LETTERHEAD OF CARROLLTON BANCORP
February 9, 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
January 26, 2007 (the "Second Comment Letter") containing your comments to our
response letter dated January 19, 2007 which responded to your initial comments
regarding 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 Second
Comment Letter:
Form 10-K for the fiscal year ended December 31, 2005
Consolidated Financial Statements
Note 1 -- Summary of Significant Accounting Policies
Derivative Instruments and Hedging Activities, page 41
Comment 1.
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We note your supplemental response to comments of our letter
dated December 15, 2006. Please tell us the following regarding this
hedging relationship:
o how you estimate the hedged future cash flows to ensure that the
cash flows are probable of occurring;
o the specific prime rate index used for determining interest
payment on the loans and the interest rate floor;
o how you considered that the interest rate index of the portfolio
of variable-rate loans is not a benchmark rate as defined in SFAS
133, including the specific reference to the literature upon
which you relied;
United States Securities and
Exchange Commission
February 9, 2007
Page 2
o clarify whether the documented hedge risk specifies that the cash
flows hedged are the overall changes in cash flows below the
designated 7% strike rate;
o how you considered margin variability (that is, changes in the
spread over the non-benchmark rate) attributable to the hedged
cash flows, which are the interest payments received first
chronologically;
o how you considered the difference in timing between the interest
payments received and the dates payment are received pursuant to
the floor agreement, provided the prime rate falls below the 7%
strike price;
o the specific quantitative and qualitative measures you use to
assess hedge effectiveness;
o the specific guidance upon which you relied in determining the
appropriate prospective and retrospective method of assessing
effectiveness;
o the specific quantitative measure you use to measure
ineffectiveness and how it is applied;
o the specific guidance upon which you relied in determining the
appropriate method of measuring ineffectiveness; and
o your response indicates that you use the variable cash flow
method approach of SFAS 133 Implementation Guidance Issue G7 for
measuring ineffectiveness; however, please note that Issue G7 is
applicable for cash flow hedges using an interest rate swap as
the hedging instrument.
Response: The Company can identify the first USD-Prime based interest
payments received each quarter by Carrollton Bank (the "Bank") for the next four
years that, in the aggregate for each quarter, are payments on the $10 million
principal balance of its existing USD-Prime + 0 margin floating rate home equity
loans. For the past few years, the Bank has originated and maintained over $20
million of home equity loans that float at a prime + 0 margin and expects to
originate and maintain over $20 million of such loans for at least the next four
years.
United States Securities and
Exchange Commission
February 9, 2007
Page 3
The floor's floating rate option is the USD-Prime rate and the floor strike rate
is 7%. The home equity loans' floating rate option is the Wall Street Journal
("WSJ") prime rate. Historically, the WSJ prime rate has changed on the same day
as the USD-Prime rate changed, and changed to equal the USD-Prime rate.
Per the amendments to the glossary of SFAS 133, a benchmark interest rate is a
widely recognized and quoted rate in an active financial market that is broadly
indicative of the overall interest rates attributable to high-credit-quality
obligors in that market. It is a rate that is widely used in a given financial
market as an underlying basis for determining the interest rates of individual
financial instruments and commonly referenced in interest-rate-related
transactions. The USD-Prime rate and the WSJ prime rate are both widely
recognized and widely used in financial markets.
The Bank is asset sensitive. The documented hedge risk is that, in a declining
interest rate environment, the Bank is exposed to interest rate risk caused by a
decline in the USD Prime and WSJ prime rates which would reduce the expected
future cash flows of the $10 million principal balance of home equity loans. The
strike rate of the floor purchased is 7%. Consequently, the cash flows hedged
are the changes in cash flows below the 7% strike rate.
There is no margin variability on the hedged cash flows of the home equity
loans. Historically, the USD-Prime rate and the WSJ prime rate have been the
same rate and have changed on the same date.
The floor resets quarterly at March 14, June 14, September 14, and December 14.
The Federal Open Market Committee ("FOMC") meets eight times per year,
approximately every six weeks, and the USD-Prime rate has historically increased
or decreased after their announcement on interest rates. The average number of
days between the FOMC meeting dates and the quarterly reset dates was fifty-one
(51) days for 2006. Over the past two years and historically, the FOMC usually
increases or decreases interest rates in increments of twenty-five (25) basis
points. The estimated cash flow shortfall on the $10 million notional amount for
fifty-one (51) days would be $3,493 ($10,000,000 * 0.0025 * 51/365).
The assessment of the hedge effectiveness at inception and on an ongoing basis
is based on the extent to which changes in USD-Prime rate and WSJ prime rate
have occurred after the FOMC meeting date announcement on interest rates
compared to the floor quarterly reset dates.
The specific guidance relied on to determine the appropriate prospective and
retrospective method of assessing effectiveness was paragraphs 28, 29, 61f, 98
and 99 of SFAS 133. Also, please see the original hedge documentation which
addresses paragraphs 28 and 29 of SFAS 133 and is enclosed with this letter. A
portion of the original hedge documentation, however, is covered under an
accompanying request for confidential treatment pursuant to 17 C.F.R. ss.
200.83.
United States Securities and
Exchange Commission
February 9, 2007
Page 4
The specific quantitative measure used to measure ineffectiveness was the
difference in the average number of days between the quarterly reset dates of
the floor and the meeting dates of the FOMC in each respective calendar year
over the term of the floor. The average number of days in 2006 between the
quarterly reset dates and the FOMC meeting dates was 51 days. Once prime goes
below 7%, the ineffectiveness for any given quarterly reset period would be
$3,493 as calculated above.
The example in paragraphs 98 and 99 of SFAS 133 discuss an asset and liability
that have interest rate resets on two different dates i.e. the end of the month
and the 10th of the month. The measure of ineffectiveness would be the extent to
which changes in the interest rate have occurred during comparable 10-day
periods in the past. This is similar to the average number of days (51) between
the quarterly reset days of the floor and the FOMC meeting dates.
Although the discussion of Method 1: Change in Variable Cash Flows Method of
SFAS 133 Implementation Guidance Issue G7 ("Issue G7") is applicable for cash
flow hedges using an interest rate swap, certain comments implied that it could
be applied to a floor. Specifically, as stated in Issue G7, "[t]he change in
variable cash flows method is consistent with the cash flow objective of
effectively offsetting the changes in the hedged cash flows attributable to the
hedged risk. The method is based on the premise that only the floating rate
component of the swap provides the cash flow hedge, and any change in the swap's
fair value attributable to the fixed-rate leg is not relevant to the variability
of the hedged interest payments(receipts) on the floating-rate liability
(asset)." In purchasing the floor, the Company paid a fixed fee and will receive
variable rate on the notional amount. The floor would be the floating rate
component and provides the cash flow hedge against the variable rate home equity
loans. Issue G7 also provides that "[t]he calculation of ineffectiveness
involves a comparison of the present value of the cumulative change in the
expected future cash flows on the variable leg of the swap and the present value
of the cumulative change in the expected future interest cash flows on the
floating rate asset or liability." The floor would represent the variable leg
and the home equity loans represent the future interest cash flows on the
floating rate asset.
It should be noted that the fee for the five year floor was $152,000. The
Company's net income for 2006 was $2.6 million. Accordingly, the amount included
in the financial statements applicable to SFAS 133 is not considered material to
the financial statements.
United States Securities and
Exchange Commission
February 9, 2007
Page 5
Comment 2.
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o Please provide us with a copy of your formal hedge documentation
you created at the inception of the hedging relationship, which
should clearly document your compliance with paragraphs 28 and 29
of SFAS 133.
Response: The original hedge documentation is enclosed with this response
letter but a portion of such documentation is covered under an accompanying
request for confidential treatment pursuant to 17 C.F.R. ss. 200.83. A copy of
the request for confidential treatment has been submitted to Office of Freedom
of Information and Privacy Act Operations pursuant to 17 C.F.R. 200.83(c)(3).
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
Enclosures: Original Hedge Documentation
Request for Confidential Treatment
Confidential Treatment Request Notification Letter
LETTERHEAD OF CARROLLTON BANCORP
February 9, 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:
The Company has submitted a hedge accounting designation analysis
(Bates Stamp Number CB-0001) (the "Confidential Document") along with its
response letter dated February 9, 2007 (the "Response Letter") to your letter of
January 26, 2007 (the "Second Comment Letter") containing your comments to our
response letter dated January 19, 2007 which responded to your initial comments
regarding the above-referenced filings (the "December 31, 2005 Form 10-K"; the
"September 30, 2006 Form 10-Q").
Pursuant to the procedures set forth in 17 C.F.R. ss. 200.83, the
Company has submitted a request for confidential treatment covering the entirety
of the Confidential Document. Accordingly, the Company has submitted the
Confidential Document in paper form with the Response Letter, but is not filing
the Confidential Document on EDGAR.
Sincerely yours,
/s/Robert A. Altieri
Chief Executive Officer and President
HEDGE INEFFECTIVENESS CALCULATION
CARROLLTON BANK
Floor
Notional amount 10,000,000
Strike rate 7.00%
Home equity loans
float at Prime + 0
margin 25,000,000
Effective date 12/14/2005
Derivative counterparty FTN Financial
Estimated
Floor Days to Cash
FOMC Quarterly Quarterly Notional Flow
Meetings Repricing Reset Amount Rate Time Shortfall
- ------------------------------------------------- ----------------------------------------------
1/31/2006 3/14/2006 42 Average days(51) 10,000,000 0.25% 0.139726 3,493
3/28/2006 6/14/2006 78
5/10/2006 6/14/2006 35
6/29/2006 9/14/2006 77
8/8/2006 9/14/2006 37
9/20/2006 12/14/2006 85 10,000,000 0.25% 1 25,000
10/24/2006 12/14/2006 51
12/12/2006 12/14/2006 2
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407 Shortfall to annual cash flow 13.97%
Average days ineffective 51