January 19, 2007
United States Securities and
Exchange Commission
450 Fifth Street, N.W.
Washington, D.C. 20549
Attn: John P. Nolan
Accounting Branch Chief
Re: Carrollton Bancorp (the "Company")
Form 10-K for the fiscal year ended December 31, 2005
Filed March 24, 2006
Form 10-Q for fiscal quarter ended September 30, 2006
File No. 000-23090
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Dear Mr. Nolan:
This will acknowledge receipt of, and thank you for, your letter of
December 15, 2006 (the "Comment Letter") containing your comments on the
above-referenced filings (the "December 31, 2005 Form 10-K"; the "September 30,
2006 Form 10-Q").
We have the following responses to the comments set forth in the Comment
Letter:
Comment 1.
Form 10-K for the fiscal year ended December 31, 2005
Management's Discussion and Analysis
Business and Overview, page 18
1. We note your disclosure regarding net income excluding the gains of
sales of securities, FHLBA prepayment penalty, and the write down and cost of
disposal of ATMs. We also note your disclosure of "core earnings" on page 19
that represents earnings before the effect of investment security transactions.
Please refer to Item 10(e) of Regulation S-K and tell us the following regarding
each non-GAAP measure:
o your conclusion as to whether each item is recurring or non-recurring
in nature;
o how management uses the measure to conduct or evaluate your business;
o the economic substance behind management's decision to use such a
measure;
o the material limitations associated with use of the non-GAAP financial
measure as compared to the use of the most directly comparable GAAP
financial measure;
o the manner in which management compensates for these limitations when
using the non-GAAP financial measure;
o the substantive reasons why management believes the non-GAAP financial
measure provides useful information to investors; and
o how the title or description of the non-GAAP financial measures is not
the same as, or confusingly similar to, titles or descriptions used
for GAAP financial measures.
Response: The write down and cost of disposal of the ATMs totaling $564,000
related to Wal-Mart terminating the agreement for Carrollton Bank, a
wholly-owned subsidiary of the Company (the "Bank"), to provide ATMs at
Wal-Mart, Sam's Club, and Wal-Mart Super Centers in Maryland, Virginia and
West Virginia. Currently, the Bank has no other contracts of this nature
and has not had any other such contracts over the past 2 years. Therefore,
this charge is considered non-recurring in nature.
The Bank paid off the $5 million FHLBA advance at 7.26% maturing May 24,
2010 and incurred a $506,000 prepayment penalty. The Bank has not entered
into any long term borrowings in 2006. Since the advance was paid off, it
would be considered non-recurring in nature.
During the year ended December 31, 2005, the Company realized gains of
$840,000 from the sale of marketable securities. The Company maintains a
portfolio of marketable securities available for sale (the "AFS Portfolio")
and may periodically sell securities from the AFS Portfolio. On July 7,
2005, the Company repurchased 42,500 shares of its outstanding stock for
approximately $599,000. Simultaneously, on July 7, 2005, the Company sold
marketable securities (consisting of shares of publicly traded common
stock) from its AFS Portfolio in order to provide the cash for the Company
to repurchase its shares and to pay estimated federal and state taxes on
the gain realized from the sale of such marketable securities. These
transactions would be considered recurring in nature. We believe that
presentations of non-GAAP financial measures excluding certain items
provide useful supplemental information to analysts and investors that
better reflect our core operating activities. Moreover, we believe these
measures are consistent with how investors and analysts typically evaluate
our industry and by providing such information, we facilitate their
analysis.
Management considers whether the transaction would be recurring in nature
and how analysts evaluate the Company when management evaluates the core
earnings of the Company.
We believe these non-GAAP measures provide information useful to investors
in understanding our ongoing core business and operational performance
trends. These measures should not be viewed as a substitute for GAAP.
Management reviews these same non-GAAP measures internally.
We do not believe that there are any material limitations associated with
the use of these non-GAAP financial measures as compared to the most
directly comparable GAAP financial measures of net income. Accordingly,
there are no limitations to compensate for when using these non-GAAP
financial measures.
Certain of the excluded items have historically been recurring in nature
such as gains and losses on the sale of securities. Furthermore, certain of
the excluded items including the write down associated with the termination
of the Wal-Mart ATM contract and the FHLBA prepayment penalty are
non-recurring in nature. We believe that excluding such items facilitates
evaluation and comparison of results for our core, ongoing business
operations, and such items are not excluded to even out our earnings. As
stated above, we believe that presentations of non-GAAP financial measures
excluding certain items provide useful supplemental information to analysts
and investors that better reflect our core operating activities. Moreover,
as also stated above, we believe these measures are consistent with how
investors and analysts typically evaluate our industry and by providing
such information, we facilitate their analysis. We will continue to
evaluate the relevance of these disclosures on an ongoing basis.
The description of the non-GAAP financial measures is similar to the
descriptions used for the GAAP financial measures. The descriptions of the
non-GAAP financial measures, however, are set off from the descriptions of
the GAAP financial measures by the phrase "using a non-GAAP financial
measure" which precedes the discussion of non-GAAP financial measures. By
including the additional non-GAAP financial measures, management's intent
was to facilitate an investor or analyst's evaluation of the Company's
results of operations from year to year. Management will assess the
relevance of these disclosures on an ongoing basis.
Comment 2. Please provide us with a similar response related to your
non-GAAP measures presented in your September 30, 2006 Form l0-Q.
Response: The check kiting charge of $1.8 million referred to in our
September 30, 2006 Form 10-Q was incurred as a result of the activities of
one of the Bank's commercial customers, which was a money service business.
The Bank has discontinued providing services to money service businesses
and has not incurred any other check kiting charges over the past 2 years.
Therefore, the check kiting charge would be considered non-recurring in
nature because the likelihood of a check kiting loss from a money service
business has been eliminated.
The Bank restructured $35 million of its total of $40 million in FHLBA
advances and incurred a prepayment penalty of $2.3 million. The weighted
average maturity of the $40 million fixed rate FHLBA advances was
approximately 3.9 years. The refinancing of $35 million of fixed rate
advances reduced the weighted average maturity from approximately 3.9 years
to less than 6 months. This transaction is considered non-recurring since
it significantly reduced the weighted average maturity of the FHLBA
advances. Under the current ALCO strategy, the weighted average maturity of
borrowings is not expected to be significantly extended.
The Company incurred gains of $2.2 million from the sale of marketable
securities. The Company maintains an AFS Portfolio and may periodically
sell securities from the AFS Portfolio. The securities sold during the
period covered by the September 30, 2006 Form 10-Q had significant gains.
These transactions would be considered recurring in nature.
Management considers whether the transactions would be recurring in nature
and how analysts evaluate the Company when management evaluates the core
earnings of the Company.
We believe these non-GAAP measures provide information that is useful to
investors in understanding our ongoing core business and operational
performance trends. These measures should not be viewed as a substitute for
GAAP. Management reviews these same non-GAAP measures internally.
We do not believe that there are any material limitations associated with
the use of these non-GAAP financial measures as compared to the most
directly comparable GAAP financial measures of net income. Accordingly,
there are no limitations to compensate for when using the non-GAAP
financial measures.
Certain of the excluded items have historically been recurring in nature
such as gains and losses on the sale of securities. Although prepayment
penalties were incurred on FHLBA advances in 2005 and 2006, the reasons for
incurring the penalties were to payoff an advance and to restructure the
weighted average maturities of long term advances. We believe that
excluding such items facilitates evaluation and comparison of results for
our core, ongoing business operations, and such items are not excluded to
even out our earnings. Specifically, we believe that presentations of
non-GAAP financial measures excluding certain items provide useful
supplemental information to analysts and investors that better reflect out
core operating activities. Furthermore, we believe these measures are
consistent with how investors and analysts typically evaluate our industry
and by providing such information, we facilitate their analysis. We will
continue to evaluate the relevance of these disclosures on an ongoing
basis.
The description of the non-GAAP financial measures is similar to the
descriptions used for the GAAP financial measures. The descriptions of the
non-GAAP financial measures, however, are set off from the descriptions of
the GAAP financial measures by the phrase "using a non-GAAP financial
measure" which precedes the discussion of non-GAAP financial measures. By
including the additional non-GAAP financial measures, management's intent
was to facilitate an investor or analyst's evaluation of the company's
results of operations from year to year. Management will assess the
relevance of these disclosures on an ongoing basis.
Comment 3. We note your disclosure of non-GAAP per diluted share measure
that excludes gains of sales of securities, FHLBA prepayment penalty, and the
write down and cost of disposal of ATMs. Note that ASR 142 states that per share
data other than that related to net income, net assets and dividends should be
avoided in reporting financial results. Although Item 10(e) of Regulation S-K
does not include a prohibition on the use of per share non-GAAP financial
measures, ASR 142 requires that the disclosure that explains how these measures
are used by management and in what way they provide meaningful information to
investors (as the per share measure would not depict the amount that accrues
directly to shareholders' benefit) is critical. Please confirm that you will
exclude the disclosure of non-GAAP earnings per share measures from future
filings. Alternatively, provide us with your proposed future disclosure that
clearly addresses the concerns raised in ASR 142. For additional guidance, refer
to Question 11 of the June 13, 2003 Frequently Asked Questions Regarding the Use
of Non-GAAP Financial Measures.
Response: We will exclude the disclosure of non-GAAP earnings per share
measures from future filings.
Comment 4. Please provide us with a similar response related to your
non-GAAP per share measures presented in your September 30, 2006 Form 10-Q.
Response: We will exclude the disclosure of non-GAAP earnings per share
measures from future filings.
Comment 5.
Consolidated Financial Statements
Note 1 -- Summary of Significant Accounting Policies
Derivative Instruments and Hedging Activities, page 41
We note your disclosure that you designated the interest rate floor entered
into in December 2005 as a cash flow hedge of future cash flows derived from
adjustable rate home equity loans. Please provide us with the following
information regarding this hedge:
o the specific designated risk being hedged;
o the specific benchmark interest rates used for the loans and the
floor;
o how you estimate the cash flows that are hedged;
o how you documented with sufficiently specify the hedged cash flows;
o how you assess at inception and an on-going basis; and
o how you measure ineffectiveness, specifically identify which of the
three methods described in SFAS 133 Implementation Issue No. G7 that
you use.
Response: On December 12, 2005, the Bank entered into an interest rate
floor with a notional amount of $10 million with an effective date of
December 14, 2005 and a scheduled termination date of December 14, 2010.
The premium for the five year floor was $152,000. The floor's floating rate
option is USD-Prime and the floor strike rate is 7%. The Bank is asset
sensitive and has increased exposure in a declining interest rate
environment. The interest rate floor will pay the Bank if the USD-Prime
interest rate falls below the 7% strike rate. The floor floating rate
adjusts quarterly beginning March 14, 2006. The Bank's outstanding
adjustable rate home equity loans adjust the day that USD-Prime decreases.
The floor and the home equity loans float off of USD-Prime. The risk being
hedged is the interest rate exposure to a decrease in the expected interest
receipts of $10 million principal of home equity loans in a declining
interest rate environment.
The cash flows are estimated at the notional amount multiplied by the
strike rate ($10,000,000 * 7% = $700,000).
At inception and at December 31, 2006, the Bank has identified over $20
million of home equity loans that float at USD-Prime + 0 margin. The Bank
expects this pool of loans to increase over the remaining four years of the
floor. However, the composition of the loans may change due to prepayments,
additional principal advances under the home equity lines of credit, new
home equity loans originated and potential defaults. The Bank can identify
the first USD-Prime based interest payments received each quarter for the
next four years that, in the aggregate for each quarter, are payments on
$10 million principal of its existing USD-Prime + 0 margin floating rate
home equity loans. Any USD-Prime + 0 based interest payments received by
the Bank after it has received payments on the $10 million aggregate
principal would be unhedged interest payments for that quarter.
At inception and on an on-going basis, the expected effectiveness of the
hedge was, and is, based on the extent that changes in USD-Prime have
occurred during a quarter compared to the actual date that USD-Prime
decreased during the quarterly reset period. The hedge would be ineffective
to the extent that the change in cash flows of the home equity loans for
the quarter was not offset by the change in the cash flows of the floor for
the portion of the quarter that the floor rate did not adjust. Thus, the
hedge will only be ineffective to the extent that the USD-Prime has
decreased below 7% between the 14th of the quarterly reset period and the
actual date prime decreased in the quarterly reset period. Pursuant to SFAS
133 Implementation Issue No. G7, we utilize the change in variable cash
flows method to measure ineffectiveness. Based on the expected Federal Open
Market Committee (FOMC) meeting dates in 2006, the average number of days
between a FOMC meeting and the floor quarterly reset date was 51 days. The
estimated cash flow shortfall for 51 days at 25 basis points (0.25%) would
be $3,493. For subsequent quarters, the decrease in the cash flow from the
$10 million of home equity loans would be offset by the cash flow from the
floor.
Carrollton Bancorp hereby acknowledges that:
o It is responsible for the adequacy and accuracy of the disclosure in
the filing;
o Staff comments or changes to disclosure in response to staff comments
do not foreclose the Securities and Exchange Commission (the
"Commission") from taking any action with respect to the filing; and
o It may not assert staff comments as a defense in any proceeding
initiated by the Commission or any person under the federal securities
laws of the United States.
If you believe that our responses to your comments require discussion, our
Chief Financial Officer, James Uveges (410-536-7308) and our counsel Charles
Moran of Ballard Spahr Andrews & Ingersoll, LLP (410-528-5689) will be available
to speak with you at your convenience.
Sincerely yours,
/s/Robert A. Altieri
Chief Executive Officer and President