(Unaudited)

 

The accompanying unaudited consolidated financial statements of The Savannah Bancorp, Inc. (the “Company”) have been prepared in accordance with accounting principles generally accepted in the United States of America for interim financial information and with the instructions to Form 10-Q and Article S-X. Accordingly, they do not include all of the information and footnotes required by accounting principles generally accepted in the United States of America for complete financial statements. In the opinion of management, all adjustments (consisting of normal recurring accruals) considered necessary for a fair presentation have been included. Operating results for the three month period ended March 31, 2005, are not necessarily indicative of the results that may be expected for the year ending December 31, 2005. For further information, refer to the consolidated financial statements and footnotes thereto, included in the Company's annual report on Form 10-K for the year ended December 31, 2004.

 

The Company's Subsidiary Banks are required by the Federal Reserve Bank to maintain minimum cash reserves based on reserve requirements calculated on their deposit balances. Cash reserves of $1,559,000 and $1,430,000 were required as of March 31, 2005 and December 31, 2004, respectively. The Company pledged interest-bearing cash balances at the Federal Home Loan Bank of Atlanta (“FHLB”) in lieu of investment securities to secure public fund deposits and securities purchased under agreements to resell. Pledged cash balances were $4,700,000 and $12,700,000 at March 31, 2005 and December 31, 2004, respectively.

 

Basic earnings per share represents net income divided by the weighted-average number of common shares outstanding during the period. Diluted earnings per share reflect 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 following:

The Company has one stock-based employee compensation plan. As permitted by Statement of Financial Accounting Standards No. 123, Accounting for Stock-Based Compensation (“Statement No. 123”), the Company accounts for the plan under the recognition and measurement principles of Accounting Principles Board Statement No. 25, Accounting for Stock Issued to Employees (“APB No. 25”) and its related interpretations. Because all options granted under the Company’s plans had an exercise price equal to the market value of the underlying common stock on the date of grant, no stock-based compensation cost is reflected in net income under the Company’s application of APB 25. The Company did not issue any options to non-employees for the three month periods ended March 31, 2005 and 2004, respectively.

 

The following table presents the effects on net income and net income per share if the Company had recognized compensation expense under the fair value recognition provisions of Statement No. 123:

23,500 option shares were granted in the first three months of 2005 and none in the same period of 2004. The fair value of each option grant is estimated on the date of grant using the Black-Scholes option pricing model and is calculated on a basis consistent with the assumptions shown in Note 1 to the Consolidated Financial Statements in the Company’s Annual Report on Form 10-K for the year ended December 31, 2004.

In April 2005, the Securities and Exchange Commission (“SEC”) delayed the effective date of the Financial Accounting Standards Board’s (“FASB”) Statement No. 123R to require the fair value of employee stock options to be expensed. Statement No. 123R was scheduled to take effect beginning with the Company’s first reporting period after June 15. The delay enables the Company to implement Statement No. 123R at the beginning of the Company’s next fiscal year - - instead of reporting period - that begins after June 15.

Various proposals have been issued by the SEC related to changes in filing requirements, accountability of executive management and directors regarding accounting policies, internal controls and audit issues. Although the eventual outcome of these proposals is expected to have no material impact on the Company’s consolidated financial statements, additional costs to comply with certain rules can be expected.

 

 

The Company may, from time to time, make written or oral “forward-looking statements,” including statements contained in the Company’s filings with the SEC (including this quarterly report on Form 10-Q) and in its reports to shareholders and in other communications by the Company, which are made in good faith by the Company pursuant to the “safe harbor” provisions of the Private Securities Litigation Reform Act of 1995.

These forward-looking statements involve risks and uncertainties, such as statements of the Company’s plans, objectives, expectations, estimates and intentions that are subject to change based on various important factors (some of which are beyond the Company’s control). The following factors, among others, could cause the Company’s financial performance to differ materially from the plans, objectives, expectations, estimates and intentions expressed in such forward-looking statements: the strength of the United States economy in general and the strength of the local economies in which the Company conducts operations; the effects of, and changes in, trade, monetary and fiscal policies and laws, including interest rate policies of the Board of Governors of the Federal Reserve System; inflation, interest rate, market and monetary fluctuations; competitors’ products and services; technological changes; acquisitions; changes in consumer spending and saving habits; and the success of the Company at managing the risks involved in the foregoing.

The Company cautions that the foregoing list of important factors is not exclusive. The Company does not undertake to update any forward-looking statement, whether written or oral, that may be made from time to time by or on behalf of the Company.

For a comprehensive presentation of the Company’s financial condition at March 31, 2005 and 2004 and results of operations for the three month periods ended March 31, 2005 and 2004, the following analysis should be reviewed with other information including the Company’s December 31, 2004 Annual Report on Form 10-K.

 

 

 

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(Unaudited)

 

 

Management's Discussion and Analysis of Financial Condition and Results of Operations (“MD & A”) provides supplemental information, which sets forth the major factors that have affected the Company's financial condition and results of operations and should be read in conjunction with the Consolidated Financial Statements and related notes. The MD & A is divided into subsections entitled:

 

Introduction

Critical Accounting Estimate

Results of Operations

Financial Condition and Capital Resources

Liquidity and Interest Rate Sensitivity Management

Off-Balance Sheet Arrangements

These discussions should facilitate a better understanding of the major factors and trends that affect the Company's earnings performance and financial condition and how the Company's performance during the three- month period ended March 31, 2005 compared with the same period in 2004. Throughout this section, The Savannah Bancorp, Inc., and its subsidiaries, collectively, are referred to as "SAVB" or the "Company." The Savannah Bank, N.A. is referred to as "Savannah," Bryan Bank & Trust is referred to as “Bryan” and Harbourside Mortgage Company, a loan production office and division of Savannah, is referred to as “Harbourside”. Collectively, Savannah and Bryan are referred to as the “Subsidiary Banks.”

The averages used in this report are based on daily balances for each respective period.

The Company is headquartered in Savannah, Georgia and, as of March 31, 2005 had 6 banking offices and 7 ATMs in Savannah, Chatham County and Richmond Hill, Georgia. The Company also has mortgage lending offices in Savannah, Richmond Hill and Hilton Head Island, South Carolina.

Savannah and Bryan are in the relatively diverse, stable and growing Savannah Metropolitan Statistical Area. The diversity of major employers includes manufacturing, port related transportation, construction, military, healthcare, tourism, education, warehousing and the supporting services and products for each of these major employers. The real estate market is experiencing moderate government and commercial growth and solid residential growth driven in part by coastal Georgia’s and South Carolina’s reputation as a desired retiree residential destination.

Harbourside, a mortgage loan production office, specifically targets real estate lending and related opportunities in the fast growing coastal South Carolina market. Mortgage loan servicing for loans originated and sold to investors is a relatively new service being offered through Harbourside. Over time, this service may provide significant fee income to the Company and strengthen the banking relationships between the customers and the Subsidiary Banks.

The primary risks to the Company include any trend or event that would cause or result in a significant decline in local employment, real estate values or a decline in loans and core deposits. The Company operates in very competitive markets with the related challenges of competitive pricing on loans, deposits and other banking services. The Company currently has a need to attract brokered deposits to fund substantially higher loan growth. Competition for the best talent is also a strategic challenge faced in competitive markets.

Enhanced growth in loans, deposits, product lines and service quality in existing markets and quality expansion into new markets are the primary strategic objectives of the Company. The Board believes the management team and the operational and internal control infrastructure are largely in place to execute the Board’s objectives over the long term.

 

The Company considers its policies regarding the allowance for credit losses to be its most critical accounting estimate due to the significant degree of management judgment involved. The allowance for credit losses is established through charges in the form of a provision for credit losses based on management's continuous evaluation of the loan portfolio. Credit losses and recoveries are charged or credited directly to the allowance. The amount of the allowance reflects management's opinion of an adequate level to absorb credit losses inherent in the loan portfolio at March 31, 2005. The amount charged to the provision and the level of the allowance is based on management's judgment and is dependent upon growth in the loan portfolio, the total amount of past due loans and nonperforming loans, known loan deteriorations and concentrations of credit. Other factors affecting the allowance are market interest rates, average loan size, portfolio maturity and composition, collateral values and general economic conditions. Finally, management's assessment of probable losses, based upon internal credit grading of the loans and periodic reviews and assessments of credit risk associated with particular loans, is considered in establishing the allowance amount.

No assurance can be given that the Company will not sustain credit losses which would be sizable in relationship to the amount reserved or that subsequent evaluation of the loan portfolio, in light of conditions and factors then prevailing, will not require significant changes in the allowance for credit losses by future charges or credits to earnings. The allowance for credit losses is also subject to review by various regulatory agencies through their periodic examinations of the Subsidiary Banks. Such examinations could result in required changes to the allowance for credit losses. No adjustment in the allowance or significant adjustments to the Banks’ internally classified loans were made as a result of the Subsidiary Banks’ most recent examinations performed by the Office of the Comptroller of the Currency (“OCC”) as of December 31, 2004 or the FDIC as of September 30, 2004.

The allowance for credit losses totaled $6.895 million, or 1.25 percent of total loans, at March 31, 2005. This is compared to an allowance of $6.389 million, or 1.28 percent of total loans, at December 31, 2004. For the three months ended March 31, 2005, the Company reported net charge-offs of $1,000. This is compared to net charge-offs of $110,000, or 0.11 percent of average loans on an annualized basis for the first three months of 2004. During the first three months of 2005, a provision for credit losses of $505,000 was added to the allowance for credit losses compared to $460,000 during the same period in 2004. Significant growth in the Savannah and Harbourside loan portfolios combined with larger credit exposures in new markets provides the primary basis for the provision for credit losses.

If the allowance for credit losses had changed by 5 percent, the effect on net income would have been approximately $214,000. If the allowance had to be increased by this amount, it would not have changed the Subsidiary Banks’ status as well-capitalized financial institutions.

The Company's nonperforming assets consist of other real estate owned, loans on nonaccrual status and loans which are contractually past due 90 days or more on which interest is still being accrued. Other real estate owned of $280,000 consisted of one foreclosed property at March 31, 2005. Nonaccrual loans and loans past due 90 days and greater totaled $364,000, or 0.07 percent of gross loans, at March 31, 2005 compared to $538,000, or 0.11 percent of gross loans, at December 31, 2004. Generally, loans are placed on nonaccrual status when the collection in full of the principal or interest becomes doubtful.

Impaired loans under Statement of Financial Accounting Standards No. 114 were all on nonaccrual status and totaled $364,000 and $538,000 at March 31, 2005 and December 31, 2004, respectively.  

Net income in the first quarter 2005 was $1,781,000, up 56 percent from $1,140,000 in the first quarter 2004. This represents annualized returns of 17.71 percent on average equity and 1.12 percent on average assets in the first quarter 2005. First quarter diluted earnings per share were $0.42 in 2005 compared to $0.27 for 2004.

First quarter net interest income was $6,141,000 in 2005 as compared to $4,491,000 in 2004, an increase of $1,650,000, or 37 percent. The increase included $634,000 of net interest income attributable to the Harbourside division. First quarter average loans were $525 million, 31 percent higher in 2005, as compared to $401 million in 2004. The prime rate increased to 5.75 percent from 4.00 percent in June 2004, in seven successive 25 basis point rate increases during the nine month time period. The first quarter net interest margin increased to 4.07 percent in 2005 from 3.85 percent in 2004. Higher interest rates are expected to favorably impact the net interest margin.

The first quarter provision for credit losses was $505,000 for 2005, compared to $460,000 for the comparable period of 2004, including $250,000 in 2005 related to Harbourside loan growth. Changes in the provision each year are impacted as discussed in the "Allowance for Credit Losses" section above. First quarter loan growth was $53 million in 2005, primarily in real estate loans, compared to $30 million in loan growth in the first quarter, 2004. First quarter net charge-offs were $1,000 in 2005 compared to $110,000 in 2004.

First quarter noninterest income was $994,000 in 2005 compared to $938,000 in 2004, an increase of $56,000 or 6.0 percent. First quarter noninterest income included gains on sale of mortgage loans of $254,000 in 2005 compared to $142,000 in 2004. No market valuation adjustments were required for loans held for sale during the first quarter of 2005 and 2004. The first quarter 2004 noninterest income total included a $91,000 non-recurring gain on sale of other real estate.

First quarter noninterest expense was $3,943,000 in 2005 compared to $3,259,000 in 2004, an increase of $684,000, or 21 percent. First quarter salaries and benefits expense increased $434,000, or 23 percent in 2005 over 2004. The salary and benefits increase included personnel expense increases of $183,000 associated with the Harbourside expansion. First quarter information technology expense increased approximately $42,000, or 16 percent, primarily due to various software upgrades throughout the Company. Other operating expenses increased $143,000, or 22 percent, primarily due to significant increases in professional, audit, regulatory and loan costs. Although no direct Sarbanes Oxley 404 related professional or audit fees have yet been incurred, indirect costs for compliance with the regulations have begun.

The first quarter provision for income taxes was $906,000 in 2005 and $570,000 in 2004. The combined effective federal and state tax rates were 33.7 percent and 33.3 percent in 2005 and 2004, respectively. The slight increase in the effective rate was due primarily to lower tax-exempt interest income in 2005 as compared to 2004. The Company does not record a valuation allowance against deferred tax assets. All deferred tax assets are considered to be realizable due to expected future taxable income.

The major changes in the assets and liabilities of the Company for the current period and the prior comparative period are shown in the consolidated statements of cash flows. The first three months increase in loans of $53 million in 2005 was funded primarily by $64 million in deposits. Deposit growth included $46 million in time deposits issued through brokers.

The Company has classified all investment securities as available for sale. Higher interest rates resulted in an overall decrease in unrealized gains on investment securities. These amounts are included in shareholders’ equity at March 31, 2005 and 2004 as other accumulated comprehensive income (loss).

Average total assets increased 30 percent in the first quarter to $645 million in 2005 from $498 million in 2004. Total assets were $673 million and $523 million at March 31, 2005 and 2004, respectively, an increase of 29 percent. The Harbourside division accounted for approximately $112 million of the March 31, 2005 assets.

The mortgage lending opportunities created by the Harbourside loan production division impact the funding sources, capital requirements and liquidity of Savannah. Historically, virtually all deposits at Savannah have been obtained from local customers. Since February 2004, funding sources have been expanded and total deposits included brokered time deposits of $134 million at March 31, 2005. Additional short-term borrowings from the FHLB were also used, primarily to fund loans held for sale. Lower growth in brokered time deposits is anticipated for the remainder of 2005. Higher growth in local core deposits and higher levels of borrowings from the FHLB are also anticipated.

The OCC has adopted capital requirements that specify the minimum level for which no prompt corrective action is required. In addition, the FDIC assesses FDIC insurance premiums based on certain “well-capitalized” risk-based and equity capital ratios. As of March 31, 2005, the Subsidiary Banks exceeded the minimum requirements necessary to be classified as “well-capitalized.”

Total equity capital for the Company was $41.4 million, or 6.14 percent of total assets at March 31, 2005. The table below includes the regulatory capital ratios for the Company and each Subsidiary Bank along with the minimum capital ratio and the ratio required to maintain a well-capitalized regulatory status.

   

($ in thousands)	Company		Savannah		Bryan		Minimum	Well- Capitalized
Qualifying Capital
Tier 1 capital	$51,463		$37,922		$12,196		-	-
Total capital	58,358		43,116		13,857		-	-
Leverage Ratios
Tier 1 capital to average assets	7.97%		7.73%		7.88%		4.00%	5.00%
Risk-Weighted Ratios
Tier 1 capital to risk-weighted assets	9.29%		9.02%		9.18%		4.00%	6.00%
Total capital to risk-weighted assets	10.53%		10.25%		10.43%		8.00%	10.00%

Tier 1 and total capital at the Company level includes $10.3 million of subordinated debt issued to the Company’s nonconsolidated subsidiaries. Total capital also includes the allowance for credit losses up to 1.25 percent of risk-weighted assets.

The Company’s higher asset growth rate during the last twelve months has resulted in lower capital ratios. The capital ratios are significantly above the well-capitalized threshold, except for the Total Capital to Risk-Weighted Assets ratios at the Subsidiary Banks which are at levels which require short-term and long-term planning as well as continuous monitoring.

 

The objectives of funds management include maintaining adequate liquidity and preserving reasonable balance between the repricing of interest sensitive assets and liabilities. The goal of liquidity management is to ensure the availability of adequate funds to meet the loan demands and the deposit withdrawal needs of customers. This is achieved through maintaining a combination of sufficient liquid assets, core deposit growth and unused capacity to purchase and borrow funds in the money markets.

 

In addition to local deposit growth, primary funding and liquidity sources include borrowing capacity with the FHLB, temporary federal funds purchased lines with correspondent banks and non-local time deposits through brokers and an Internet bulletin board service. Backup funding and liquidity sources include the ability to sell loans or participations in certain loans to investors and borrowing from the Federal Reserve Bank of Atlanta discount window.

 

Savannah and Bryan have credit lines approved by the FHLB of 20 percent and 16 percent of assets, respectively, subject to the FHLB collateral requirements. Both Subsidiary Banks have a Blanket Floating Lien Agreement with the FHLB. Under these agreements, the Subsidiary Banks have credit lines up to 80 percent of the FHLB qualifying collateral value of their 1-4 family first mortgage loans. In addition, Savannah’s credit line includes up to 50 percent of the FHLB qualifying collateral value of their home equity lines of credit and second mortgage loans. In aggregate, the Company has FHLB borrowing capacity of approximately $128 million of which $30 million was advanced at March 31, 2005. Qualifying collateral reports have been filed providing immediately accessible funding of approximately $87 million. These credit arrangements serve as a core funding source as well as liquidity backup for the Banks. The Subsidiary Banks also have conditional federal funds borrowing lines available from upstream correspondent banks that can provide $15-20 million of temporary funding needs for 30-60 days.

 

A continuing objective of asset/liability management is to maintain appropriate levels of variable rate assets, including variable rate loans and shorter-maturity investments, relative to interest rate sensitive liabilities, in order to control potential negative impacts upon earnings due to changes in interest rates. Interest rate sensitivity management requires analyses and actions that take into consideration volumes of assets and liabilities repriced and the timing and magnitude of their price changes to determine the effect upon net interest income.

 

The Company’s cash flow maturity and repricing gap at March 31, 2005 was approximately $113 million at one year, or 17 percent of total interest-earning assets. Fixed rate earning assets with maturities over five years totaled $16 million, or 2.5 percent of total interest-earning assets. See Table 1 for cash flow maturity and repricing gap.

 

The Company is asset-sensitive within one year. The Company is well-positioned for a rising rate environment, which began in the second quarter 2004. The Federal Reserve increased the federal funds target rate by 25 basis points seven times between June 30, 2004 and March 22, 2005. It has communicated a bias toward higher interest rates implemented in a measured process.

 

The gap position between one and five years is of less concern because management has time to respond to changing financial conditions and interest rates with actions that reduce the impact of the longer-term gap positions on net interest income. However, fixed rate assets with maturities over five years may include significant rate risk and market value of equity concerns in the event of significant interest rate increases.

 

Management monitors interest rate risk quarterly using rate-sensitivity gap analysis, rate shock simulation and performance forecasting measures. If and when projected interest rate risk exposures are outside of policy tolerances, specific actions to return interest rate risk exposures to acceptable levels are reported to the Board by management. Management continues to upgrade its interest rate risk reporting systems to provide better information on a more frequent basis. These capabilities are especially valuable during periods of volatile interest rates.

 

 

 

 

Table 3 - Off-Balance Sheet Arrangements

 

In order to meet the financing needs of its customers, the Company is a party to financial instruments with off-balance sheet risks in the normal course of business. At March 31, 2005, the Company had unfunded commitments to extend credit of $135.5 million and outstanding stand-by letters of credit of $7.5 million. Since many of the commitments are expected to expire without being drawn upon, the total commitment amounts do not necessarily represent future cash requirements. The Company uses the same credit policies in establishing commitments and issuing letters of credit as it does for on-balance sheet instruments. Management does not anticipate that funding obligations arising from these financial instruments will adversely impact its ability to fund future loan growth or deposit withdrawals.

The following table includes a breakdown of short-term and long-term payments due under long-term contracts:

 

 

 

 

 

 

 

 

We have evaluated the effectiveness of the design and operation of our disclosure controls and procedures as of the end of the period covered by this quarterly report as required by Rule 13a-15 of the Securities Exchange Act of 1934, as amended. This evaluation was carried out under the supervision and with the participation of our management, including our chief executive officer, president and chief financial officer.

Based on this evaluation, the chief executive officer, president and chief financial officer have concluded that our disclosure controls and procedures are effective in timely alerting them to material information relating to The Savannah Bancorp, Inc. (including its consolidated subsidiaries) required to be included in our periodic SEC filings. No changes occurred during the period covered by this report that materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.

Item 1. Legal proceedings. None

Item 2. Unregistered sales of equity securities and use of proceeds. None

Item 3. Defaults upon senior securities. None

Item 4. Submission of matters to a vote of security holders. None

Item 5. Other information. None

Item 6. Exhibits

Exhibit 11.  Computation of Per Share Earnings *

*     Data required by Statement of Financial Accounting Standards No. 128, Earnings per Share, is provided in Note 3 to the condensed consolidated financial statements in this report.

Exhibit 31.1  Certification Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002

Exhibit 31.2  Certification Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002

Exhibit 31.3  Certification Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002

Exhibit 32 Certification Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002

Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.

 

 

	The Savannah Bancorp, Inc.
	(Registrant)
Date:  5-11-05	/s/  G. Mike Odom, Jr.
	G. Mike Odom, Jr. Chief Executive Officer (Principal Executive Officer)
Date:  5-11-05	/s/ John C. Helmken II
	John C. Helmken II President
Date:  5-11-05	/s/  Robert B. Briscoe
	Robert B. Briscoe Chief Financial Officer (Principal Financial Officer)