margin, from 5.09% in 2000 to 4.56% in 2001 to 3.90% in 2002 to 3.73%
in 2003 to 3.72% in 2004. Despite these reductions, the Company's practice of
managing its interest rate risk process has mitigated the negative effect of
such a severely declining and low rate environment. As the rate increases have
begun to impact the Company, the net interest margin improved slightly in 2005,
increasing to 3.79%. The Company expects that continued increases in the federal
funds target rate will contribute to increased margin as earning assets reprice,
while repricing of deposits lags. However, as discussed further under "Liquidity
and Interest Rate Sensitivity Management," as a result of competitive factors,
market conditions, customer preferences and other factors, the Company may not
be able to benefit from further increases in market interest rates.
Although the Company has continued to grow in asset size since its
inception in 1998, it has been able to control its operating efficiency. Within
the past two years the Company expanded into the Chantilly and Manassas markets,
opened a new operations center, opened a loan production office in Gaithersburg,
Maryland, and expanded its mortgage lending division. These are growth oriented
initiatives taken after additional capital was raised in the fourth quarter of
2003. While these pro-active initiatives have increased operating expenses, as
evidenced by the rise in the Bank's efficiency ratio to 61.07% during 2005, the
Company's focus remains on a long term strategy of expanding our franchise
throughout the Northern Virginia market. The efficiency ratio is a non-GAAP
financial measure, which we believe provides investors with important
information regarding our operational efficiency. We compute our efficiency
ratio by dividing noninterest expense by the sum of net interest income on a tax
equivalent basis and noninterest income, which includes securities gains or
losses and gains or losses on the sale of mortgage loans. Comparison of our
efficiency ratio with those of other companies may not be possible, because
other companies may calculate the efficiency ratio differently.
NET INTEREST INCOME, AVERAGE BALANCES AND YIELDS
Net interest income is the difference between interest and fees earned
on assets and the interest paid on deposits and borrowings. Net interest income
is one of the major determining factors in the Bank's performance as it is the
principal source of revenue and earnings. Unlike the larger regional or
mega-banks that have significant sources of fee income, community banks, such as
James Monroe Bank, rely on net interest income from traditional banking
activities as the primary revenue source.
Table 1 provides certain information relating to the Company's average
consolidated statements of financial condition and reflects the interest income
on interest earning assets and interest expense of interest bearing liabilities
for the years ended December 31, 2005, 2004 and 2003 and the average yields
earned and rates paid during those periods. These yields and costs are derived
by dividing income or expense by the average daily balance of the related asset
or liability for the periods presented. The Company did not have any tax exempt
income during any of the periods presented in Table 1. Nonaccrual loans have
been included in the average balances of loans receivable.
2005 vs. 2004. For the year ended December 31, 2005, net interest
income increased $5.2 million, or 41%, to $17.8 million from the $12.6 million
for the year ended December 31, 2004. This was primarily a result of the
increase in the volume of interest earning assets, and partially offset by the
effect of deposit repricings. Total average earning assets increased by $130.5
million, or 38%, from 2004 to 2005. The yield on earning assets increased by 68
basis points from
20
2004, partially a reflection the rising interest rate market, but more
importantly, the benefit derived from balance sheet growth occurring in higher
yielding loans rather than lower yielding securities and overnight investments.
Average loans outstanding grew by $115.3 million, or 55%, during 2005. The yield
on such loans increased by 47 basis points. Average federal funds decreased
$12.1 million, or 54%, while the yield increased 111 basis points. The average
balance of the security portfolio grew $25.8 million, or 24%, and the yield on
the portfolio improved 15 basis points.
For the year ended December 31, 2005, average interest bearing
liabilities increased $108.0 million or 45% from the prior year. Interest
bearing deposits grew $94.7 million and borrowings, which includes federal funds
purchased and trust preferred capital notes, increased $13.3 million. Interest
expense paid on these liabilities for 2005 was $9.5 million compared with $4.8
million for 2004. The cost of funds increased 72 basis points from 2.01% during
2004 to 2.73% during 2005.
The resulting effect of the changes in interest rates between 2005 and
2004, offset by changes in the volume and mix of earning assets and interest
bearing liabilities resulted in an increase in the net interest margin of 7
basis point to 3.79% in 2005 versus 3.72% in 2004. Management believes this
stability is indicative of the Company's interest rate risk management process.
2004 vs. 2003. For the year ended December 31, 2004, net interest
income increased $3.2 million, or 34%, to $12.6 million from the $9.4 million
for the year ended December 31, 2003. This was primarily a result of the
increase in the volume of interest earning assets, and partially offset by the
effect of loan repricings. Total average earning assets increased by $87.2
million, or 35%, from 2003 to 2004. The yield on earning assets decreased by
only 2 basis points from 2003, reflecting the benefit of faster growth in higher
yielding loans rather than lower yielding securities and overnight investments.
Average loans outstanding grew by $63.3 million, or 44%, during 2004. The yield
on such loans decreased by 48 basis points. Average federal funds increased $2.4
million, or 12%, while the yield increased 53 basis points. The average balance
of the security portfolio grew $21.8 million, or 25%, and the yield on the
portfolio improved 27 basis points. Although many agency bonds were called
throughout 2004 they were reinvested at favorable rates in similar instruments.
For the year ended December 31, 2004, average interest bearing
liabilities increased $64.8 million or 37% from the prior year. Interest bearing
deposits grew $59.6 million and borrowings, which includes federal funds
purchased and trust preferred capital notes, increased $5.2 million. Interest
expense paid on these liabilities for 2004 was $4.8 million compared with $3.6
million for 2003. The cost of funds declined 4 basis points from 2.05% during
2003 to 2.01% during 2004.
The resulting effect of the changes in interest rates between 2004 and
2003, offset by changes in the volume and mix of earning assets and interest
bearing liabilities resulted in a virtually stable net interest margin of 3.72%
in 2004 versus 3.73% in 2003. Management believes this stability is indicative
of the Company's interest rate risk management process.
21
TABLE 1: AVERAGE BALANCE SHEETS, NET INTEREST INCOME AND YIELDS/RATES
Year Ended Year Ended Year Ended
December 31, 2005 December 31, 2004 December 31, 2003
------------------------------- ------------------------------- -------------------------------
Average Yield/ Average Yield/ Average Yield/
(Dollars in thousands) Balance Interest Rate Balance Interest Rate Balance Interest Rate
----------- ------------------- ---------------------- -------- -------------------------------
ASSETS
Loans:
Commercial $ 71,449 $ 4,886 6.84% $ 54,979 $ 3,353 6.10% $ 39,171 $ 2,501 6.38%
Commercial real estate 229,002 15,126 6.61% 138,877 8,715 6.28% 92,410 6,302 6.82%
Consumer 23,251 1,527 6.57% 14,585 818 5.61% 13,537 855 6.32%
----------- ---------- ----------- --------- ------------ ---------
Total loans 323,702 21,539 6.65% 208,441 12,886 6.18% 145,118 9,658 6.66%
Loans held for sale 2,459 140 5.69% 881 49 5.56% 1,230 60 4.88%
Taxable securities 133,797 5,399 4.04% 108,004 4,196 3.89% 86,213 3,118 3.62%
Federal funds sold and cash
equivalents 10,221 265 2.59% 22,353 331 1.48% 19,955 190 0.95%
----------- ---------- ----------- --------- ------------ ---------
Total earning assets 470,179 27,343 5.82% 339,679 17,462 5.14% 252,516 13,026 5.16%
----------- ---------- ----------- --------- ------------ ---------
Less: allowance for loan losses (3,439) (2,319) (1,643)
Cash and due from banks 16,765 16,698 13,671
Premises and equipment, net 2,396 2,075 1,392
Other assets 5,022 3,362 1,890
----------- ------------ -------------
TOTAL ASSETS $490,923 $359,495 $ 267,826
=========== ============ =============
LIABILITIES AND
STOCKHOLDERS' EQUITY
Interest bearing deposits:
Interest bearing demand deposits $ 15,848 $ 130 0.82% $ 12,692 $ 85 0.67% $ 10,919 $ 88 0.81%
Money market deposit accounts 196,414 4,491 2.29% 158,653 2,958 1.86% 113,802 2,064 1.81%
Savings accounts 3,722 51 1.37% 3,665 46 1.26% 1,954 26 1.33%
Time deposits 107,552 3,526 3.28% 53,821 1,256 2.33% 42,543 1,115 2.62%
----------- ---------- ----------- --------- ------------ ---------
Total interest bearing deposits 323,536 8,198 2.53% 228,831 4,345 1.90% 169,218 3,293 1.95%
Borrowings:
Trust preferred capital notes 11,314 742 6.56% 9,279 452 4.87% 6,688 323 4.83%
Other borrowed funds 14,024 572 4.08% 2,781 36 1.29% 216 2 0.93%
----------- ---------- ----------- --------- ------------ ---------
Total borrowings 25,338 1,314 5.19% 12,060 488 4.05% 6,904 325 4.71%
----------- ---------- ----------- --------- ------------ ---------
Total interest bearing
liabilities 348,874 9,512 2.73% 240,891 4,833 2.01% 176,122 3,618 2.05%
----------- ---------- ----------- --------- ------------ ---------
Net interest income and net
yield on interest earning
assets $ 17,831 3.79% $ 12,629 3.72% $ 9,408 3.73%
========== ========== ==========
Noninterest-bearing demand
deposits 102,241 81,961 69,124
Other liabilities 1,609 1,067 798
Stockholders' equity 38,199 35,576 21,782
----------- ------------ -------------
TOTAL LIABILITIES AND
STOCKHOLDERS' EQUITY $490,923 $359,495 $ 267,826
=========== ============ =============
22
Table 2 shows the composition of the net change in net interest income
for the periods indicated, as allocated between the change due to changes in the
volume of average earning assets and interest bearing liabilities, and the
changes due to changes in interest rates. As the table shows, the increase in
net interest income of $5.2 million for the year ended December 31, 2005, as
compared to the year ended December 31, 2004, is due to the growth in the volume
of earning assets and interest bearing liabilities. While the rise in interest
rates has, to date, had a significant impact on interest income, it has had a
greater impact on interest expense. Management has controlled its exposure to
changes in interest rates such that dramatic declines in rates from 2001 through
2003 and the low but steadily rising interest rate environment since June 2004
has resulted in a modest $317,000 decline of net interest income during the year
ended December 31, 2005 compared to the year ended December 31, 2004, whereas
the growth in earning assets and interest bearing liabilities resulted in an
increase of $5.5 million to net interest income. Interest income increased $9.9
million during 2005 compared to 2004 as higher yielding loans grew at a faster
pace than securities and overnight investments resulting in a $8.0 million
increase in interest income attributable to asset growth while changes in rates
resulted in growth of interest income of $1.8 million. Interest expense during
these comparable periods increased $4.7 million with $2.5 million of this rise
attributable to growth in interest bearing liabilities while changes in rates
resulted in an increase of interest expense of $2.2 million.
Similar to changes in 2005, the increase in net interest income of $3.2
million for the year ended December 31, 2004 as compared to the twelve months
ended December 31, 2003 was due to growth in the volume of earning assets and
interest bearing liabilities. Balance sheet growth during 2004 resulted in an
increase of $3.7 million in net interest income, whereas changes in rates
resulted in a modest $501,000 decline of net interest income. Interest income
increased $4.4 million from December 31, 2003 to December 31, 2004 as higher
yielding loans grew at a faster pace than other assets resulting in a $5.0
million increase in interest income attributable to asset growth while the
interest rate environment resulted in a decline in interest income of $572,000.
Interest expense during these comparable periods increased $1.2 million with
$1.3 million attributable to growth in interest bearing liabilities while
changes in rates resulted in a decline in interest expense of $71,000.
TABLE 2
Year Ended December 31, Year Ended December 31,
2005 vs. 2004 2004 vs. 2003
---------------------------------------- ----------------------------------------
Increase Due to Change Increase Due to Change
or in Average or in Average
------------------------- -------------------------
(Dollars in thousands) (Decrease) Volume Rate (Decrease) Volume Rate
------------- ----------- ------------ ------------- ----------- -----------
EARNING ASSETS:
Loans $ 8,653 $ 7,126 $ 1,527 $ 3,228 $ 4,214 $ (986)
Mortgage loans 91 88 3 (11) (17) 6
Taxable securities 1,203 1,002 201 1,085 788 297
Federal funds sold and cash equivalents (66) (180) 114 134 23 111
------------- ----------- ------------ ------------- ----------- -----------
Total interest income 9,881 8,036 1,845 4,436 5,008 (572)
INTEREST BEARING LIABILITIES:
Interest bearing demand deposits 45 21 24 (3) 14 (17)
Money market deposit accounts 1,533 704 829 894 813 81
Savings deposits 5 1 4 20 23 (3)
Time deposits 2,270 1,254 1,016 141 296 (155)
Borrowed funds 826 537 289 163 140 23
------------- ----------- ------------ ------------- ----------- -----------
Total interest expense 4,679 2,517 2,162 1,215 1,286 (71)
------------- ----------- ------------ ------------- ----------- -----------
Net interest income $ 5,202 $ 5,519 $ (317) $ 3,221 $ 3,722 $ (501)
============= =========== ============ ============= =========== ===========
23
PROVISION AND ALLOWANCE FOR LOAN LOSSES
The provision for loan losses is based upon a methodology that includes
among other factors, a specific evaluation of commercial and commercial real
estate loans that are considered special mention, substandard or doubtful. All
other loans are then categorized in pools of loans with common characteristics.
A potential loss factor is applied to these loans which considers the historical
charge off history of the Company and its peer group, trends in delinquencies
and loan grading, current economic conditions, and factors that include the
composition of the Company's loan portfolio. At December 31, 2005, the Company
had a $163,000 impaired loan on nonaccrual status, and an additional $94,000 in
loans on nonaccrual status or past due 90 days or more and still accruing. See
Note 3 to the audited consolidated financial statements for additional
information regarding the Company's asset quality and allowance for loan losses.
While the dollar volume of total nonperforming loans at December 31, 2005
declined $92,000, or 26%, from $349,000 at December 31, 2004, more importantly,
the percentage of total loans represented by such nonperforming loans has
declined significantly from 0.14% at December 31, 2004 to 0.07% at December 31,
2005.
The Company's methodology determining an appropriate allowance for loan
losses was approved by the Audit Committee and the Board of Directors. The
quarterly allowance and provision are approved by the Board. The methodology is
reevaluated on a quarterly basis. Pending the development of a negative trend
with respect to past due loans or charge offs or significant changes in economic
conditions, the Company continues to maintain an allowance it believes is
adequate.
As reflected in Table 4 below, the allowance is allocated among the
various categories of loans based upon the methodology described herein.
TABLE 3
The following table presents the activity in the allowance for loan
losses for the years ended December 31, 2001 through 2005.
DECEMBER 31,
-----------------------------------------------------------------------------------------
(Dollars in thousands) 2005 2004 2003 2002 2001
---------------- --------------- --------------- ---------------- ----------------
Balance, January 1 $ 2,790 $ 1,955 $ 1,390 $ 1,030 $ 600
Provision for loan losses 1,167 990 662 483 450
Loan charge-offs:
Commercial (35) (135) (71) (122) (5)
Consumer (2) (21) (41) (4) (15)
---------------- --------------- --------------- ---------------- ----------------
Total charge-offs (37) (156) (112) (126) (20)
Loan recoveries:
Commercial - - 15 - -
Consumer - 1 - 3 -
---------------- --------------- --------------- ---------------- ----------------
Net charge-offs (37) (155) (97) (123) (20)
---------------- --------------- --------------- ---------------- ----------------
Balance, December 31 $ 3,920 $ 2,790 $ 1,955 $ 1,390 $ 1,030
================ =============== =============== ================ ================
Ratio of net charge-offs
during the period to average
loans outstanding 0.01% 0.07% 0.07% 0.12% 0.03%
24
TABLE 4
The following table shows the allocation of the allowance for loan
losses at the dates indicated. The allocation of portions of the allowance to
specific categories of loans is not intended to be indicative of future losses,
and does not restrict the use of the allowance to absorb losses in any category
of loans. See Note 3 to the audited consolidated financial statements included
in this report for additional information regarding the allowance for loan
losses and nonperforming assets.
DECEMBER 31,
-----------------------------------------------------------------------------------------------------
2005 2004 2003 2002 2001
------------------- ------------------- ------------------- ------------------- -------------------
Percent Percent Percent Percent Percent
of total of total of total of total of total
(Dollars in thousands) Amount loans Amount loans Amount loans Amount loans Amount loans
--------- --------- ------------------- ------------------- ------------------- -------------------
Construction loans $ 338 11.6% $ 299 14.1% $ 50 10.7% $ 35 10.0% $ 78 10.9%
Commercial loans 982 12.5% 553 13.1% 984 14.7% 765 23.0% 281 27.3%
Commercial real estate
loans 2,516 71.2% 1,868 67.0% 823 67.0% 504 58.1% 528 51.3%
Real estate 1-4 family
residental loans 4 0.4% 20 0.6% 4 2.2% 6 1.7% 40 3.9%
Home equity loans 21 2.1% 17 2.2% 9 1.9% 8 2.0% 19 1.8%
Consumer loans 59 2.2% 33 3.0% 85 3.4% 72 5.2% 84 4.8%
--------- --------- ------------------- ------------------- ------------------- -------------------
Balance end of period $ 3,920 100.0% $ 2,790 100.0% $ 1,955 100.0% $ 1,390 100.0% $ 1,030 100.0%
========= ========= =================== =================== =================== ===================
TABLE 5
The following table shows the amounts of non-performing assets at the dates
indicated.
DECEMBER 31,
-----------------------------------------------------------------------
(Dollars in Thousands) 2005 2004 2003 2002 2001
------------ ------------ ------------- ------------ ------------
Nonaccrual loans excluded from impaired loans:
Commercial $ - $ - $ 150 $ 22 $ -
Consumer - - 36 34 -
Accruing loans- past due 90 days or more:
Commercial 9 - - - 266
Consumer 25 - - - -
Impaired loans:
Commercial 223 349 324 240 -
------------ ------------ ------------- ------------ ------------
Total non-performing assets $ 257 $ 349 $ 510 $ 296 $ 266
============ ============ ============= ============ ============
At December 31, 2005, there were no performing loans considered
potential problem loans, defined as loans which are not included in the past
due, nonaccrual or restructured categories, but for which known information
about possible credit problems causes management to have serious doubts as to
the ability of the borrowers to comply with the present loan repayment terms. It
is the Company's policy to apply all payments received on nonaccrual loans to
principal until the balance has been satisfied or the loan returns to accrual
status. During 2003, approximately $33,000 in gross interest income would have
been recorded on nonaccrual and impaired loans had the loans been accruing
interest throughout the period. No amounts were included in gross interest
income in respect of nonaccrual or impaired loans in 2004 and 2005.
LOANS
The loan portfolio is the largest component of earning assets and
accounts for the greatest portion of total interest income. At December 31,
2005, total loans were $378.5 million, a 51.4% increase from the $250.0 million
in loans outstanding at December 31, 2004. Total loans at December 31, 2004
represented a 47.9% increase from the $169.0 million of loans at December 31,
2003. In general, loans are internally generated with the exception of a small
percentage
25
of participation loans purchased from other local community banks. Lending
activity is largely confined to our market of Northern Virginia. We do not
engage in highly leveraged transactions or foreign lending activities.
Loans in the commercial category, as well as commercial real estate
mortgages, consist primarily of short-term (five year or less final maturity)
and/or floating or adjustable rate commercial loans made to small to
medium-sized companies. We do not have any agricultural loans in the portfolio.
There are no substantial loan concentrations to any one industry or to any one
borrower.
Virtually all of the Company's commercial real estate mortgage and
development loans, which account for approximately 71% of our total loans at
December 31, 2005, relate to property in the Northern Virginia market. As such,
they are subject to risks relating to the general economic conditions in that
market, and the market for real estate in particular. The local real estate
market remains generally strong, and the Company attempts to mitigate risk
though careful underwriting, including primary reliance on the borrower's
financial capacity and ability to repay without resort to the property, and
lends primarily with respect to properties occupied or managed by the owner.
The Company's 1-4 family residential real estate loans are generally
not the typical purchase money first mortgage loan or refinancing, but are loans
made for other purposes and the collateral obtained is a first deed of trust on
the residential property of the borrower. The underlying loan would have a final
maturity much shorter than the typical first mortgage and may be a variable or
fixed rate loan. As reflected in Table 6, 22% of the Company's loans are fixed
rate loans and 96% of the Company's loans reprice or have a maturity date that
falls within five years.
Consumer loans consist primarily of secured installment credits to
individuals, residential construction loans secured by a first deed of trust,
home equity loans, or home improvement loans. The consumer portfolio, which
includes consumer loans, home equity loans, and 1-4 family residential loans,
represents 4.7% of the loan portfolio at December 31, 2005, as compared to 5.8%
at December 31, 2004 and 7.5% at December 31, 2003.
TABLE 6
Table 6 shows the maturities of the loan portfolio and the sensitivity
of loans to interest rate fluctuations at December 31, 2005. Maturities are
based on the earlier of contractual maturity or repricing date. Demand loans,
loans with no contractual maturity and overdrafts are represented in one year or
less.
December 31, 2005
---------------------------------------------------------
After One
Within Year Through After Five
(Dollars in thousands) One Year Five Years Years Total
--------- ----------- -------- --------
Construction loans $ 36,704 $ 2,376 $ 4,780 $ 43,860
Commercial loans 37,225 9,957 244 47,426
Commercial real estate loans 133,425 124,727 11,269 269,421
Real estate 1-4 family residential 396 661 284 1,341
Home equity loans 8,033 - - 8,033
Consumer loans 6,526 1,638 - 8,164
Deposit overdrafts 246 - - 246
--------- ----------- -------- --------
Total $ 222,555 $ 139,359 $ 16,577 $378,491
========= =========== ======== ========
After One
Within Year Through After Five
(Dollars in thousands) One Year Five Years Years Total
--------- ----------- -------- --------
Fixed rate $ 25,367 $ 47,778 $ 9,079 $ 82,224
Variable/Adjustable rate 197,188 91,581 7,498 296,267
--------- ----------- -------- ---------
Total $ 222,555 $ 139,359 $ 16,577 $ 378,491
========= =========== ======== =========
26
At December 31, 2005, the aggregate amount of loans due after one year
which have fixed rates was approximately $56.9 million, and the amount with
variable or adjustable rates was approximately $99.1 million.
TABLE 7
The following table presents the composition of the loan portfolio by type of
loan at the dates indicated.
DECEMBER 31,
----------------------------------------------------------------------------------------
(Dollars in thousands) 2005 2004 2003 2002 2001
--------------- --------------- ---------------- ---------------- ----------------
Construction loans $ 43,860 $ 35,166 $ 18,130 $ 12,160 $ 9,408
Commercial loans 47,426 32,782 24,885 27,862 23,478
Commercial real estate loans 269,421 167,696 113,316 70,318 44,192
Real estate-1-4 family residential 1,341 1,559 3,801 2,069 3,363
Home equity loans 8,033 5,400 3,193 2,390 1,554
Consumer loans 8,164 7,290 5,691 6,088 4,025
Overdrafts 246 103 31 160 119
--------------- --------------- ---------------- ---------------- ----------------
Total 378,491 249,996 169,047 121,047 86,139
Less allowance for loan losses (3,920) (2,790) (1,955) (1,390) (1,030)
--------------- --------------- ---------------- ---------------- ----------------
Total Net Loans $ 374,571 $ 247,206 $ 167,092 $ 119,657 $ 85,109
=============== =============== ================ ================ ================
INVESTMENT SECURITIES
The carrying value (fair value) of the Company's securities portfolio
decreased $27.8 million to $119.0 million at December 31, 2005 from $146.8
million at December 31, 2004. The carrying value (fair value) of the Company's
securities portfolio increased $24.5 million to $146.8 million at December 31,
2004 from $122.3 million at December 31, 2003.
The Company currently, and for all periods shown, classifies its
entire securities portfolio as available for sale. Increases in the portfolio
have occurred whenever deposit growth has outpaced loan demand and the forecast
for loan growth is such that the investment of excess liquidity in investment
securities (as opposed to short term investments such as federal funds) is
warranted. In general, our investment philosophy is to acquire high quality
government agency securities or high grade corporate bonds, with a maturity of
five to six years or less in the case of fixed rate securities. In the case of
mortgage backed securities, the policy is to invest only in those securities
whose average expected life is projected to be approximately five to six years
or less. Mortgage backed securities with a maturity of ten years or more are
either adjustable rate securities or the expected life of the mortgage pool is
generally no more than five or six years. To the extent possible, we attempt to
"ladder" the one time call dates for all our securities. The Company's
investment policy is driven by its interest rate risk process and the need to
minimize the effect of changing interest rates to the entire balance sheet.
27
TABLE 8
The following table presents detail of investment securities in our portfolio at
the dates indicated.
DECEMBER 31,
---------------------------------------------------------------------------------
2005 2004 2003
-------------------------- ------------------------- --------------------------
Percent of Percent of Percent of
(Dollars in thousands) Balance Portfolio Balance Portfolio Balance Portfolio
------------- ------------ ------------- ----------- -------------- -----------
Available for Sale (at Market Value):
U.S. Agency $ 96,977 81.5% $ 121,137 82.5% $ 94,929 77.6%
Mortgage-backed securities 17,475 14.7% 20,580 14.0% 16,250 13.3%
Adjustable rate mortgage-backed securities 979 0.8% 1,592 1.1% 3,677 3.0%
Corporate bonds 1,649 1.4% 2,148 1.5% 6,571 5.4%
Restricted stock 1,906 1.6% 1,338 0.9% 901 0.7%
------------- ------------ ------------- ----------- -------------- -----------
Total $ 118,986 100.0% $ 146,795 100.0% $ 122,328 100.0%
============= ============ ============= =========== ============== ===========
TABLE 9
The following table provides information regarding the maturity
composition of our investment portfolio, at fair value, at December 31, 2005.
MATURITY OF SECURITIES
Years to Maturity
Within Over 1 Year Over 5 Years Over
(Dollars in thousands) 1 Year through 5 Years through 10 Years 10 Years Total
-------------- --------------- ---------------- --------------- -----------------
Amount Yield Amount Yield Amount Yield Amount Yield Amount Yield
-------- ---- -------- ---- ------ ---- -------- ---- --------- -----
AVAILABLE FOR SALE (FAIR VALUE):
U. S. Agency $ 69,705 3.97% $ 24,289 3.79% $2,983 6.00% $ - - $ 96,977 3.99%
Mortgage-backed securities 26 6.09% 299 4.55% 1,995 4.22% 15,155 4.76% 17,475 4.70%
Adjustable rate mortgage-
backed securities - - - - - - 979 3.92% 979 3.92%
Corporate bonds - - 1,649 5.22% - - - - 1,649 5.22%
Restricted stock - - - - - - 1,906 4.60% 1,906 4.60%
-------- -------- ------ -------- --------- ----
Total debt securities
available for sale $ 69,731 3.97% $ 26,237 3.89% $4,978 5.29% $ 18,040 4.70% $ 118,986 4.12%
======== ======== ====== ======== ========= ====
For additional information regarding the investment portfolio, see Note
2 to the consolidated financial statements for the year ended December 31, 2005.
At December 31, 2005, there were no issuers, other than issuers who are
U.S. government agencies, whose securities owned by the Company had an aggregate
book value of more than 10% of total stockholders' equity of the Company.
OFF BALANCE SHEET ARRANGEMENTS
Credit-Related Financial Instruments. The Company is a party to credit
related financial instruments with off-balance sheet risk in the normal course
of business to meet the financing needs of its customers. These financial
instruments include commitments to extend credit, standby letters of credit and
commercial letters of credit. Such commitments involve, to varying degrees,
elements of credit and interest rate risk in excess of the amount recognized in
consolidated balance sheets.
28
The Company's exposure to credit loss is represented by the contractual
amount of these commitments. The Company follows the same credit policies in
making commitments as it does for on-balance sheet instruments. At December 31,
2005 and 2004, the following financial instruments were outstanding whose
contract amounts represent credit risk:
(Dollars in thousands) 2005 2004
---------------- ---------------
Commitments to extend credit $ 84,411 $ 52,461
Standby letters of credit $ 2,730 $ 2,591
Commitments to extend credit are agreements to lend to a customer as
long as there is no violation of any condition established in the contract.
Commitments generally have fixed expiration dates or other termination clauses
and may require payment of a fee. The commitments for equity lines of credit may
expire without being drawn upon. Therefore, the total commitments amounts do not
necessarily represent future cash requirements. The amount of collateral
obtained, if it is deemed necessary by the Company, is based on management's
credit evaluation of the customer.
Unfunded commitments under commercial lines-of-credit, revolving credit
lines and overdraft protection agreements are commitments for possible future
extensions of credit to existing customers. These lines-of-credit are
uncollateralized and usually do not contain a specified maturity date and may
not be drawn upon to the total extent to which the Company is committed.
Commercial and standby letters-of-credit are conditional commitments
issued by the Company to guarantee the performance of a customer to a third
party. Those letters-of-credit are primarily issued to support public and
private borrowing arrangements. Essentially all letters-of-credit issued have
expiration dates within one year. The credit risk involved in issuing
letters-of-credit is essentially the same as that involved in extending loan
facilities to customers. The Company generally holds collateral supporting those
commitments if deemed necessary.
With the exception of these off-balance sheet arrangements, and the
Company's obligations in connection with its trust preferred securities, the
Company has no off-balance sheet arrangements that have or are reasonably likely
to have a current or future effect on the Company's financial condition, changes
in financial condition, revenues or expenses, results of operations, liquidity,
capital expenditures, or capital resources, that is material to investors. For
further information, see Notes 11 and 17 to the consolidated financial
statements.
CONTRACTUAL OBLIGATIONS
TABLE 10
The Company has entered into certain contractual obligations including
long term debt, operating leases and obligations under service contracts. The
following table summarizes the Company's contractual cash obligations as of
December 31, 2005.
PAYMENTS DUE-BY PERIOD
-----------------------------------------------------------------------
LESS THAN ONE TO FOUR TO FIVE AFTER FIVE
(DOLLARS IN THOUSANDS) TOTAL ONE YEAR THREE YEARS YEARS YEARS
-------- -------- ----------- ------------ ----------
Trust preferred capital notes $ 17,527 $ - $ - $ - $ 17,527
Operating leases 4,884 886 1,402 1,156 1,440
Data processing services 2,100 516 1,584 - -
-------- -------- --------- ---------- ----------
Total contractual cash obligations $ 24,511 $ 1,402 $ 2,986 $ 1,156 $ 18,967
======== ======== ========= ========== ==========
The table does not reflect quarterly interest payments in respect to
trust preferred capital notes. For additional information on the interest
requirements of such notes, see Note 17 to the financial statements. The table
does not reflect deposit liabilities entered into in the ordinary course of the
Company's banking business. At December 31, 2005, the
29
Company had $277.8 million of demand and savings deposits, exclusive of
interest, which have no stated maturity or payment date. The Company also had
$193.5 million of time deposits, exclusive of interest, the maturity
distribution of which is set forth in Note 5 to the Consolidated Financial
Statements. For additional information about the Company's deposit obligations,
see "Net Interest Income" and "Deposits" above. See Note 17 to the Consolidated
Financial Statements for additional information regarding the trust preferred
securities and related capital notes.
LIQUIDITY AND INTEREST RATE SENSITIVITY MANAGEMENT
The primary objectives of asset and liability management are to provide
for the safety of depositor and investor funds, assure adequate liquidity, and
maintain an appropriate balance between interest sensitive earning assets and
interest bearing liabilities. Liquidity management involves the ability to meet
the cash flow requirements of customers, who may be depositors wanting to
withdraw funds or borrowers needing assurance that sufficient funds will be
available to meet their credit needs.
We define liquidity for these purposes as the ability to raise cash
quickly at a reasonable cost without principal loss. The primary liquidity
measurement we utilize is called the Basic Surplus, which captures the adequacy
of our access to reliable sources of cash relative to the stability of our
funding mix of deposits. Accordingly, we have established borrowing facilities
with other banks (Federal funds) and the Federal Home Loan Bank as sources of
liquidity in addition to the deposits.
Financial institutions utilize a number of methods to evaluate interest
rate risk. Methods range from the original static gap analysis (the difference
between interest sensitive assets and interest sensitive liabilities repricing
during the same period, measured at a specific point in time), to running
multiple simulations of potential interest rate scenarios, to rate shock
analysis, to highly complicated duration analysis.
One tool that we utilize in managing our interest rate risk is the
matched funding matrix. The matrix arrays repricing opportunities along a time
line for both assets and liabilities. The longer term, more fixed rate sources
are presented in the upper left hand corner while the shorter term, more
variable rate items, are at the lower left. Similarly, uses of funds, such as
assets, are arranged across the top moving from left to right.
The body of the matrix is derived by allocating the longest fixed rate
funding sources to the longest fixed rate assets and shorter term variable
sources to shorter term variable uses. The result is a graphical depiction of
the time periods over which we expect to experience exposure to rising or
falling rates. Since the scales of the liability and assets sides are identical,
all numbers in the matrix would fall within the diagonal lines if we were
perfectly matched across all repricing time frames. Numbers outside the diagonal
lines represent two general types of mismatches: liability sensitive in time
frames when numbers are to the left of the diagonal line and asset sensitive in
time frames when numbers are to the right of the diagonal line. Corresponding
yields are included under the balances.
At December 31, 2005, we were modestly liability sensitive in the short
term and then we become asset sensitive beyond three years. This is primarily
caused by the assumptions used in allocating a repricing term to nonmaturity
deposits--demand deposits, savings accounts, and money market deposit accounts.
The actual impact due to changes in interest rates is difficult to quantify in
that the administrative ability to change rates on these products is influenced
by competitive market conditions in changing rate environments, prepayments of
loans, customer demands, and many other factors. These products may not reprice
consistently with assets such as variable rate commercial loans or other loans
that immediately reprice as the prime rate changes. While the traditional gap
analysis and the matched funding matrix show a general picture of our potential
sensitivity to changes in interest rates, it cannot quantify the actual impact
of interest rate changes.
Thus, the Company manages its exposure to possible changes in interest
rates by simulation modeling or "what if" scenarios to quantify the potential
financial implications of changes in interest rates. In practice, each quarter
approximately 8 different "what if" scenarios are evaluated which include the
following scenarios: Static Rates, Most Likely Rate Projection, Rising Rate
Environment, Economic Low Rate Environment, Ramp Up 100bp and 200bp over
12-months, and Ramp Down 100bp and 200bp over 12-months scenarios. In addition,
8 rate shock scenarios are modeled at 50bp up and 50bp down increments but not
below zero. At December 31, 2005, the following 12-month impact on net interest
income
30
is estimated to range from a positive impact of 7.6% in a rising rate scenario,
to a negative impact of (4.5)% if rates decline 200 basis points from current
levels. In the rate shock scenarios the 12-month impact on net interest income
is estimated to range from a positive impact of 4.0% if rates were to
immediately increase 200 basis points, to a negative impact of (5.5)% if rates
were to immediately decline 200 basis points. The Company believes these ranges
of exposure to changes in interest rates to be well within acceptable range
given a wide variety of potential rate change scenarios. This process is
performed each quarter to ensure the Company is not materially at risk to
possible changes in interest rates.
The following are the projected potential percentage impact on the
Company's net interest income over the next 12 months for the scenarios the
Company believes are most likely to occur, but measured against a static
interest rate environment as of December 31, 2005. The Company is positioned to
improve earnings if rates continue to rise. With respect to further reductions
in rates, the Company would experience further negative implications on margins
and earnings; however, the Company does not believe that a 200 basis point
decline is realistic given that interest rates remain at relatively low levels,
and in light of the Federal Reserve's indications with respect to the interest
rate environment. Thus management believes the exposure to further changes in
anticipated interest rates would not have a material negative effect on the
results of operations, although there can be no assurance.
Rising Rate Scenario 7.6 %
Ramp Up 200bp- 12 months 4.0 %
Ramp Up 100bp- 12 months 2.1 %
Most Likely Rates 1.4 %
Static Rates -0- %
Ramp Down 100bp- 12 months (2.2)%
Ramp Down 200bp- 12 months (4.5)%
Low Rate Environment (3.5)%
31
TABLE 11
(Dollars in thousands)
MATCH FUNDING MATRIX
JAMES MONROE BANK
DECEMBER 31, 2005
- ----------- ------- ------- ------- -------- ------- ------- ------- ------- -------- ------- -------
ASSETS> 60+ 37 - 60 25 - 36 13 - 24 10 - 12 7 - 9 4 - 6 1 - 3 O/N TOTAL
MONTHS MONTHS MONTHS MONTHS MONTHS MONTHS MONTHS MONTHS
- ----------- ------- ------- ------- -------- ------- ------- ------- ------- -------- ------- -------
56,374 74,404 73,239 78,511 14,575 23,447 28,292 27,656 153,409 529,907
LIABILITIES
& EQUITY 5.65% 5.36% 5.62% 5.20% 5.78% 5.99% 5.79% 5.98% 7.72%
- ----------- ------- ------- ------- -------- ------- ------- ------- ------- -------- ------- -------
60+ 147,926 56,374 74,404 17,148 147,926
MONTHS 0.00% 5.65% 5.36% 5.62%
- ----------- ------- ------- ------- -------- ------- ------- ------- ------- -------- ------- -------
37-60 11,531 11,531 11,531
MONTHS 5.61% 0.01% ASSET SENSITIVE
- ----------- ------- ------- ------- -------- ------- ------- ------- ------- -------- ------- -------
25-36 3,209 3,209 3,209
MONTHS 3.66% 1.96%
- ----------- ------- ------- ------- -------- ------- ------- ------- ------- -------- ------- -------
13-24 13,778 13,778 13,778
MONTHS 3.45% 2.17%
- ----------- ------- ------- ------- -------- ------- ------- ------- ------- -------- ------- -------
10-12 19,455 19,455 19,455
MONTHS 3.81% 1.81%
- ----------- ------- ------- ------- -------- ------- ------- ------- ------- -------- ------- -------
7-9 74,472 8,118 66,354 74,472
MONTHS 4.70% 0.92% 0.50%
- ----------- ------- ------- ------- -------- ------- ------- ------- ------- -------- ------- -------
4-6 27,350 12,157 14,575 618 27,350
MONTHS 3.73% 1.47% 2.05% 2.26%
- ----------- ------- ------- ------- -------- ------- ------- ------- ------- -------- ------- -------
1-3 232,186 22,829 28,292 27,656 153,409 232,186
MONTHS 2.94% 3.05% 2.85% 3.04% 4.78%
- ----------- ------- ------- ------- -------- ------- ------- ------- ------- -------- ------- -------
O/N 0 0 0
0.00% LIABILITY SENSITIVE 0.00%
- ----------- ------- ------- ------- -------- ------- ------- ------- ------- -------- ------- -------
TOTAL 529,907 56,374 74,404 73,239 78,511 14,575 23,447 28,292 27,656 153,409 529,907
- ----------- ------- ------- ------- -------- ------- ------- ------- ------- -------- ------- -------
32
NONINTEREST INCOME AND EXPENSE
Noninterest income consists primarily of gains on the sale of loans,
service charges on deposit accounts and fees and other charges for banking
services. Noninterest expense consists primarily of salary and benefit costs and
occupancy and equipment expense. To date, the Company has not been required to
pay any premiums for deposit insurance. To the extent that deposit premiums may
become required, the Company's results of operations will be adversely affected.
TABLE 12
The categories of noninterest income that exceed 1% of operating
revenue are as follows:
DECEMBER 31,
-------------------------------------------------
(Dollars in thousands) 2005 2004 2003
--------------- --------------- ---------------
Service charges on deposit accounts $ 345 $ 340 $ 290
Cash management fee income 111 100 113
Gain on sale of securities 13 59 299
Gain on sale of loans 824 423 255
Other fee income 334 253 190
--------------- --------------- ---------------
Total noninterest income $ 1,627 $ 1,175 $ 1,147
=============== =============== ===============
The increases in noninterest income for the each period shown are the
result of the continued growth of the Company and the expansion of products
resulting in fee income. During the second quarter of 2003, we began originating
conforming residential mortgage loans on a pre-sold basis, for sale to secondary
market investors, servicing released. In addition, the Company earned cash
management fees relating to off-balance sheet customer sweep accounts which had
average balances of $27.1 million during 2005. During 2005, cash management fees
increased as product balances grew in response to rising interest rates. Gain on
sale of loans increased during 2005 as mortgage production increased during 2005
to $56.2 million from $23.6 million in 2004.
TABLE 13
The categories of noninterest expense that exceed 1% of operating
revenues are as follows:
DECEMBER 31,
---------------------------------------------------------
(Dollars in thousands) 2005 2004 2003
----------------- ----------------- ----------------
Salaries and benefits $ 7,145 $ 4,689 $ 3,240
Occupancy cost, net 1,209 871 611
Equipment expense 686 497 430
Data processing costs 589 498 373
Advertising and public relations 293 229 102
Professional fees - compliance related 200 74 -
Professional fees - other 272 285 197
Director fees 247 169 99
Courier and express services 31 122 134
Meals and entertainment 73 66 55
Supplies 108 73 70
Postage 65 58 52
State franchise tax 392 263 217
Other 573 393 384
----------------- ----------------- ----------------
Total noninterest expense $ 11,883 $ 8,287 $ 5,964
================= ================= ================
33
Non-interest expense increased $3.6 million or 43.3% from $8.3 million
for the year ended December 31, 2004, to $11.9 million for 2005. Approximately
68% of this increase was in salary and benefit costs. In 2005 the Company added
a number of commercial loan officers, processing staff, and administrative
support staff to support the growth in customers and transactions being
processed. The increase in occupancy cost during 2005 is due in part to the
opening of a commercial loan production office in Maryland in addition to a full
year of expenses at our Chantilly and Manassas operations. The rise in equipment
expense is attributable to additional investments in technology. Growth in other
expenses is due in part to costs related to higher volumes in services such as
lockbox processing and mortgage originations.
DEPOSITS AND OTHER BORROWINGS
The principal sources of funds for the Bank are core deposits (demand
deposits, NOW accounts, money market accounts, savings accounts and certificates
of deposit less than $100,000) from the local market areas surrounding the
Bank's offices. The Bank's deposit base includes transaction accounts, time and
savings accounts and accounts which customers use for cash management and which
provide the Bank with a source of fee income and cross-marketing opportunities
as well as a low-cost source of funds. Time and savings accounts, including
money market deposit accounts, also provide a relatively stable and low-cost
source of funding.
TABLE 14
The following table reflects average deposits and average rates paid by
category for the periods indicated.
YEAR ENDED DECEMBER 31,
----------------------------------------------------------------------------
2005 2004 2003
----------------------- ----------------------- -----------------------
AVERAGE AVERAGE AVERAGE AVERAGE AVERAGE AVERAGE
(Dollars in thousands) BALANCE RATE BALANCE RATE BALANCE RATE
--------- ------- --------- -------- --------- -------
Deposits:
Noninterest-bearing demand $ 102,241 0.00% $ 81,961 0.00% $ 69,124 0.00%
Interest-bearing demand 15,848 0.82% 12,692 0.67% 10,919 0.81%
Money Market 196,414 2.29% 158,653 1.86% 113,802 1.81%
Savings 3,722 1.37% 3,665 1.26% 1,954 1.32%
Certificates of deposit of $100,000 or more 92,024 3.34% 40,002 2.33% 27,954 2.62%
Other time 15,528 2.94% 13,819 2.34% 14,589 2.62%
--------- ---- --------- ---- --------- ----
Total interest bearing deposits $ 323,536 2.53% $ 228,831 1.90% $ 169,218 1.95%
--------- --------- ---------
Total Deposits $ 425,777 $ 310,792 $ 238,342
========= ========= =========
TABLE 15
The following table indicates the amount of certificates of deposit of
$100,000 or more and less than $100,000, and their remaining maturities.
3 MONTHS 4 TO 6 7 TO 9 10 TO 12 OVER 12
(Dollars in thousands) OR LESS MONTHS MONTHS MONTHS MONTHS TOTAL
--------------------------------------------------------------------------
Certificates of deposit less than $100,000 $ 2,683 $ 3,330 $ 33,356 $ 6,740 $ 4,676 $ 50,785
Certificates of deposit of $100,000 or more 49,304 24,020 41,116 12,714 15,594 142,748
--------------------------------------------------------------------------
$ 51,987 $ 27,350 $ 74,472 $ 19,454 $ 20,270 $193,533
==========================================================================
Other borrowings include Federal funds purchased and short term
advances from the Federal Home Loan Bank of Atlanta. Federal funds are unsecured
overnight borrowings from other financial institutions. Federal Home Loan Bank
of Atlanta advances are collateralized by real estate secured loans. Both types
of borrowings are generally used to
34
accommodate short-term liquidity needs. Table 16 provides information on the
balances and interest rates on other borrowings for the years ended December 31,
2005, 2004 and 2003.
TABLE 16
2005 2004 2003
------------------ ------------------ -----------------
(Dollars in thousands) BALANCE RATE BALANCE RATE BALANCE RATE
-------- ---- ------- ---- ------- ----
AT DECEMBER 31,
Short term borrowings $ - $ - $ 6,886 1.00%
AVERAGE FOR THE YEAR ENDED DECEMBER 31,
Short term borrowings $ 14,024 4.08% $ 2,781 1.29% $ 216 0.93%
MAXIMUM MONTH-END OUTSTANDING FOR THE
YEAR ENDED DECEMBER 31,
Short term borrowings $ 32,974 3.85% $ 7,406 1.10% $ 6,886 1.00%
CAPITAL MANAGEMENT
Management monitors historical and projected earnings, asset growth, as
well as its liquidity and various balance sheet risks in order to determine
appropriate capital levels. At December 31, 2005, stockholders' equity increased
$2.7 million to $39.6 million from the $36.9 million of equity at December 31,
2004 primarily as a result of an increase of $4.2 million in retained earnings
for 2005, offset by an increase in other comprehensive loss related to
unrealized losses on available for sale securities.
The Company has reported a steady improvement in earnings since the
Bank opened on June 8, 1998. Positive earnings were reported in the ninth month
of operations and have continued with $810 thousand of earnings in 2000, $1.1
million of earnings for 2001, $1.6 million of earnings for 2002, $2.6 million of
earnings for 2003, $3.0 million of earnings for 2004, and $4.2 million of
earnings for 2005. One of the Company's first strategies was to restore the lost
capital from the initial organization costs of $254 thousand and the accumulated
earnings loss of $452 thousand for 1998. As of December 31, 2001, the earnings
for 2000 and 2001 had recouped the losses and at December 31, 2002 the Company
had retained earnings of approximately $2.9 million. In addition, the Company
has fully utilized its net operating losses for tax purposes beginning in
September 2001 and has been at a 34% effective tax rate since that date.
The Company and Bank are required to comply with various regulatory
capital requirements. At December 31, 2005, the Company and Bank were in
compliance with all such requirements. For information regarding our regulatory
capital ratios, please refer to note 10 to the consolidated financial
statements.
The ability of the Company to continue to grow is dependent on its
earnings and the ability to obtain additional funds for contribution to the
Bank's capital, through borrowing, the sale of additional common stock, or
through the issuance of additional trust preferred securities. In the event that
the Company is unable to obtain additional capital for the Bank on a timely
basis, the growth of the Company and the Bank may be curtailed, and the Company
and the Bank may be required to reduce their level of assets in order to
maintain compliance with regulatory capital requirements. Under those
circumstances net income and the rate of growth of net income may be adversely
affected. The Company believes that its current capital is sufficient to meet
anticipated growth, although there can be no assurance.
The Federal Reserve has revised the capital treatment of trust
preferred securities, in light of recent accounting pronouncements and
interpretations regarding variable interest entities, which have been read to
encompass the subsidiary trusts established to issue trust preferred securities,
and to which the Company issued subordinated debentures. As a result, the
capital treatment of trust preferred securities has been revised to provide that
in the future, such securities can be
35
counted as Tier 1 capital at the holding company level, together with certain
other restricted core capital elements, up to 25% of total capital (net of
goodwill), and any excess as Tier 2 capital up to 50% of Tier 1 capital. At
December 31, 2005 trust preferred securities represented 25% of the Company's
tier 1 capital and 28% of its total capital. Future trust preferred issuances to
increase holding company capital levels may not be available to the same extent
as currently. The Company may be required to raise additional equity capital,
through the sale of common stock or otherwise, sooner than it would otherwise do
so.
36
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTAL DATA.
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
To the Stockholders and Directors
James Monroe Bancorp, Inc. and Subsidiaries
Arlington, Virginia
We have audited the accompanying consolidated balance sheets of James
Monroe Bancorp, Inc. and Subsidiaries as of December 31, 2005 and 2004, and the
related consolidated statements of income, changes in stockholders' equity and
cash flows for the years ended December 31, 2005, 2004 and 2003. These financial
statements are the responsibility of the Company's management. Our
responsibility is to express an opinion on these financial statements based on
our audits.
We conducted our audits in accordance with the standards of the Public
Company Accounting Oversight Board (United States). Those standards require that
we plan and perform the audit to obtain reasonable assurance about whether the
financial statements are free of material misstatement. The Company is not
required to have, nor were we engaged to perform, an audit of its internal
control over financial reporting. Our audits included consideration of internal
control over financial reporting as a basis for designing audit procedures that
are appropriate in the circumstances, but not for the purposes of expressing an
opinion on the effectiveness of the Company's internal control over financial
reporting. Accordingly, we express no such opinion. An audit also includes
examining, on a test basis, evidence supporting the amounts and disclosures in
the financial statements, assessing the accounting principles used and
significant estimates made by management, as well as evaluating the overall
financial statement presentation. We believe that our audits provide a
reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above
present fairly, in all material respects, the financial position of James Monroe
Bancorp, Inc. and Subsidiaries as of December 31, 2005 and 2004, and the results
of their operations and their cash flows for the years ended December 31, 2005,
2004 and 2003, in conformity with U.S. generally accepted accounting principles.
/s/ Yount, Hyde & Barbour, P.C.
Winchester, Virginia
January 27, 2006
37
JAMES MONROE BANCORP, INC.
AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
December 31, 2005 and 2004
(Dollars in thousands, except share data)
DECEMBER 31,
-----------------------------------
2005 2004
---------------- ----------------
ASSETS
Cash and due from banks $ 19,960 $ 9,286
Interest bearing deposits in banks 24 2,442
Federal funds sold 5,968 35,754
Securities available for sale, at fair value 118,986 146,795
Loans held for sale 2,299 2,987
Loans:
Loans, net of unearned income 378,491 249,996
Allowance for loan losses (3,920) (2,790)
---------------- ----------------
Loans, net 374,571 247,206
Bank premises and equipment, net 2,226 2,438
Accrued interest receivable 2,392 1,977
Other assets 3,495 1,885
---------------- ----------------
TOTAL ASSETS $ 529,921 $ 450,770
================ ================
LIABILITIES AND STOCKHOLDERS' EQUITY
Deposits:
Noninterest bearing deposits $ 106,831 $ 91,857
Interest bearing deposits 364,468 312,197
---------------- ----------------
Total deposits 471,299 404,054
Trust preferred capital notes 17,527 9,279
Accrued interest payable and other liabilities 1,450 536
---------------- ----------------
Total liabilities 490,276 413,869
---------------- ----------------
STOCKHOLDERS' EQUITY
Common stock, $1 par value; authorized
10,000,000 shares; 5,574,710 issued and
outstanding at December 31, 2005, 4,445,224
at December 31, 2004 5,575 4,445
Capital surplus 23,386 24,325
Retained earnings 12,672 8,458
Accumulated other comprehensive (loss) (1,988) (327)
---------------- ----------------
Total stockholders' equity 39,645 36,901
---------------- ----------------
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $ 529,921 $ 450,770
================ ================
The accompanying notes are an integral part of these consolidated
financial statements.
38
JAMES MONROE BANCORP, INC.
AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME
For the Years Ended December 31, 2005, 2004 and 2003
(Dollars in thousands, except per share data)
YEAR ENDED DECEMBER 31,
--------------------------------------------
2005 2004 2003
------------- ------------- -------------
INTEREST AND DIVIDEND INCOME:
Loans, including fees $ 21,539 $ 12,886 $ 9,658
Loans held for sale 140 49 60
Securities, taxable 5,399 4,196 3,118
Federal funds sold 224 324 189
Other interest income 41 7 1
------------- ------------- -------------
Total interest and dividend income 27,343 17,462 13,026
------------- ------------- -------------
INTEREST EXPENSE:
Deposits 8,198 4,345 3,293
Federal funds purchased 573 36 2
Borrowed funds 741 452 323
------------- ------------- -------------
Total interest expense 9,512 4,833 3,618
------------- ------------- -------------
Net interest income 17,831 12,629 9,408
PROVISION FOR LOAN LOSSES 1,167 990 662
------------- ------------- -------------
Net interest income after provision for loan losses 16,664 11,639 8,746
------------- ------------- -------------
NONINTEREST INCOME:
Service charges and fees 345 340 290
Gain on sale of securities 13 59 299
Gain on sale of loans 824 423 255
Other 445 353 303
------------- ------------- -------------
Total noninterest income 1,627 1,175 1,147
------------- ------------- -------------
NONINTEREST EXPENSES:
Salaries and wages 6,037 3,964 2,678
Employee benefits 1,108 725 562
Occupancy expenses 1,209 871 611
Equipment expenses 686 497 430
Other operating expenses 2,843 2,230 1,683
------------- ------------- -------------
Total noninterest expenses 11,883 8,287 5,964
------------- ------------- -------------
Income before income taxes 6,408 4,527 3,929
PROVISION FOR INCOME TAXES 2,191 1,557 1,328
------------- ------------- -------------
Net income $ 4,217 $ 2,970 $ 2,601
============= ============= =============
EARNINGS PER SHARE, basic $ 0.76 $ 0.54 $ 0.58
EARNINGS PER SHARE, diluted $ 0.72 $ 0.51 $ 0.54
The accompanying notes are an integral part of these consolidated
financial statements.
39
JAMES MONROE BANCORP, INC.
AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY
For the Years Ended December 31, 2005, 2004 and 2003
(Dollars in thousands)
ACCUMULATED
OTHER TOTAL
COMMON CAPITAL RETAINED COMPREHENSIVE COMPREHENSIVE STOCKHOLDERS'
STOCK SURPLUS EARNINGS INCOME (LOSS) INCOME EQUITY
------ --------- -------- ------------- ------------- -------------
BALANCE, DECEMBER 31, 2002 $ 1,841 $ 13,354 $ 2,894 $ 1,106 $ 19,195
Comprehensive income:
Net income 2,601 $ 2,601 2,601
Net change in unrealized gain
on available for sale securities, net of
deferred taxes of $452 (878)
Less: reclassification adjustment,
net of income taxes of $102 (197)
------------
Other comprehensive (loss), net of tax (1,075) (1,075) (1,075)
------------
Total comprehensive income $ 1,526
============
Issuance of common stock 603 12,201 12,804
Exercise of stock options 40 330 370
Effect of stock split 460 (460) -
Cash paid in lieu of fractional shares (4) (4)
------- -------- ------- -------- -----------
BALANCE, DECEMBER 31, 2003 2,944 25,425 5,491 31 33,891
Comprehensive income:
Net income 2,970 $ 2,970 2,970
Net change in unrealized gain (loss)
on available for sale securities,
net of deferred taxes of $164 (319)
Less: reclassification adjustment,
net of income taxes of $20 (39)
------------
Other comprehensive (loss), net of tax (358) (358) (358)
------------
Total comprehensive income $ 2,612
============
Issuance of common stock 6 121 127
Exercise of stock options 17 257 274
Effect of stock split 1,478 (1,478) -
Cash paid in lieu of fractional shares (3) (3)
------- -------- ------- -------- -----------
BALANCE, DECEMBER 31, 2004 4,445 24,325 8,458 (327) 36,901
Comprehensive income:
Net income 4,217 $ 4,217 4,217
Net change in unrealized (loss)
on available for sale securities,
net of deferred taxes of $851 (1,652)
Less: reclassification adjustment,
net of income taxes of $4 (9)
------------
Other comprehensive (loss), net of tax (1,661) (1,661) (1,661)
------------
Total comprehensive income $ 2,556
============
Issuance of common stock 8 134 142
Exercise of stock options 8 41 49
Effect of stock split 1,114 (1,114) -
Cash paid in lieu of fractional shares (3) (3)
------- -------- -------- -------- -----------
BALANCE, DECEMBER 31, 2005 $ 5,575 $ 23,386 $ 12,672 $ (1,988) $ 39,645
======= ======== ======== ======== ===========
The accompanying notes are an integral part of these consolidated
financial statements.
40
JAMES MONROE BANCORP, INC.
AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
For the Years Ended December 31, 2005, 2004 and 2003
(Dollars in thousands)
YEARS ENDED DECEMBER 31,
--------------------------------------------------------
2005 2004 2003
----------------- ----------------- -----------------
CASH FLOWS FROM OPERATING ACTIVITIES
Net income $ 4,217 $ 2,970 $ 2,601
Adjustments to reconcile net income to net cash provided by
operating activities:
Depreciation and amortization 621 436 323
Provision for loan losses 1,167 990 662
Amortization of bond premium 234 318 439
Accretion of bond discount (222) (140) (69)
Realized (gain) on sales of securities available for sale (13) (59) (299)
Realized (gain) on sales of loans held-for-sale (824) (423) (255)
Origination of loans held-for-sale (56,296) (23,627) (17,222)
Proceeds from sales of loans held-for-sale 57,808 21,624 16,916
Deferred income tax (benefit) (402) (291) (220)
(Increase) in accrued interest receivable (415) (641) (420)
(Increase) decrease in other assets (353) (92) 28
Increase (decrease) in accrued interest payable and other liabilities 914 (222) 30
----------------- ----------------- -----------------
Net cash provided by operating activities 6,436 843 2,514
----------------- ----------------- -----------------
CASH FLOWS FROM INVESTING ACTIVITIES
Purchases of securities available for sale (3,178) (103,961) (144,197)
Proceeds from calls and maturities of securities available for sale 14,772 37,658 23,835
Proceeds from sales of securities available for sale 13,700 41,174 72,397
Purchases of premises and equipment (409) (1,486) (378)
(Increase) decrease in interest bearing cash balances 2,418 (2,442) 655
(Increase) decrease in federal funds sold 29,786 (35,754) 28,826
Net (increase) in loans (128,532) (81,104) (48,097)
----------------- ----------------- -----------------
Net cash (used in) investing activities (71,443) (145,915) (66,959)
----------------- ----------------- -----------------
CASH FLOWS FROM FINANCING ACTIVITIES
Net increase (decrease) in demand deposits, savings deposits
and money market accounts (53,156) 124,319 31,054
Net increase in time deposits 120,401 24,619 10,192
Net increase (decrease) in federal funds purchased - (6,886) 6,886
Proceeds from issuance of common stock 191 401 13,174
Proceeds from issuance of trust preferred capital notes 8,248 - 4,000
Cash paid in lieu of fractional shares (3) (3) (4)
----------------- ----------------- -----------------
Net cash provided by financing activities 75,681 142,450 65,302
----------------- ----------------- -----------------
Increase (decrease) in cash and due from banks 10,674 (2,622) 857
CASH AND DUE FROM BANKS
Beginning 9,286 11,908 11,051
----------------- ----------------- -----------------
Ending $ 19,960 $ 9,286 $ 11,908
================= ================= =================
SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION
Interest paid on deposits and borrowed funds $ 9,028 $ 4,731 $ 3,709
================= ================= =================
Income taxes paid $ 2,463 $ 2,143 $ 1,272
================= ================= =================
SUPPLEMENTAL SCHEDULE OF NONCASH INVESTING ACTIVITIES,
unrealized (loss) on securities available for sale $ (2,516) $ (542) $ (1,629)
================= ================= =================
The accompanying notes are an integral part of these consolidated
financial statements.
41
Notes to Audited Consolidated Financial Statements
JAMES MONROE BANCORP, INC.
AND SUBSIDIARIES
NOTES TO AUDITED CONSOLIDATED FINANCIAL STATEMENTS
NOTE 1. NATURE OF BANKING ACTIVITIES AND SIGNIFICANT ACCOUNTING POLICIES
BASIS OF PRESENTATION AND CONSOLIDATION
The consolidated financial statements include the accounts of
James Monroe Bancorp, Inc. (the "Company") and its wholly owned
subsidiaries, James Monroe Bank (the "Bank"), James Monroe
Statutory Trust I ("Trust I"), James Monroe Statutory Trust II
("Trust II") and James Monroe Statutory Trust III ("Trust III").
In consolidation, significant inter-company accounts and
transactions have been eliminated. FASB Interpretation No. 46(R)
requires that the Company no longer eliminate through
consolidation the equity investments in James Monroe Statutory
Trust I, II and III which approximated $527,000 and $279,000 at
December 31, 2005 and 2004, respectively.
BUSINESS
The Company, through its banking subsidiary, offers various loan,
deposit and other financial service products to its customers,
principally located throughout Northern Virginia. Additionally,
the Company maintains correspondent banking relationships and
transacts daily federal funds transactions on an unsecured basis,
with regional correspondent banks.
The accounting and reporting policies and practices of the Company
conform with U.S. generally accepted accounting principles. The
following is a summary of the most significant of such policies
and procedures.
USE OF ESTIMATES
The preparation of consolidated financial statements in conformity
with U.S. 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. Material estimates that are particularly
susceptible to significant change in the near term relate to the
determination of the allowance for loan losses.
CASH AND CASH EQUIVALENTS
For purposes of reporting cash flows, cash and due from banks
include cash on hand and amounts due from banks, including cash
items in process of clearing.
INTEREST BEARING DEPOSITS IN BANKS
Interest bearing deposits in banks mature within one month and are
carried at cost.
SECURITIES AVAILABLE FOR SALE
Securities classified as available for sale are equity securities
with readily determinable fair values and those debt securities
that the Company intends to hold for an indefinite period of time
but not necessarily to maturity. Any decision to sell a security
classified as available for sale would be based on various
factors, including significant movements in interest rates,
changes in the maturity mix of the Company's assets and
liabilities, liquidity needs, regulatory capital considerations,
and other similar factors. These securities are carried at fair
value, with any unrealized gains or losses reported as a separate
component of other comprehensive income net of the related
deferred tax effect. Purchase premiums and discounts are
recognized in interest income using the interest method over the
terms of the securities. Declines in the fair value of available
for sale securities below their cost that are deemed to be other
than temporary are reflected in earnings as realized losses. In
estimating other than temporary impairment losses, management
considers (1)
42
Notes to Audited Consolidated Financial Statements
the length of time and the extent to which the fair value has been
less than cost, (2) the financial condition and near-term
prospects of the issuer, and (3) the intent and ability of the
Company to retain its investment in the issuer for a period of
time sufficient to allow for any anticipated recovery in fair
value. Gains and losses on the sale of securities are recorded on
the trade date and are determined using the specific
identification method.
LOANS
The Company, through its banking subsidiary, grants mortgage,
commercial and consumer loans to customers. A substantial portion
of the loan portfolio is represented by commercial real estate
loans throughout Northern Virginia. The ability of the Company's
debtors to honor their contracts is dependent upon the real estate
and general economic conditions in this area.
Loans that management has the intent and ability to hold for the
foreseeable future or until maturity or pay-off generally are
reported at their outstanding unpaid principal balances adjusted
for charge offs, the allowance for loan losses, and any deferred
fees or costs on originated loans. Interest income is accrued on
the unpaid principal balance. Loan origination fees, net of
certain direct origination costs, are deferred and recognized as
an adjustment of the related loan yield using the interest method.
The accrual of interest on mortgage and commercial loans is
discontinued at the time the loan is 90 days delinquent unless the
credit is well-secured and in process of collection. Other
personal loans are typically charged off no later than 180 days
past due. In all cases, loans are placed on nonaccrual or charged
off at an earlier date if collection of principal or interest is
considered doubtful.
All interest accrued but not collected for loans that are placed
on nonaccrual or charged off is reversed against interest income.
The interest on these loans is accounted for on the cash-basis or
cost-recovery method, until qualifying for return to accrual.
Loans are returned to accrual status when all the principal and
interest amounts contractually due are brought current and future
payments are reasonably assured.
LOANS HELD FOR SALE
Loans originated and intended for sale in the secondary market are
carried at the lower of cost or estimated fair value in the
aggregate. Net unrealized losses, if any, are recognized through a
valuation allowance by charges to income. The Company generally
does not retain the mortgage servicing.
ALLOWANCE FOR LOAN LOSSES
The allowance for loan losses is established as losses are
estimated to have occurred through a provision for loan losses
charged to earnings. Loan losses are charged against the allowance
when management believes the uncollectibility of a loan balance is
confirmed. Subsequent recoveries, if any, are credited to the
allowance.
The allowance consists of specific, general and unallocated
components. The specific component relates to loans that are
classified as either special mention, substandard or doubtful. For
such loans that are also classified as impaired, an allowance is
established when the discounted cash flows (or collateral value or
observable market price) of the impaired loan is lower than the
carrying value of that loan. The general component covers
non-classified loans and is based on historical loss experience
adjusted for qualitative factors. An unallocated component is
maintained to cover uncertainties that could affect management's
estimate of probable losses. The unallocated component of the
allowance reflects the margin of imprecision inherent in the
underlying assumptions used in the methodologies for estimating
specific and general losses in the portfolio.
A loan is considered impaired when, based on current information
and events, it is probable that a creditor will be unable to
collect the scheduled payments of principal or interest when due
according to the contractual terms of the loan agreement. Factors
considered by management in determining impairment include payment
status, collateral value and the probability of collecting
scheduled principal and interest payments when due.
43
Notes to Audited Consolidated Financial Statements
Loans that experience insignificant payment delays and payment
shortfalls generally are not classified as impaired. Management
determines the significance of payment delays and payment
shortfalls on a case-by-case basis, taking into consideration all
of the circumstances surrounding the loan and the borrower,
including the length of the delay, the reasons for the delay, the
borrower's prior payment record, and the amount of the shortfall
in relation to the principal and interest owed. Impairment is
measured on a loan by loan basis for commercial and construction
loans by either the present value of expected future cash flows
discounted at the loan's effective interest rate, the loan's
obtainable market price, or the fair value of the collateral if
the loan is collateral dependent.
Large groups of smaller balance homogeneous loans are collectively
evaluated for impairment. Accordingly, the Company does not
separately identify individual consumer and residential loans for
impairment disclosures.
BANK PREMISES AND EQUIPMENT
Premises and equipment are stated at cost less accumulated
depreciation and amortization that is computed using the
straight-line method over the following estimated useful lives:
YEARS
Leasehold improvements 10
Furniture and equipment 3-10
Costs incurred for maintenance and repairs are expensed currently.
INCOME TAXES
Deferred income tax assets and liabilities are determined using
the liability (or balance sheet) method. Under this method, the
net deferred tax asset or liability is determined based on the tax
effects of the temporary differences between the book and tax
bases of the various balance sheet assets and liabilities and
gives current recognition to changes in tax rates and laws.
Deferred tax assets are reduced by a valuation allowance when, in
the opinion of management, it is more likely than not that some
portion or all of the deferred tax assets will not be realized.
FAIR VALUE OF FINANCIAL INSTRUMENTS
Statement of Financial Accounting Standards (SFAS) No. 107,
Disclosures About Fair Value of Financial Instruments, requires
disclosure of fair value information about financial instruments,
whether or not recognized in the balance sheet, for which it is
practicable to estimate that value. In cases where quoted market
prices are not available, fair values are based on estimates using
present value techniques. Those techniques are significantly
affected by the assumptions used, including the discount rate and
estimates of future cash flows. In that regard, the derived fair
value estimates cannot be substantiated by comparison to
independent markets and, in many cases, could not be realized in
immediate settlement of the instrument. SFAS No. 107 excludes
certain financial instruments and all nonfinancial instruments
from its disclosure requirements. Accordingly, the aggregate fair
value amounts presented should not be considered an indication of
the fair value of the Company taken as a whole.
ADVERTISING COSTS
The Company follows the policy of charging costs of advertising to
expense as incurred.
RATE LOCK COMMITMENTS
The Company enters into commitments to originate loans whereby the
interest rate on the loan is determined prior to funding (rate
lock commitments). Rate lock commitments on mortgage loans that
are intended to be sold are considered to be derivatives.
Accordingly, such commitments, along with any related fees
received
44
Notes to Audited Consolidated Financial Statements
from potential borrowers, are to be recorded at fair value in
derivative assets or liabilities, with changes in fair value
recorded in the net gain or loss on sale of loans. Fair value is
based on fees currently charged to enter into similar agreements,
and for fixed-rate commitments also considers the difference
between current levels of interest rates and the committed rates.
STOCK COMPENSATION PLANS
At December 31, 2005, the Company had three stock-based
compensation plans which are described more fully in Note 8.
Through December 31, 2005, the Company accounted for these plans
under the recognition and measurement principles of APB Opinion
No. 25, Accounting for Stock Issued to Employees, and related
interpretations. No stock-based employee compensation cost is
reflected in net income, as all options granted under those plans
had an exercise price equal to the market value of the underlying
common stock on the date of the grant. The following table
illustrates the effect on net income and earnings per share if the
Company had applied the fair value recognition provisions of SFAS
No. 123, Accounting for Stock-Based Compensation, to stock-based
employee compensation.
Effective April 13, 2005, the Board of Directors of the Company
approved the acceleration of the vesting of all "underwater"
unvested stock options including options held by executive
officers. A stock option was considered "underwater" if the option
exercise price was greater than $14.44 per share, the opening
market price as of the date of the board action. In addition, the
Board of Directors of the Company approved the granting and
immediate vesting of 14,063 shares of the Company's stock to an
Executive Officer of the Company. Under the Executive Officer's
employment agreement with the Company these shares were originally
scheduled to be granted in the fourth quarter of 2005. As a result
of these actions, the vesting of options to purchase 83,125 shares
of the Company's common stock was accelerated. The decision to
accelerate the vesting of options was undertaken to eliminate the
future compensation expense the Company would otherwise recognize
in its income statement with respect to those options upon the
adoption of SFAS 123R. Information has been restated to reflect
the stock splits as discussed in Note 18.
YEARS ENDED DECEMBER 31,
----------------------------------------------------------
2005 2004 2003
----------------- ----------------- ----------------
(Dollars in thousands, except per share data)
Net income, as reported $ 4,217 $ 2,970 $ 2,601
Additional expense had the company adopted SFAS No. 123 (1,089) (667) (299)
----------------- ----------------- ----------------
Pro forma net income $ 3,128 $ 2,303 $ 2,302
================= ================= ================
Earnings per share:
Basic- as reported $ 0.76 $ 0.54 $ 0.58
================= ================= ================
Basic- pro forma 0.56 0.42 0.51
================= ================= ================
Diluted- as reported 0.72 0.51 0.54
================= ================= ================
Diluted- pro forma 0.53 0.39 0.48
================= ================= ================
The fair value of each option grant is estimated on the date of
grant using the Black-Scholes option-pricing model with the
following weighted-average assumptions:
2005 2004 2003
--------- --------- ---------
Dividend yield 0.00% 0.00% 0.00%
Expected life 6.2 years 7.7 years 8.3 years
Expected volatility 27.97% 37.23% 32.07%
Risk-free interest rate 3.66% 3.80% 4.07%
45
Notes to Audited Consolidated Financial Statements
EARNINGS PER SHARE
Basic earnings per share represents income available to common
stockholders divided by the weighted-average number of common
shares outstanding during the period. Diluted earnings per share
reflects additional common shares that would have been outstanding
if dilutive potential common shares had been issued, as well as
any adjustment to income that would result from the assumed
issuance. Potential common shares that may be issued by the
Company relate solely to outstanding stock options, and are
determined using the treasury stock method.
Earnings per common share have been computed based on the
information in the following table. Shares have been restated to
reflect the stock splits as discussed in Note 18. No options were
excluded from the computation of diluted earnings per share for
the year ended December 31, 2005. Options totaling 6,250 and 5,391
for the years ended December 31, 2004 and 2003, respectively were
excluded from the computation of diluted earnings per share as
their effect would have been anti-dilutive. For the years
presented, there was no adjustment to income from potential common
shares.
YEARS ENDED DECEMBER 31,
------------------------------------------------------
2005 2004 2003
---------------- ---------------- ----------------
(Dollars in thousands, except share and per share data)
Net Income $ 4,217 $ 2,970 $ 2,601
================ ================ ================
Weighted average shares outstanding--basic 5,563,758 5,544,881 4,487,414
Common share equivalents for stock options 333,327 299,083 299,963
---------------- ---------------- ----------------
Weighted average shares outstanding--diluted 5,897,085 5,843,964 4,787,377
================ ================ ================
Earnings per share-basic $ 0.76 $ 0.54 $ 0.58
================ ================ ================
Earnings per share-diluted $ 0.72 $ 0.51 $ 0.54
================ ================ ================
RECENT ACCOUNTING PRONOUNCEMENTS
In November 2005, the Financial Accounting Standards Board (FASB)
issued FASB Staff Position 115-1, "The Meaning of
Other-Than-Temporary Impairment and Its Application to Certain
Investments" (FSP 115-1). The FSP addresses the determination as
to when an investment is considered impaired, whether that
impairment is other than temporary, and the measurement of an
impairment loss. FSP 115-1 also includes accounting considerations
subsequent to the recognition of an other-than-temporary
impairment and requires certain disclosures about unrealized
losses that have not been recognized as other-than-temporary
impairments. The guidance in this FSP amends SFAS No. 115,
"Accounting for Certain Investments in Debt and Equity
Securities," and APB Opinion No. 18, "The Equity Method of
Accounting for Investments in Common Stock". The FSP applies to
investments in debt and equity securities and cost-method
investments. The application guidance within the FSP includes
items to consider in determining whether an investment is
impaired, evaluating if an impairment is other than temporary and
recognizing impairment losses equal to the difference between the
investment's cost and its fair value when an impairment is
determined. FSP 115-1 is required for all reporting periods
beginning after December 15, 2005. Earlier application is
permitted. The Company does not anticipate the amendment will have
a material effect on its financial statements.
In May 2005, the Financial Accounting Standards Board (FASB)
issued Statement No. 154, "Accounting Changes and Error
Corrections - A Replacement of APB Opinion No. 20 and FASB
Statement No. 3" (SFAS No. 154). The new standard changes the
requirements for the accounting for and reporting of a change in
accounting principle. Among other changes, SFAS No. 154 requires
that a voluntary change in accounting principle be applied
retrospectively with all prior period financial statements
presented on the new accounting
46
Notes to Audited Consolidated Financial Statements
principle, unless it is impracticable to do so. SFAS No. 154 also
provides that (1) a change in method of depreciating or amortizing
a long-lived nonfinancial asset be accounted for as a change in
estimate (prospectively) that was effected by a change in
accounting principle, and (2) correction of errors in previously
issued financial statements should be termed a "restatement. " The
new standard is effective for accounting changes and corrections
of errors made in fiscal years beginning after December 15, 2005.
The Company does not anticipate this revision will have a material
effect on its financial statements.
In December 2004, FASB issued Statement No. 123 (Revised 2004),
"Share-Based Payment" (SFAS No. 123R), which requires that the
compensation cost relating to share-based payment transactions be
recognized in financial statements. SFAS No. 123R replaces SFAS
No. 123, "Accounting for Stock-Based Compensation," and supersedes
APB Opinion No. 25, "Accounting for Stock Issued to Employees."
Share-based compensation arrangements include share options,
restricted share plans, performance-based awards, share
appreciation rights and employee share purchase plans. SFAS No.
123R requires all share-based payments to employees to be valued
using a fair value method on the date of grant and expensed based
on that fair value over the applicable vesting period. SFAS No.
123R also amends SFAS No. 95 "Statement of Cash Flows" requiring
the benefits of tax deductions in excess of recognized
compensation cost be reported as financing instead of operating
cash flows. The Securities and Exchange Commission (SEC) issued
Staff Accounting Bulletin No. 107 (SAB No. 107), which expresses
the SEC's views regarding the interaction between SFAS No. 123R
and certain SEC rules and regulations. Additionally, SAB No. 107
provides guidance related to share-based payment transactions for
public companies. The Company will be required to apply SFAS No.
123R as of the annual reporting period that begins after September
15, 2005. The Company does not anticipate this revision will have
a material effect on its financial statements.
In December 2003, the Accounting Standards Executive Committee of
the American Institute of Certified Public Accountants issued
Statement of Position 03-3, "Accounting for Certain Loans or Debt
Securities Acquired in a Transfer" (SOP 03-3). SOP 03-3 addresses
accounting for differences between contractual cash flows and cash
flows expected to be collected from an investor's initial
investment in loans or debt securities (loans) acquired in a
transfer if those differences are attributable, at least in part,
to credit quality. It includes loans purchased by the Company or
acquired in business combinations. SOP 03-3 does not apply to
loans originated by the Company. The Company adopted the
provisions of SOP 03-3 effective January 1, 2005. The initial
implementation had no material effect on the Company's financial
statements.
47
Notes to Audited Consolidated Financial Statements
NOTE 2. SECURITIES AVAILABLE FOR SALE
The amortized cost and estimated fair value of securities
available for sale, with gross unrealized gains and losses,
follows:
DECEMBER 31, 2005
----------------------------------------------------------------
GROSS GROSS
AMORTIZED UNREALIZED UNREALIZED MARKET
(Dollars in thousands) COST GAINS LOSSES VALUE
--------------- -------------- --------------- --------------
U.S. agency $ 99,276 $ - $ (2,299) $ 96,977
Mortgage backed 18,968 23 (537) 18,454
Corporate notes 1,849 - (200) 1,649
Restricted stock 1,906 - - 1,906
--------------- -------------- --------------- --------------
Total securities $ 121,999 $ 23 $ (3,036) $ 118,986
=============== ============== =============== ==============
DECEMBER 31, 2004
----------------------------------------------------------------
GROSS GROSS
AMORTIZED UNREALIZED UNREALIZED MARKET
(Dollars in thousands) COST GAINS LOSSES VALUE
--------------- -------------- --------------- --------------
U.S. agency $ 121,594 $ 229 $ (686) $ 121,137
Mortgage backed 22,208 172 (208) 22,172
Corporate notes 2,151 26 (29) 2,148
Restricted stock 1,338 - - 1,338
--------------- -------------- --------------- --------------
Total securities $ 147,291 $ 427 $ (923) $ 146,795
=============== ============== =============== ==============
Information pertaining to securities with gross unrealized losses
at December 31, 2005 and December 31, 2004, aggregated by
investment category and length of time that the individual
securities have been in a continuous loss position, follows:
DECEMBER 31, 2005
-------------------------------------------------------
LESS THAN 12 MONTHS 12 MONTHS OR MORE
--------------------------- --------------------------
UNREALIZED UNREALIZED
(Dollars in thousands) FAIR VALUE (LOSS) FAIR VALUE (LOSS)
------------- ------------- ------------ ------------
U.S. agency $ 69,704 $ (1,660) $ 27,268 $ (639)
Mortgage backed - - 16,535 (537)
Corporate notes - - 1,649 (200)
------------- ------------- ------------ ------------
Total securities $ 69,704 $ (1,660) $ 45,452 $ (1,376)
============= ============= ============ ============
DECEMBER 31, 2004
-------------------------------------------------------
LESS THAN 12 MONTHS 12 MONTHS OR MORE
--------------------------- --------------------------
UNREALIZED UNREALIZED
(Dollars in thousands) FAIR VALUE (LOSS) FAIR VALUE (LOSS)
------------- ------------- ------------ ------------
U.S. agency $ 53,745 $ (336) $ 11,192 $ (350)
Mortgage backed 7,505 (109) 3,556 (99)
Corporate notes 1,020 (29) - -
------------- ------------- ------------ ------------
Total securities $ 62,270 $ (474) $ 14,748 $ (449)
============= ============= ============ ============
48
Notes to Audited Consolidated Financial Statements
Management evaluates securities for other-than-temporary
impairment at least on a quarterly basis, and more frequently when
economic or market concerns warrant such evaluation. Consideration
is given to (1) the length of time and the extent to which the
fair value has been less than cost, (2) the financial condition
and near-term prospects of the issuer, and (3) the intent and
ability of the Company to retain its investment in the issuer for
a period of time sufficient to allow for any anticipated recovery
in fair value.
The bonds in an unrealized loss position at December 31, 2005 were
temporarily impaired due to the current interest rate environment
and not increased credit risk. All securities owned by the Company
are payable at par at maturity. Of the temporarily impaired
securities, 45 are U.S. Government agency issued bonds (Government
National Mortgage Association and the Federal Home Loan Bank)
rated AAA by Standard and Poor's, 19 are government sponsored
enterprise issued bonds (Federal National Mortgage Association and
Federal Home Loan Mortgage Corporation) rated AAA by Standard and
Poor's, and one is a corporate bond rated BBB by Standard and
Poor's. As management has the ability to hold debt securities
until maturity, or for the foreseeable future, no declines are
deemed to be other than temporary.
The amortized cost and fair value of securities by contractual
maturity at December 31, 2005 follows:
AMORTIZED FAIR
(Dollars in thousands) COST VALUE
----------------- -----------------
Due within one year $ 71,396 $ 69,731
Due after one year but within five years 27,059 26,237
Due after five years but within ten 5,049 4,978
Due after ten years 16,589 16,134
----------------- -----------------
Total 120,093 117,080
Restricted stock 1,906 1,906
----------------- -----------------
Total available for sale securities $ 121,999 $ 118,986
================= =================
Securities carried at $49,070,000 and $43,510,000 at December 31,
2005 and 2004, respectively, were pledged to secure public
deposits and for other purposes required or permitted by law.
For the years ended December 31, 2005, 2004 and 2003, proceeds
from sales of securities available for sale amounted to
$13,700,000, $41,174,000 and $72,397,000, respectively. Gross
realized gains amounted to $13,000, $59,000 and $299,000,
respectively. The tax provision applicable to these realized gains
amounted to $4,000, $20,000 and $102,000, respectively. There were
no gross realized losses in 2005, 2004 or 2003.
49
Notes to Audited Consolidated Financial Statements
NOTE 3. LOANS AND ALLOWANCE FOR LOAN LOSSES
Major classifications of loans are as follows:
DECEMBER 31,
------------------------------------
(Dollars in thousands) 2005 2004
----------------- -----------------
Construction loans $ 43,860 $ 35,166
Commercial loans 47,426 32,782
Commercial real estate loans 269,421 167,696
Real estate-1-4 family residential 1,341 1,559
Home equity loans 8,033 5,400
Consumer loans 8,164 7,290
Deposit overdrafts 246 103
----------------- -----------------
Total loans 378,491 249,996
Less allowance for loan losses (3,920) (2,790)
----------------- -----------------
Total net loans $ 374,571 $ 247,206
================= =================
Changes in the allowance for loan losses are as follows:
YEARS ENDED DECEMBER 31,
--------------------------------------------------------------
(Dollars in thousands) 2005 2004 2003
------------------- ------------------- -------------------
Beginning balance $ 2,790 $ 1,955 $ 1,390
Loan charge-offs:
Commercial (35) (135) (71)
Consumer (2) (21) (41)
------------------- ------------------- -------------------
Total charge-offs (37) (156) (112)
Recoveries of loans previously charged-off:
Commercial - - 15
Consumer - 1 -
------------------- ------------------- -------------------
Total recoveries - 1 15
------------------- ------------------- -------------------
Net charge-offs (37) (155) (97)
------------------- ------------------- -------------------
Provision for loan losses 1,167 990 662
------------------- ------------------- -------------------
Ending balance allowance for loan losses $ 3,920 $ 2,790 $ 1,955
=================== =================== ===================
50
Notes to Audited Consolidated Financial Statements
The following is a summary of information pertaining to impaired
loans:
DECEMBER 31,
------------------------------------------
(Dollars in thousands) 2005 2004 2003
------------ ------------ -------------
Impaired loans with a valuation allowance $ 223 $ 349 $ 324
Impaired loans without a valuation allowance - - -
------------ ------------ -------------
Total impaired loans $ 223 $ 349 $ 324
============ ============ =============
Valuation allowance related to impaired loans $ 196 $ 349 $ 184
============ ============ =============
YEARS ENDED DECEMBER 31,
---------------------------------------------
(Dollars in thousands) 2005 2004 2003
------------- ------------- -------------
Average investments in impaired loans $ 248 $ 359 $ 282
============= ============= =============
Interest income recognized on impaired loans $ - $ - $ 21
============= ============= =============
Interest income recognized on a cash basis on
impaired loans $ - $ - $ 21
============= ============= =============
No additional funds are committed to be advanced in connection
with impaired loans.
All nonaccrual loans were included in the impaired loan disclosure
under SFAS No. 114 as of December 31, 2005 and 2004. Nonaccrual
loans excluded from impaired loan disclosure under SFAS No. 114
amounted to $186,000 at December 31, 2003. If interest on these
loans had been accrued, such income would have approximated
$12,000 for 2003.
Loans totaling $34,000 and $34,000 were 90 days past due and still
accruing interest at December 31, 2005 and 2003, respectively.
There were no loans 90 days past due and still accruing interest
at December 31, 2004.
NOTE 4. BANK PREMISES AND EQUIPMENT
Bank premises and equipment consist of the following:
DECEMBER 31,
---------------------------------
(Dollars in thousands) 2005 2004
---------------- ---------------
Leasehold improvements $ 1,298 $ 1,243
Furniture and equipment 1,549 1,370
Computers 923 813
Software 481 399
Premises and equipment in process 4 22
---------------- ---------------
Total original cost 4,255 3,847
Less accumulated depreciation 2,029 1,409
---------------- ---------------
Total book value $ 2,226 $ 2,438
================ ===============
51
Notes to Audited Consolidated Financial Statements
Depreciation and amortization charged to operations totaled
$621,000, $436,000 and $323,000 the years ended December 31, 2005,
2004 and 2003, respectively.
NOTE 5. DEPOSITS
Interest bearing deposits consist of the following:
DECEMBER 31,
-----------------------------------
(Dollars in thousands) 2005 2004
---------------- ----------------
NOW accounts $ 12,787 $ 14,389
Savings accounts 3,020 4,361
Money market accounts 155,128 220,315
Certificates of deposit under $100,000 50,785 13,822
Certificates of deposit $100,000 and over 142,748 59,310
---------------- ----------------
Total interest bearing deposits $ 364,468 $ 312,197
================ ================
At December 31, 2005, the scheduled maturities of time deposits
are as follows:
(Dollars in thousands)
2006 $ 173,263
2007 13,778
2008 3,209
2009 2,346
2010 937
--------------
Total time deposits $ 193,533
==============
52
Notes to Audited Consolidated Financial Statements
NOTE 6. INCOME TAXES
Significant components of the Company's net deferred tax assets
consist of the following:
DECEMBER 31,
---------------------------------
(Dollars in thousands) 2005 2004
--------------- ---------------
Deferred tax assets:
Provision for loan losses $ 1,290 $ 901
Unrealized loss on securities available for sale 1,025 169
Nonaccrual interest 22 21
--------------- ---------------
2,337 1,091
--------------- ---------------
Deferred tax liabilities:
Depreciation (6) (18)
--------------- ---------------
Deferred tax asset, net $ 2,331 $ 1,073
=============== ===============
Allocation of federal income taxes between current and deferred
portions for the years ended December 31, 2005, 2004 and 2003 is
as follows:
DECEMBER 31,
--------------------------------------------------
(Dollars in thousands) 2005 2004 2003
--------------- -------------- ---------------
Current tax provision $ 2,593 $ 1,848 $ 1,548
Deferred tax (benefit) (402) (291) (220)
--------------- -------------- ---------------
Total $ 2,191 $ 1,557 $ 1,328
=============== ============== ===============
The income tax provision differs from the amount of income tax
determined by applying the U.S. federal income tax rate to pretax
income for the years ended December 31, 2005, 2004 and 2003, due
to the following:
DECEMBER 31,
-------------------------------------------------
(Dollars in thousands) 2005 2004 2003
--------------- --------------- ---------------
Computed "expected" tax expense $ 2,179 $ 1,539 $ 1,336
Increase (decrease) in income taxes resulting from:
Nondeductible expenses 12 11 9
Other - 7 (17)
--------------- --------------- ---------------
Total $ 2,191 $ 1,557 $ 1,328
=============== =============== ===============
53
Notes to Audited Consolidated Financial Statements
NOTE 7. LEASE COMMITMENTS AND TOTAL RENTAL EXPENSE
The Company leases its facilities under operating leases expiring
at various dates through 2013. The leases provide that the Company
pay as additional rent, its proportionate share of real estate
taxes, insurance, and other operating expenses. The majority of
the leases contain a provision for annual increases of 3%. Total
rental expense for the years ended December 31, 2005, 2004 and
2003 was $926,000, $662,000 and $450,000, respectively.
The minimum lease commitments for the next five years and
thereafter are:
(Dollars in thousands)
2006 $ 886
2007 850
2008 551
2009 569
2010 587
Thereafter 1,440
---------------
Total $ 4,883
===============
NOTE 8. STOCK OPTION PLANS
The Company's stock option plans for key employees and directors
are accounted for in accordance with Accounting Principles Board
(APB) Opinion 25, Accounting for Stock Issued to Employees, and
related interpretations. Accordingly, no compensation has been
recognized for grants under the plans. The 1998 Plan provides that
323,015 shares of the Company's common stock will be reserved for
both incentive stock options and non-qualified stock options to
purchase common stock of the Company. The exercise price per share
for incentive stock options and non-qualified stock options shall
not be less than the fair market value of a share of common stock
on the date of grant, and may be exercised in increments,
commencing after the date of grant. One-third of the options
granted become vested and exercisable in each of the three years
following the grant date. Each incentive and non-qualified stock
option granted under this plan shall expire not more than ten
years from the date the option is granted.
In 1999, the Company adopted a stock option plan in which options
for 235,125 shares of common stock were reserved for issuance to
directors of the Company. The stock option plan requires that
options be granted at an exercise price equal to at least 100% of
the fair market value of the common stock on the date of grant.
All options granted under this plan have vested and expire not
more than ten years from the date the options were granted.
In 2003, the Company adopted the 2003 Executive Compensation plan
that reserves 468,750 shares of the Company's common stock for
both incentive and non-qualified stock options, restricted stock,
and stock appreciation rights, for issuance to employees and
directors. The stock option plan required that options be granted
at an exercise price equal to at least 100% of the fair market
value of the common stock on the date of grant. Options granted
under this plan become vested and exercisable within three to five
years following the grant date with the exception of options
granted to directors which vest immediately. Options granted under
this plan shall expire not more than ten years from the date the
option is granted.
54
Notes to Audited Consolidated Financial Statements
A summary of the status of the Company's employee stock options is
presented in the table below. Information has been restated to
reflect the stock splits as discussed in Note 18.
2005 2004 2003
---------------------------- ---------------------------- ----------------------------
WEIGHTED WEIGHTED WEIGHTED
AVERAGE AVERAGE AVERAGE
EXERCISE EXERCISE EXERCISE
SHARES PRICE SHARES PRICE SHARES PRICE
------------- ------------- ------------- ------------- -------------- -------------
Outstanding at beginning of year 374,778 $ 9.17 250,232 $ 6.06 253,583 $ 3.32
Granted 70,438 14.90 142,500 14.83 76,687 12.52
Exercised (9,608) 5.08 (9,265) 7.65 (75,585) 3.41
Forfeited (9,419) 12.84 (8,689) 12.68 (4,453) 6.23
------------- ------------- --------------
Outstanding at end of year 426,189 10.13 374,778 9.17 250,232 6.06
============= ============= ==============
Options excercisable at year end 426,085 $ 10.13 263,246 $ 6.98 187,136 $ 4.37
============= ============= ==============
Weighted average fair value of
options granted during the year $ 5.88 $ 7.78 $ 5.36
A summary of the status of the Company's director stock options is
presented in the table below. Information has been restated to
reflect the stock splits as discussed in Note 18.
2005 2004 2003
---------------------------- ---------------------------- ----------------------------
WEIGHTED WEIGHTED WEIGHTED
AVERAGE AVERAGE AVERAGE
EXERCISE EXERCISE EXERCISE
SHARES PRICE SHARES PRICE SHARES PRICE
------------- ------------- ------------- ------------- -------------- -------------
Outstanding at beginning of year 291,112 $ 6.89 239,061 $ 4.63 201,572 $ 3.22
Granted 14,062 14.44 71,250 14.89 37,489 12.19
Exercised - - (19,199) 8.39 - -
------------- ------------- --------------
Outstanding at end of year 305,174 7.24 291,112 6.89 239,061 4.63
============= ============= ==============
Options excercisable at year end 305,174 $ 7.24 291,112 $ 6.89 239,061 $ 4.63
============= ============= ==============
Weighted average fair value of
options granted during the year $ 5.30 $ 5.71 $ 6.21
55
Notes to Audited Consolidated Financial Statements
Information pertaining to options outstanding for all plans at
December 31, 2005 is as follows:
OPTIONS OUTSTANDING OPTIONS EXERCISABLE
-------------------------------------------------- ---------------------------------
WEIGHTED
AVERAGE WEIGHTED WEIGHTED
REMAINING AVERAGE AVERAGE
RANGE OF NUMBER CONTRACTUAL EXERCISE NUMBER EXERCISE
EXERCISE PRICES OUSTANDING LIFE PRICE EXERCISABLE PRICE
- ----------------------------- --------------- ---------------- --------------- ---------------- ---------------
$2.84 - 4.12 310,360 3.19 years $ 2.87 310,360 $ 2.87
$5.16 - 5.26 39,853 6.22 5.21 39,853 5.21
$12.03 - 15.38 381,150 8.33 14.24 381,046 14.24
--------------- ----------------
Total 731,363 6.03 years 8.92 731,259 8.92
=============== ================
NOTE 9. 401(K) PLAN
Effective January 1, 1999, the Company adopted a Section 401(k)
plan covering employees meeting certain eligibility requirements
as to minimum age and years of service. Employees may make
voluntary contributions to the 401(k) plan through payroll
deductions on a pre-tax basis. The Company may make discretionary
contributions to the 401(k) plan based on its earnings. The plan
has a KSOP component whereby employees may elect to allocate a
portion of funds to an Employee Stock Ownership Plan. The
employer's contributions are subject to a vesting schedule
requiring the completion of five years of service before these
benefits become vested. A participant's 401(k) plan account,
together with investment earnings thereon, is distributable
following retirement, death, disability or other termination of
employment under various payout options. For the years ended
December 31, 2005, 2004 and 2003, expense attributable to the plan
amounted to $152,000, $80,000 and $43,000 respectively.
NOTE 10. MINIMUM REGULATORY CAPITAL REQUIREMENTS
The Company (on a consolidated basis) and the Bank are subject to
various regulatory capital requirements administered by the
federal banking agencies. Failure to meet minimum capital
requirements can initiate certain mandatory and possibly
additional discretionary actions by regulators that, if
undertaken, could have a direct material effect on the Company's
and Bank's financial statements. Under capital adequacy guidelines
and the regulatory framework for prompt corrective action, the
Company and the Bank must meet specific capital guidelines that
involve quantitative measures of their assets, liabilities and
certain off-balance-sheet items as calculated under regulatory
accounting practices. The capital amounts and classification are
also subject to qualitative judgments by the regulators about
components, risk weightings, and other factors. Prompt corrective
action provisions are not applicable to bank holding companies.
Quantitative measures established by regulation to ensure capital
adequacy require the Company and the Bank to maintain minimum
amounts and ratios (set forth in the following table) of total and
Tier 1 capital (as defined in the regulations) to risk-weighted
assets (as defined) and of Tier 1 capital (as defined) to average
assets (as defined). Management believes, as of December 31, 2005
and 2004, that the Company and the Bank exceeded all capital
adequacy requirements to which they are subject.
As of December 31, 2005, the most recent notification from the
Federal Deposit Insurance Corporation categorized the Bank as well
capitalized under the regulatory framework for prompt corrective
action. To be categorized as well capitalized, an institution must
maintain minimum total risk-based, Tier 1 risk-based and Tier 1
leverage ratios as set forth in the following tables. There are no
conditions or events since the notification that management
believes have changed the Bank's category. The Company's and the
Bank's actual capital amounts and ratios as of December 31, 2005
and 2004 are also presented in the table.
56
Notes to Audited Consolidated Financial Statements
MINIMUM TO BE WELL
CAPITALIZED UNDER
MINIMUM CAPITAL PROMPT CORRECTIVE
ACTUAL REQUIREMENT ACTION PROVISIONS
------------------------- ------------------------ ------------------------
(Dollars in thousands) AMOUNT RATIO AMOUNT RATIO AMOUNT RATIO
------------ ---------- ------------ ---------- ------------ ----------
As of December 31, 2005:
Total Capital (to Risk Weighted Assets):
Consolidated $ 63,080 15.9% $ 31,679 8.0% N/A N/A
Bank $ 49,447 12.6% $ 31,470 8.0% $ 39,337 10.0%
Tier 1 Capital (to Risk Weighted Assets):
Consolidated $ 55,511 14.0% $ 15,838 4.0% N/A N/A
Bank $ 45,527 11.6% $ 15,740 4.0% $ 23,610 6.0%
Tier 1 Capital (to Average Assets):
Consolidated $ 55,511 10.6% $ 20,908 4.0% N/A N/A
Bank $ 45,527 8.9% $ 20,370 4.0% $ 25,463 5.0%
As of December 31, 2004:
Total Capital (to Risk Weighted Assets):
Consolidated $ 49,019 17.1% $ 22,906 8.0% N/A N/A
Bank $ 34,782 12.3% $ 22,659 8.0% $ 28,324 10.0%
Tier 1 Capital (to Risk Weighted Assets):
Consolidated $ 46,229 16.1% $ 11,485 4.0% N/A N/A
Bank $ 31,992 11.3% $ 11,335 4.0% $ 17,002 6.0%
Tier 1 Capital (to Average Assets):
Consolidated $ 46,229 10.7% $ 17,234 4.0% N/A N/A
Bank $ 31,992 7.7% $ 16,641 4.0% $ 20,801 5.0%
RESTRICTION ON DIVIDENDS
Prior approval of the Bank's regulatory agencies is required to
pay dividends which exceed the Bank's net profits for the current
year, plus its retained net profits for the preceding two years.
At December 31, 2005, the Bank could pay $10,163,000 in dividends
without prior regulatory approval. The Bank did not pay any cash
dividends during the years ended December 31, 2005, 2004 or 2003.
NOTE 11. OFF-BALANCE SHEET ACTIVITIES
Credit-Related Financial Instruments. The Company is a party to
credit related financial instruments with off-balance sheet risk
in the normal course of business to meet the financing needs of
its customers. These financial instruments include commitments to
extend credit, standby letters of credit and commercial letters of
credit. Such commitments involve, to varying degrees, elements of
credit and interest rate risk in excess of the amount recognized
in consolidated balance sheets.
The Company's exposure to credit loss is represented by the
contractual amount of these commitments. The Company follows the
same credit policies in making commitments as it does for
on-balance sheet instruments. At December 31, 2005 and 2004, the
following financial instruments were outstanding whose contract
amounts represent credit risk:
(Dollars in thousands) 2005 2004
---------------- ---------------
Commitments to extend credit $ 84,411 $ 52,461
Standby letters of credit $ 2,730 $ 2,591
57
Notes to Audited Consolidated Financial Statements
Commitments to extend credit are agreements to lend to a customer
as long as there is no violation of any condition established in
the contract. Commitments generally have fixed expiration dates or
other termination clauses and may require payment of a fee. The
commitments for equity lines of credit may expire without being
drawn upon. Therefore, the total commitments amounts do not
necessarily represent future cash requirements. The amount of
collateral obtained, if it is deemed necessary by the Company, is
based on management's credit evaluation of the customer.
Unfunded commitments under commercial lines of credit, revolving
credit lines and overdraft protection agreements are commitments
for possible future extensions of credit to existing customers.
These lines of credit are uncollateralized and usually do not
contain a specified maturity date and may not be drawn upon to the
total extent to which the Company is committed.
Commercial and standby letters of credit are conditional
commitments issued by the Company to guarantee the performance of
a customer to a third party. Those letters of credit are primarily
issued to support public and private borrowing arrangements.
Essentially all letters of credit issued have expiration dates
within one year. The credit risk involved in issuing letters of
credit is essentially the same as that involved in extending loan
facilities to customers. The Company generally holds collateral
supporting those commitments if deemed necessary.
The Company maintains a portion of its cash balances with several
financial institutions. Accounts at each institution are secured
by the Federal Deposit Insurance Corporation up to $100,000.
Unsecured balances were approximately $254,000 at December 31,
2005.
NOTE 12. TRANSACTIONS WITH DIRECTORS AND OFFICERS
The Company has had, and may be expected to have in the future,
banking transactions in the ordinary course of business with
directors and principal officers, their immediate families and
affiliated companies in which they are principal stockholders
(commonly referred to as related parties). In the opinion of
management, such loans are made on the same terms, including
interest rates and collateral, as those prevailing at the time for
comparable transactions with others. They do not involve more than
normal credit risk or present other unfavorable features.
Aggregate loan balances with related parties totaled $4,702,000
and $4,030,000 at December 31, 2005 and 2004, respectively. During
the year ended December 31, 2005, total principal additions were
$1,498,000 and total principal payments were $826,000.
NOTE 13. FAIR VALUE OF FINANCIAL INSTRUMENTS AND INTEREST RATE RISK
The following methods and assumptions were used to estimate the
fair value of each class of financial instruments for which it is
practicable to estimate that value:
CASH AND CASH EQUIVALENTS - For these instruments, the carrying
amount is a reasonable estimate of fair value.
INTEREST BEARING DEPOSITS IN BANKS - The carrying amounts of
interest bearing deposits maturing within ninety days approximate
their fair value.
AVAILABLE FOR SALE SECURITIES - Fair values for securities,
excluding restricted stock, are based on quoted market prices. If
a quoted market price is not available, fair value is estimated
using quoted market prices for similar securities. The carrying
value of restricted stock approximates fair value based on the
redemption provisions of the respective entity.
LOANS RECEIVABLE - Fair value for performing loans is calculated
by discounting estimated cash flows using interest rates currently
being offered for loans with similar terms to borrowers of similar
credit quality.
58
Notes to Audited Consolidated Financial Statements
Fair value for non-performing loans is based on the lesser of
estimated cash flows which are discounted using a rate
commensurate with the risk associated with the estimated cash
flows, or values of underlying collateral.
MORTGAGE LOANS HELD FOR SALE - Fair values of mortgage loans held
for sale are based on commitments on hand from investors or
prevailing market prices.
DEPOSIT LIABILITIES - The fair value of demand deposits, savings
accounts and certain money market deposits is the amount payable
on demand at the reporting date. The fair value of certificates of
deposit is based on the discounted value of contractual cash
flows. The discount rate is estimated using the rates currently
offered for deposits of similar remaining maturities.
LONG-TERM BORROWINGS - The fair values of the Company's long-term
borrowings are estimated using discounted cash flow analysis based
on the Company's current incremental borrowing rates for similar
types of borrowing arrangements.
ACCRUED INTEREST - The carrying amounts of accrued interest
approximate fair value.
OFF BALANCE SHEET INSTRUMENTS - Fair values for off-balance sheet
credit-related instruments are based on fees currently charged to
enter similar arrangements, taking into account the remaining
terms of the agreements and the present creditworthiness of the
counterparties. For fixed rate loan commitments, fair value also
considers the difference between current levels of interest rates
and the committed rates. The fair value of standby letters of
credit is based on fees currently charged for similar agreements
or on the estimated cost to terminate them or otherwise settle the
obligations with the counterparties at the reporting date. At
December 31, 2005 and 2004, the fair values of loan commitments
and standby letters of credit were deemed immaterial.
59
Notes to Audited Consolidated Financial Statements
The estimated fair values of the Company's financial instruments
at December 31, 2005 and 2004 are as follows:
DECEMBER 31, 2005 DECEMBER 31, 2004
-------------------------------- --------------------------------
CARRYING FAIR CARRYING FAIR
(Dollars in thousands) AMOUNT VALUE AMOUNT VALUE
-------------- --------------- -------------- ---------------
FINANCIAL ASSETS:
Cash and due from banks $ 19,960 $ 19,960 $ 9,286 $ 9,286
Interest bearing deposits in banks 24 24 2,442 2,442
Federal funds sold 5,968 5,968 35,754 35,754
Securities available for sale 118,986 118,986 146,795 146,795
Loans held for sale 2,299 2,299 2,987 2,987
Loans, net 374,571 366,123 247,206 238,439
Accrued interest 2,392 2,392 1,977 1,977
FINANCIAL LIABILITIES:
Deposits $ 471,299 $ 470,701 $ 404,054 $ 403,399
Long-term borrowings 17,527 16,198 9,279 9,256
Accrued interest 701 701 217 217
The Company assumes interest rate risk (the risk that general
interest rate levels will change) as a result of its normal
operations. As a result, the fair values of the Company's
financial instruments will change when interest rate levels change
and that change may be either favorable or unfavorable to the
Company. Management attempts to match maturities of assets and
liabilities to the extent believed necessary to minimize interest
rate risk. However, borrowers with fixed rate obligations are less
likely to prepay in a rising rate environment and more likely to
prepay in a falling rate environment. Conversely, depositors who
are receiving fixed rates are more likely to withdraw funds before
maturity in a rising rate environment and less likely to do so in
a falling rate environment. Management monitors rates and
maturities of assets and liabilities and attempts to minimize
interest rate risk by adjusting terms of new loans and deposits
and by investing in securities with terms that mitigate the
Company's overall interest rate risk.
NOTE 14. COMMITMENTS AND CONTINGENT LIABILITIES
The Bank has unsecured lines of credit with correspondent banks
totaling $125,720,000 available for overnight borrowing. There
were no amounts drawn on these lines at December 31, 2005 or 2004.
As a member of the Federal Reserve System, the Bank is required to
maintain certain average reserve balances. For the final reporting
period in the year ended December 31, 2005, the aggregate amount
of daily average balances was approximately $7,280,000.
NOTE 15. OTHER NONINTEREST INCOME AND EXPENSES
The principal components of other noninterest income in the
consolidated statements of income are:
(Dollars in thousands) 2005 2004 2003
-------------- -------------- ---------------
Cash management fee income $ 111 $ 100 $ 113
Other fee income 334 253 190
-------------- -------------- ---------------
$ 445 $ 353 $ 303
============== ============== ===============
60
Notes to Audited Consolidated Financial Statements
The principal components of other operating expenses in the
consolidated statements of income are:
(Dollars in thousands) 2005 2004 2003
---------- --------- ---------
Data processing costs $ 589 $ 498 $ 373
Advertising and public relations 293 229 102
Professional fees 472 359 197
Courier and express services 31 122 134
Meals and entertainment 73 66 55
Supplies 108 73 70
Postage 65 58 52
State franchise tax 392 263 217
Other 820 562 483
---------- --------- ---------
$ 2,843 $ 2,230 $ 1,683
========== ========= =========
NOTE 16. CONDENSED FINANCIAL STATEMENTS OF PARENT COMPANY
Financial information pertaining only to James Monroe Bancorp, Inc. is
as follows:
CONDENSED BALANCE SHEETS
December 31, 2005 and 2004
(Dollars in thousands) 2005 2004
--------------- ----------------
ASSETS
Interest bearing deposits in banks $ 4,206 $ 2,442
Securities available for sale, at fair value 8,368 11,347
Investment in subsidiary bank 43,578 31,686
Other assets 1,056 710
--------------- ----------------
$ 57,208 $ 46,185
=============== ================
LIABILITIES AND STOCKHOLDERS' EQUITY
Other liabilities $ 36 $ 5
Trust preferred capital notes 17,527 9,279
Stockholders' equity 39,645 36,901
--------------- ----------------
$ 57,208 $ 46,185
=============== ================
61
Notes to Audited Consolidated Financial Statements
CONDENSED INCOME STATEMENTS
For the Years Ended December 31, 2005, 2004 and 2003
(Dollars in thousands) 2005 2004 2003
---------------- --------------- ----------------
Interest income $ 365 $ 660 $ 284
Interest expense 742 452 323
Gain on sale of securities 5 - -
Operating expense 111 152 102
---------------- --------------- ----------------
Income (loss) before income tax expense
(benefit) and equity in undistributed
income of subsidiaries (483) 56 (141)
Income tax expense (benefit) (164) 38 (67)
Equity in undistributed income of subsidiaries 4,536 2,952 2,675
---------------- --------------- ----------------
Net income $ 4,217 $ 2,970 $ 2,601
================ =============== ================
CONDENSED STATEMENTS OF CASH FLOW
For the Years Ended December 31, 2005, 2004 and 2003
(Dollars in thousands) 2005 2004 2003
-------------- -------------- --------------
CASH FLOWS FROM OPERATING ACTIVITIES
Net income $ 4,217 $ 2,970 $ 2,601
Adjustments to reconcile net income to
net cash provided by (used in) operating activities:
Equity in undistributed income of subsidiaries (4,536) (2,952) (2,675)
Gain on sale of securities (5) - -
(Increase) decrease in other assets (346) 60 (294)
Increase in other liabilities 31 - 4
-------------- -------------- --------------
Net cash provided by (used in) operating activities (639) 78 (364)
-------------- -------------- --------------
CASH FLOWS FROM INVESTING ACTIVITIES
Purchases of securities available for sale (5,029) (1,980) (17,011)
Proceeds from calls and maturities of securities available for sale 7,996 8,595 4,901
Investment in subsidiary bank (9,000) (6,000) (4,000)
(Increase) decrease in interest bearing deposits in banks (1,764) (2,442) 655
-------------- -------------- --------------
Net cash (used in) investing activities (7,797) (1,827) (15,455)
-------------- -------------- --------------
CASH FLOWS FROM FINANCING ACTIVITIES
Proceeds from issuance of common stock 191 401 13,174
Proceeds from issuance of trust preferred capital notes 8,248 - 4,000
Cash paid in lieu of fractional shares (3) (3) (4)
-------------- -------------- --------------
Net cash provided by financing activities 8,436 398 17,170
-------------- -------------- --------------
Increase (decrease) in cash and cash equivalents - (1,351) 1,351
CASH AND CASH EQUIVALENTS, beginning of year - 1,351 -
-------------- -------------- --------------
CASH AND CASH EQUIVALENTS, end of year $ - $ - $ 1,351
============== ============== ==============
62
Notes to Audited Consolidated Financial Statements
NOTE 17. TRUST PREFERRED CAPITAL SECURITIES
On March 25, 2002, James Monroe Statutory Trust I, a subsidiary of
the Company, was formed for the purpose of issuing redeemable
trust preferred securities and purchasing the Company's junior
subordinated debentures, which are its sole assets. The Company
owns all of Trust I's outstanding common securities. On March 26,
2002, $5.2 million of the trust preferred securities were issued
in a pooled underwriting totaling approximately $500 million. The
securities bear interest at a rate equal to the three month LIBOR
plus 360 basis points, subject to a cap of 11% which is set and
payable on a quarterly basis. During 2005, the interest rates
ranged from 6.15% to 7.56%. The rate for the quarterly period
beginning December 27, 2005, was 8.12%. The securities have a
maturity date of March 25, 2032, and are subject to varying call
provisions beginning March 26, 2007.
On July 16, 2003, James Monroe Statutory Trust II, a subsidiary of
the Company, was formed for the purpose of issuing redeemable
trust preferred securities and purchasing the Company's junior
subordinated debentures, which are its sole assets. The Company
owns all of Trust II's outstanding common securities. On July 31,
2003, $4.1 million of the trust preferred securities were issued
in a private placement transaction. The securities bear interest
at a rate equal to the three month LIBOR plus 310 basis points,
subject to a cap of 12% which is set and payable on a quarterly
basis. During 2005, the interest rates ranged from 5.66% to 7.06%.
The rate for the quarterly period beginning December 31, 2005, was
7.63%. The securities have a maturity date of July 31, 2033, and
are subject to ranging call provisions beginning July 31, 2008.
On October 3, 2005, James Monroe Statutory Trust III, a newly
formed subsidiary of the Company, was formed for the purpose of
issuing redeemable trust preferred securities and purchasing the
Company's junior subordinated debentures, which are its sole
assets. The Company owns all of Trust III's outstanding common
securities. On October 3, 2005, $8.2 million of the trust
preferred securities were issued in a private placement
transaction. The securities bear interest at a rate of 6.253%
until September 15, 2010 at which time the rate adjusts quarterly
to the three month LIBOR plus 155 basis points. The securities
have a maturity date of December 15, 2035, and are redeemable at
par beginning December 15, 2010.
The trust preferred securities may be included in Tier 1 capital
for regulatory capital adequacy determination purposes up to 25%
of Tier 1 capital. The portion of the securities not considered as
Tier 1 capital will be included in Tier 2 capital. At December 31,
2005, $13,878,000 of the trust preferred securities qualified as
Tier I capital and the remaining $3,649,000 qualified as Tier II
capital. At December 31, 2004, all of the trust preferred
securities qualified as Tier 1 capital.
The Company and the Trusts believe that, taken together, the
Company's obligations under the junior subordinated debentures,
the Indentures, the Trust Declarations and the Guarantees entered
into in connection with the issuance of the trust preferred
securities constitute a full and unconditional guarantee by the
Company of the Trusts' respective obligations with respect to the
trust preferred securities.
Subject to certain exceptions and limitations, the Company may
elect from time to time to defer interest payments on the junior
subordinated debt securities, which would result in a deferral of
distribution payments on the related trust preferred securities.
NOTE 18. COMMON STOCK SPLITS
On May 16, 2003, the Company issued 459,968 additional shares
necessary to affect a 5-for-4 common stock split in the form of a
25% stock dividend to shareholders of record April 25, 2003. The
earnings per common share for all periods prior to May 2003 have
been restated to reflect the stock split.
On June 1, 2004, the Company issued 1,478,317 additional shares
necessary to affect a 3-for-2 common stock split in the form of a
50% stock dividend to shareholders of record on May 14, 2004. The
earnings per common share for all periods prior to June 2004 have
been restated to reflect the stock split.
63
Notes to Audited Consolidated Financial Statements
On December 28, 2005, the Company issued 1,114,439 additional
shares necessary to affect a 5-for-4 common stock split in the
form of a 25% stock dividend to shareholders of record on November
28, 2005. The earnings per common share for all periods prior to
December 2005 have been restated to reflect the stock split.
64
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE.
None.
ITEM 9A. CONTROLS AND PROCEDURES.
The Company's management, under the supervision and with the
participation of the Chief Executive Officer, Chief Operating Officer and Chief
Financial Officer, evaluated, as of the last day of the period covered by this
report, the effectiveness of the design and operation of the Company's
disclosure controls and procedures, as defined in Rule 13a-15(e) under the
Securities Exchange Act of 1934. Based on that evaluation, the Chief Executive
Officer, Chief Operating Officer and Chief Financial Officer concluded that the
Company's disclosure controls and procedures were effective. There were no
changes in the Company's internal control over financial reporting (as defined
in Rule 13a-15 under the Securities Act of 1934) during the quarter ended
December 31, 2005 that has materially affected, or is reasonably likely to
materially affect, the Bank's internal control over financial reporting.
ITEM 9B. OTHER INFORMATION.
None.
65
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT.
Code of Ethics. The Company has adopted a Code of Ethics that applies
to the President and Senior Executive Vice President/Chief Operating Officer.
The Company will provide a copy of the Code of Ethics without charge upon
written request directed to Richard I. Linhart, Secretary, James Monroe Bancorp,
Inc., 3033 Wilson Boulevard 22201.
The other information required by Item 10 is incorporated by reference
from the material under the caption "Election of Directors", and under the
caption "Compliance with Section 16(a) of the Securities Exchange Act of 1934",
of the Company's definitive proxy statement for the 2006 annual meeting of
shareholders expected to be filed on or before May 1, 2006 (the "Proxy
Statement").
ITEM 11. EXECUTIVE COMPENSATION.
The information required by Item 11 is incorporated by reference from
the material under the caption "Executive Compensation," in the Proxy Statement.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND
RELATED STOCKHOLDER MATTERS.
The information required by Item 12 is incorporated by reference from
the material under the captions "Securities Ownership of Directors, Executive
Officers and Five Percent Beneficial Owners" in the Proxy Statement, and
included under the caption "Securities Authorized for Issuance Under Equity
Compensation Plans" under Item 5 hereof.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS.
The information required by Item 13 is incorporated by reference from
the material under the caption "Certain Relationships and Related Transactions"
in the Proxy Statement.
ITEM 14. PRINCIPAL ACCOUNTANT FEES AND SERVICES.
The information required by Item 14 is incorporated by reference from
the material under the caption "Independent Registered Public Accounting Firm"
in the Proxy Statement.
ITEM 15. EXHIBITS AND FINANCIAL STATEMENT SCHEDULES.
(A) THE FOLLOWING FINANCIAL STATEMENTS ARE INCLUDED IN THIS REPORT:
Report of Independent Auditors
Consolidated Balance Sheets at December 31, 2004 and 2005
Consolidated Statements of Income for the years ended December 31, 2003,
2004 and 2005
Consolidated Statements of Cash Flows for the years ended
December 31, 2003, 2004 and 2005
Consolidated Statements of Changes in Stockholders' Equity for the years
ended December 31, 2003, 2004 and 2005
Notes to the Consolidated Financial Statements
(B) EXHIBITS
Exhibit No. Description of Exhibits
3(a) Articles of Incorporation of James Monroe Bancorp, as amended (1)
3(b) Bylaws of James Monroe Bancorp (2)
4(a) Indenture, dated as of March 26, 2002 between James Monroe Bancorp,
Inc. and State Street Bank and Trust Company of Connecticut,
National Association, as trustee (3)
66
4(b) Amended and Restated Declaration of Trust, dated as of March 26,
2002 among James Monroe Bancorp, Inc., State Street Bank and Trust
Company of Connecticut, National Association, as Institutional
Trustee, and John R. Maxwell, David W. Pijor and Richard I. Linhart
as Administrators (3)
4(c) Guarantee Agreement dated as of March 26, 2002, between James Monroe
Bancorp, Inc. and State Street Bank and Trust Company of
Connecticut, National Association, as trustee (3)
4(d) Indenture, dated as of July 31, 2003 between James Monroe Bancorp,
Inc. and U.S. Bank, National Association, as trustee (3)
4(e) Amended and Restated Declaration of Trust, dated as of July 31, 2003
among James Monroe Bancorp, Inc., U.S. Bank, National Association,
as Institutional Trustee, and John R. Maxwell, David W. Pijor and
Richard I. Linhart as Administrators (3)
4(f) Guarantee Agreement dated as of July 31, 2003, between James Monroe
Bancorp, Inc. and U.S. Bank, National Association, as trustee (3)
4(g) Indenture, dated as of October 3, 2005 between James Monroe Bancorp,
Inc. and U.S. Bank, National Association, as trustee (3)
4(h) Amended and Restated Declaration of Trust, dated as of October 3,
2005 among James Monroe Bancorp, Inc., U.S. Bank, National
Association, as Institutional Trustee, and John R. Maxwell and John
J. Brough as Administrators (3)
4(i) Guarantee Agreement dated as of October 3, 2005, between James
Monroe Bancorp, Inc. and U.S. Bank, National Association, as
guarantee trustee (3)
10(a) Employment contract between James Monroe Bancorp and John R.
Maxwell(4)
10(b) Employment contract between James Monroe Bancorp and Richard I.
Linhart (5)
10(c) James Monroe Bancorp 1998 Management Incentive Stock Option Plan (6)
10(d) James Monroe Bancorp 2000 Director's Stock Option Plan (7)
10(e) James Monroe Bancorp, Inc. 2003 Equity Compensation Plan (8)
11 Statement re: Computation of Per Share Earnings
Please refer to Note 1 to the financial statements included in this
report.
21 Subsidiaries of the Registrant
23 Independent Auditor's Consent
31(a) Certification of Chief Executive Officer
31(b) Certification of Chief Operating Officer
31(c) Certification of Chief Financial Officer
32(a) Certification of Chief Executive Officer
32(b) Certification of Chief Operating Officer
32(c) Certification of Chief Financial Officer
- --------------------------
(1) Incorporated by reference to exhibit 3(a) to the Company's Annual
Report on Form 10-KSB for the year ended December 31, 2002.
(2) Incorporated by reference to exhibit 3(b) to the Company's
registration statement on Form SB-2 (No. 333-38098).
(3) Not filed in accordance with the provisions of Item 601(b)(4)(iii)
of Regulation SK. The Company agrees to provide a copy of these
documents to the Commission upon request.
(4) Incorporated by reference to exhibit 10.1 to the Company's Current
Report on Form 8-K filed on February 23, 2006.
(5) Incorporated by reference to exhibit of same number to the Company's
Annual Report on Form 10-KSB for the year ended December 31, 2003.
(6) Incorporated by reference to exhibit 10(b) to the Company's
registration statement on Form SB-2 (No. 333-38098).
(7) Incorporated by reference to exhibit 10(c) to the Company's
registration statement on Form SB-2 (No. 333-38098).
(8) Incorporated by reference to exhibit 10(e) to the Company's
Quarterly Report on Form 10-QSB for the quarter ended March 31, 2003
67
SIGNATURES
In accordance with Section 13 of the Securities Exchange Act of 1934,
the registrant caused this report to be signed on its behalf by the undersigned,
thereunto duly authorized.
JAMES MONROE BANCORP, INC.
March 8, 2006 By: /s/ John R. Maxwell
-----------------------------
John R. Maxwell, President
In accordance with the Securities Exchange Act of 1934, this report has
been signed below by the following persons on behalf of the registrant and in
the capacities and on the dates indicated.
SIGNATURE TITLE DATE
/s/ Dr. Terry L. Collins Director March 8, 2006
- ---------------------------------------------
Dr. Terry L. Collins
/s/ Norman P. Horn Director March 8, 2006
- ---------------------------------------------
Norman P. Horn
/s/ Dr. David C. Karlgaard Director March 8, 2006
- ---------------------------------------------
Dr. David C. Karlgaard
/s/ Richard I. Linhart Director, Senior Executive Vice President, March 8, 2006
- --------------------------------------------- Chief Operating Officer, Secretary
Richard I. Linhart
/s/ Richard C. Litman Director March 8, 2006
- ---------------------------------------------
Richard C. Litman
/s/ John R. Maxwell Director, President, Chief Executive Officer, March 8, 2006
- --------------------------------------------- (Principal Executive Officer)
John R. Maxwell
/s/ Dr. Alvin E. Nashman Director March 8, 2006
- ---------------------------------------------
Dr. Alvin E. Nashman
/s/ Thomas L. Patterson Director March 8, 2006
- ---------------------------------------------
Thomas L. Patterson
/s/ David W. Pijor Chairman of the Board of Directors March 8, 2006
- ---------------------------------------------
David W. Pijor
/s/ Helen Newman Roche Director March 8, 2006
- ---------------------------------------------
Helen Newman Roche
/s/ Russell E. Sherman Director March 8, 2006
- ---------------------------------------------
Russell E. Sherman
/s/ John J. Brough Executive Vice President, Chief Financial March 8, 2006
- --------------------------------------------- Officer, (Principal Accounting and Financial Officer)
John J. Brough
68