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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-K
FOR ANNUAL AND TRANSITION REPORTS
PURSUANT TO SECTIONS 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
(Mark One)
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
For the fiscal year ended December 31, 2002
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the transition period from ___________ to __________
Commission File No. 0-18279
TRI-COUNTY FINANCIAL CORPORATION
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(Exact name of registrant as specified in its charter)
MARYLAND 52-1652138
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(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
3035 LEONARDTOWN ROAD, WALDORF, MARYLAND 20601
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(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code: (301) 645-5601
Securities registered pursuant to Section 12(b) of the Act: NONE
Securities registered pursuant to Section 12(g) of the Act:
COMMON STOCK, PAR VALUE $.01 PER SHARE
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(Title of Class)
Indicate by check mark whether the registrant (1) has filed all reports required
by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the
preceding 12 months (or 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
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Indicate by check mark if disclosure of delinquent filers pursuant to Item 405
of Regulation S-K is not contained herein, 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. [ X ]
Indicate by check mark whether the registrant is an accelerated filer (as
defined in Exchange Act Rule 12b-2). Yes No X
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At December 31, 2002, the registrant had 767,549 shares of its Common Stock,
$0.01 par value, outstanding. The aggregate market value of voting stock held by
non-affiliates of the registrant at March 26, 2003, was approximately $26.2
million based on the price at which the Common Stock was last sold. For purposes
of this calculation only, the shares held by directors and executive officers of
the registrant and by any stockholder beneficially owning more than 5% of the
registrant's outstanding common stock are deemed to be shares held by
affiliates.
Number of shares of Common Stock outstanding as of March 3, 2003: 767,649
DOCUMENTS INCORPORATED BY REFERENCE
1. Portions of Proxy Statement for 2003 Annual Meeting of Stockholders. (Part
III)
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PART I
ITEM 1. BUSINESS
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Tri-County Financial Corporation (the "Company") is a bank holding company
organized in 1989 under the laws of the State of Maryland. It presently owns all
the outstanding shares of capital stock of the Community Bank of Tri-County (the
"Bank"), a Maryland-chartered commercial bank. The Bank was originally organized
in 1950 as Tri-County Building and Loan Association of Waldorf, a mutual savings
and loan association, and in 1986 converted to a federal stock savings bank and
adopted the name Tri-County Federal Savings Bank. In 1997, the Bank converted to
a Maryland-chartered commercial bank and adopted its current corporate title.
The Company engages in no significant activity other than holding the stock of
the Bank and operating the business of the Bank. Accordingly, the information
set forth in this report, including financial statements and related data,
relates primarily to the Bank and its subsidiaries.
The Bank serves the southern Maryland counties of Charles, Calvert and St.
Mary's through its main office and seven branches located in Waldorf, Bryans
Road, Dunkirk, Leonardtown, La Plata, Charlotte Hall, and California, Maryland.
During 2002, the Bank closed one of its Waldorf branches. The Bank also operates
fourteen Automated Teller Machines ("ATMs") including six stand-alone locations
in the Tri-County area. The Bank is engaged in the commercial and retail banking
business as authorized by the banking statutes of the State of Maryland and
applicable Federal regulations, including the acceptance of demand and time
deposits, and the origination of loans to individuals, associations,
partnerships and corporations. The Bank's real estate financing consists of
residential first and second mortgage loans, home equity lines of credit and
commercial mortgage loans. Commercial lending consists of both secured and
unsecured loans. The Bank is a member of the Federal Reserve and Federal Home
Loan Bank ("FHLB") Systems and its deposits are insured up to applicable limits
by Savings Association Insurance Fund ("SAIF") of the Federal Deposit Insurance
Corporation ("FDIC").
The Company's executive offices are located at 3035 Leonardtown Road, Waldorf,
Maryland. Its telephone number is (301) 645-5601. The Bank also maintains a
website at www.communitybktricounty.com.
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MARKET AREA
The Bank considers its principal lending and deposit market area to consist of
the Southern Maryland counties of Charles, Calvert and St. Mary's. These
counties have experienced significant population growth during the past decade
due to their proximity to the rapidly growing Washington, D.C. and Baltimore
metropolitan areas. Southern Maryland is generally considered to have more
affordable housing than many other Washington and Baltimore area suburbs. In
addition, the area has experienced rapid growth in businesses and federal
facilities located in the area. Major federal facilities include the Patuxent
Naval Air Station in St. Mary's county. The Patuxent Naval Air Station has
undergone significant expansion in the last several years and is projected to
continue to expand for several more years.
Rapid growth in our market area has been constrained by certain government
policies, as all three counties have attempted to limit growth in certain areas.
These policies have created some uncertainty about zoning and land use
regulations. In some cases, real estate development work has been delayed or
cancelled as a result of these policies. Recently Charles county introduced a
user fee system which would involve upfront payments in real estate development
but would remove subsequent regulatory delays. This system is expected to be
fully implemented in 2003. Future developments in this area may adversely affect
the Bank's loan growth.
LENDING ACTIVITIES
GENERAL. The Bank offers a wide variety of consumer and commercial loans. The
Bank's lending activities include residential and commercial real estate loans,
construction loans, land acquisition and development loans, equipment financing,
and commercial and consumer demand and installment loans. Most of the Bank's
customers are residents of, or businesses located in the southern Maryland area.
The Bank's primary market for commercial loans consists of small and medium
sized businesses located in southern Maryland. The Bank believes that this
market is responsive to the Bank's ability to provide personal service and
flexibility. The Bank attracts customers for its consumer lending products based
upon its ability to offer
2
service, flexibility, and competitive pricing, as well as by leveraging
other banking relationships such as soliciting deposit customers for loans.
The Bank's previous savings and loan charter restricted its ability to hold
certain loan types in its portfolio. As a result, prior to its conversion to a
state chartered commercial bank, the Bank's loan portfolio was primarily
comprised of residential mortgage loans. Since conversion, the Bank has moved to
diversify its lending by adding a larger portion of commercial real estate,
commercial, and consumer loans to its portfolio. Management believes that this
diversification of the loan portfolio will increase the Bank's overall long-term
financial performance. Management recognizes that these new loan types may
increase the Bank's risk of losses due to loan default.
RESIDENTIAL FIRST MORTGAGE LOANS. Prior to its conversion to a commercial bank
on March 29, 1997, residential first mortgages made up the majority of the
Bank's loan portfolio. Since that date, residential first mortgage loans have
represented a progressively smaller portion of the Bank's loan portfolio. Since
December 31, 1997, residential first mortgage loans have decreased in dollar
amount to $50.0 million from $62.2 million, while falling as a percentage of the
loan portfolio to 24.4% from 50%.
Residential first mortgage loans made by the Bank are generally long-term loans,
amortized on a monthly basis, with principal and interest due each month. The
initial contractual loan payment period for residential loans typically ranges
from 10 to 30 years. The Bank's experience indicates that real estate loans
remain outstanding for significantly shorter periods than their contractual
terms. Borrowers may refinance or prepay loans at their option, without penalty.
The Bank originates both fixed- and adjustable-rate residential first mortgages.
The Bank emphasizes the origination of adjustable-rate mortgages for its
portfolio. The Bank offers mortgages which are adjustable on a one, three, and
five-year basis generally with limitations on upward adjustments of two
percentage points per year and six percentage points over the life of the loan.
The Bank markets adjustable-rate loans with rate adjustments based upon a United
States Treasury bill index. As of December 31, 2002, the Bank had $19.4 million
in residential mortgage loans using a U.S. Treasury bill index. In the past, the
Bank also offered adjustable-rate mortgage loans based upon other indices
including various cost of funds indices. These adjustable rate loans totaled
$148 thousand as of December 31, 2002. The Bank also offers long-term,
fixed-rate loans. Fixed-rate loans may be packaged and sold in the secondary
market, primarily to the Federal Home Loan Mortgage Corporation ("FHLMC"),
private mortgage correspondents, the Federal National Mortgage Association
("FNMA") and the Mortgage Partnership Finance program of the FHLB of Atlanta.
The Bank may also add these loans to its portfolio. Depending on market
conditions the Bank may elect to retain the right to service the loans sold for
a payment based upon a percentage, (generally 0.25% of the outstanding loan
balance). These servicing rights may be sold to other qualified servicers. As of
December 31, 2002, the Bank serviced $73.2 million in residential mortgage loans
for various organizations.
The retention of adjustable-rate mortgage loans in the Bank's loan portfolio
helps reduce the negative effects of increases in interest rates on the Bank's
net interest income. Under certain conditions, however, the annual and lifetime
limitations on interest rate adjustments may limit the increases in interest
rates on these loans. There are also unquantifiable credit risks resulting from
potential increased costs to the borrower as a result of repricing of
adjustable-rate mortgage loans. It is foreseeable that during periods of rising
interest rates, the risk of default on adjustable-rate mortgage loans may
increase due to the upward adjustment of interest cost to the borrower. In
addition, depending on market conditions, the initial interest rate on
adjustable-rate loans is generally lower than that on a fixed-rate loan of
similar credit quality and size.
The Bank makes loans up to 95% of appraised value or sales price of the
property, whichever is less, to qualified owner-occupants upon the security of
single-family homes. Non-owner occupied one- to four-family loans and loans
secured by other than residential real estate are generally permitted to a
maximum 70% loan-to-value of the appraised value depending on the overall
strength of the application. The Bank currently requires that substantially all
residential loans with loan-to-value ratios in excess of 80% carry private
mortgage insurance to lower the Bank's exposure to approximately 80% of the
value of the property.
3
All improved real estate which serves as security for a loan made by the Bank
must be insured, in the amount and by such companies as may be approved by the
Bank, against fire, vandalism, malicious mischief and other hazards. Such
insurance must be maintained through the entire term of the loan and in an
amount not less than that amount necessary to pay the Bank's indebtedness in
full.
COMMERCIAL REAL ESTATE AND OTHER NON-RESIDENTIAL REAL ESTATE LOANS. The Bank has
increased its emphasis on loans for the permanent financing of commercial and
other improved real estate projects, including, to a limited extent, office
buildings, as well as churches and other special purpose projects. As a result,
commercial real estate loans increased $8.7 million or 13.2% during 2002. The
primary security on a commercial real estate loan is the real property and the
leases which produce income for the real property. Commercial real estate loans
amounted to approximately $74.3 million or 37.1% of the Bank's loan portfolio at
December 31, 2002. The Bank generally limits its exposure to a single borrower
to 15% of the Bank's capital and frequently participates with other lenders on
larger projects. Loans secured by commercial real estate are generally limited
to 80% of appraised value and have an initial contractual loan payment period
ranging from three to 20 years. Virtually all of the Bank's commercial real
estate loans, as well as its construction loans discussed below, are secured by
real estate located in the Bank's primary market area.
Loans secured by commercial real estate are larger and involve greater risks
than one to four family residential mortgage loans. Because payments on loans
secured by such properties are often dependent on the successful operation or
management of the properties, repayment of such loans may be subject to a
greater extent to adverse conditions in the real estate market or the economy.
As a result of the greater emphasis that the Bank places on commercial real
estate loans under its business plan as a commercial bank, the Bank is
increasingly exposed to the risks posed by this type of lending.
CONSTRUCTION AND LAND DEVELOPMENT LOANS. The Bank offers construction loans to
individuals and building contractors primarily for the construction of one- to
four-family dwellings. Loans to individuals primarily consist of
construction/permanent loans which have fixed rates, payable monthly for the
construction period and are followed by a 30-year, fixed or adjustable rate
permanent loan. The construction/permanent loans provide for disbursement of
loan funds based on draw requests submitted by the builder during construction
and site inspections by independent inspectors. The Bank will also make a
construction loan if the borrower has a commitment from another lender for a
permanent loan at the completion of the construction. These loans typically have
terms of six months. The application process includes the same items which are
required for other mortgage loans and also requires the borrower to submit to
the Bank accurate plans, specifications, and costs of the property to be
constructed. These items are used as a basis to determine the appraised value of
the subject property.
The Bank also provides construction and land development loans to home building
and real estate development companies. Generally, these loans are secured by the
real estate under construction as well as by guarantees of the principals
involved. Draws are made upon satisfactory completion of pre-defined stages of
construction or development. The Bank will lend up to 80% of the appraised
value.
The Bank also offers builders lines of credit, which are revolving notes
generally secured by real property. Outstanding builders lines of credit
amounted to approximately $9.0 million at December 31, 2002. The Bank offers a
builder's master note program in which the builder receives a revolving line of
credit at a market rate and the Bank obtains security in the form of a first
lien on home sites under construction.
In addition, the Bank offers loans for the purpose of acquisition and
development of land, as well as loans on undeveloped, subdivided lots for home
building by individuals. Land acquisition and development loans, included in
construction loans discussed above, totaled $5.4 million at December 31, 2002.
Bank policy requires that zoning and permits must be in place prior to making
development loans.
The Bank's ability to originate all types of construction and development loans
is heavily dependent on the continued demand for single-family housing
construction in the Bank's market areas. In the event the demand for new houses
in the Bank's market areas were to decline, the Bank may be forced to shift a
portion of its lending emphasis. There can be no assurance of the Bank's ability
to continue growth and profitability in its construction lending activities in
the event of such a decline.
4
Construction and land development loans are inherently riskier than providing
financing on owner occupied real estate. The Bank's risk of loss is dependent on
the accuracy of the initial estimate of the market value of the completed
project as well as the accuracy of the cost estimates made to complete the
project. As these projects may take an extended period of time to complete,
market, economic, and regulatory conditions may change during the construction
or development period.
HOME EQUITY AND SECOND MORTGAGE LOANS. The Bank has maintained a growing level
of home equity and second mortgage loans in recent years. Home equity loans,
which totaled $14.3 million at December 31, 2002, are generally made in the form
of lines of credit with minimum amounts of $5,000, have terms of up to 20 years,
variable rates priced at prime or some margin above prime and require an 80% or
90% loan-to-value ratio (including any prior liens), depending on the specific
loan program. Second mortgage loans which totaled $4.7 million at December 31,
2002 are fixed and variable rate loans which have original terms between 5 and
15 years. Loan-to-value ratios of up to 80% or 90% are allowed depending on the
specific loan program.
These products represent a higher risk of default than residential first
mortgages as in the event of foreclosure, the first mortgage would need to be
paid off prior to collection of the second. The Bank believes that its policies
and procedures are sufficient to mitigate the additional risk.
CONSUMER AND COMMERCIAL LOANS. The Bank has developed a number of programs to
serve the needs of its customers with primary emphasis upon direct loans secured
by automobiles, boats, recreational vehicles and trucks and heavy equipment. The
Bank also makes home improvement loans and offers both secured and unsecured
lines of credit.
The Bank also offers a variety of commercial loan services including term loans,
lines of credit and equipment financing. The Bank's commercial loans are
primarily underwritten on the basis of the borrower's ability to service the
debt from income. Such loans are generally made for terms of five years or less
at interest rates which adjust periodically.
The higher interest rates and shorter loan terms available on commercial and
consumer lending make these products attractive to the Bank. In particular, the
consumer and commercial loan portfolio will increase its yield as interest rates
increase. Consumer and commercial business loans, however, entail greater risk
than residential mortgage loans, particularly in the case of consumer loans
which are unsecured or secured by rapidly depreciable assets such as
automobiles. In such cases, any repossessed collateral may not provide an
adequate source of repayment of the outstanding loan balance as a result of the
greater likelihood of damage, loss or depreciation. The remaining deficiency
often does not warrant further substantial collection efforts against the
borrower. In addition, consumer loan collections are dependent on the borrower's
continuing financial stability, and thus are more likely to be adversely
affected by job loss, divorce, illness or personal bankruptcy. Furthermore, the
application of various Federal and state laws including Federal and state
bankruptcy and insolvency laws, may limit the amount which can be recovered on
such loans. Such loans may also give rise to claims and defenses by a consumer
loan borrower against an assignee such as the Bank, and a borrower may be able
to assert against such assignee claims and defenses which it has against the
seller of the underlying collateral.
5
LOAN PORTFOLIO ANALYSIS. Set forth below is selected data relating to the
composition of the Bank's loan portfolio by type of loan on the dates indicated.
AT DECEMBER 31,
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2002 2001 2000
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AMOUNT % AMOUNT % AMOUNT %
------ ------ ------ ------ ------ ------
Real Estate Loans
Residential first mortgage $ 48,976 24.44% $ 61,430 31.26% $ 67,975 38.89%
Commercial 74,292 37.07% 65,617 33.39% 42,226 24.16%
Construction and land development 14,579 7.27% 18,136 9.23% 17,301 9.90%
Home equity and second mortgage 19,007 9.48% 18,580 9.46% 18,637 10.66%
Commercial loans 29,947 14.94% 18,539 9.44% 15,047 8.61%
Consumer loans 13,630 6.80% 14,187 7.22% 13,610 7.79%
-------- ------ -------- ------ -------- ------
Total loans 200,431 100.00% 196,489 100.00% 174,796 100.00%
====== ====== ======
Less: Deferred loan fees 668 757 776
Loan loss reserve 2,314 2,282 1,930
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Loans receivable, net $197,449 $193,450 $172,090
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AT DECEMBER 31,
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1999 1998
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AMOUNT % AMOUNT %
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Real Estate Loans
Residential first mortgage $ 66,263 44.42% $ 64,243 47.55%
Commercial 29,947 20.08% 19,733 14.60%
Construction and land development 17,142 11.49% 20,776 15.38%
Home equity and second mortgage 16,691 11.19% 16,314 12.07%
Commercial loans 10,025 6.72% 6,161 4.56%
Consumer loans 9,102 6.10% 7,889 5.84%
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Total loans 149,170 100.00% 135,116 100.00%
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Less: Deferred loan fees 808 930
Loan loss reserve 1,653 1,540
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Loans receivable, net $146,710 $132,646
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6
LOAN ORIGINATIONS, PURCHASES AND SALES. The Bank solicits loan applications
through its branch network, direct solicitation of customers, referrals from
customers, and marketing by commercial and residential mortgage loan officers.
Loans are processed and approved according to guidelines deemed appropriate for
each product type. Loan requirements such as income verification, collateral
appraisal, credit reports, etc. vary by loan type. Loan processing functions are
generally centralized except for small consumer loans. Loan approval authority
is established by Board policy and delegated as deemed necessary and
appropriate. Loan approval authorities vary by individual with the President
having approval authority up to $750,000, Senior Vice Presidents up to $400,000,
and Business Development officers up to $150,000. Authorities may be combined up
to $1,000,000. For residential mortgage loans, the residential loan underwriter
may approve loans up to the conforming loan limit of $307,000. Selected branch
personnel may approve secured loans up to $75,000, and unsecured loans up to
$50,000. A loan committee consisting of the President and two members of the
Board, ratify all real estate mortgages and approve all loans in excess of
$1,000,000. Depending on the loan and collateral type, conditions for protecting
the Bank's collateral are specified in the loan documents. Typically these
conditions might include requirements to maintain hazard and title insurance,
pay property taxes, and other conditions.
Depending on market conditions, mortgage loans may be originated primarily with
the intent to sell to third parties such as FNMA or FHLMC. During the year 2002,
the Bank sold $23.9 million of mortgage loans which were originated during the
year generating $499 thousand in income. In order to comply with internal and
regulatory limits on loans to one borrower, the Bank routinely sells portions of
commercial and commercial real estate loans to other lenders. The Bank also
routinely buys portions of loans, whole loans, or participation certificates
from other lenders. The Bank only purchases loans or portions of loans after
reviewing loan documents, underwriting support, and other procedures as
necessary. Purchased loans are subject to the same regulatory and internal
policy requirements as other loans in the Bank's portfolio.
LOANS TO ONE BORROWER. Under Maryland law, the maximum amount which the Bank is
permitted to lend to any one borrower and their related interests may generally
not exceed 10% of the Bank's unimpaired capital and surplus which is defined to
include the Bank's capital, surplus, retained earnings and 50% of its reserve
for possible loan losses. Under this authority, the Bank would have been
permitted to lend up to $2.8 million to any one borrower at December 31, 2002.
By interpretive ruling of the Commissioner of Financial Regulation, Maryland
banks have the option of lending up to the amount that would be permissible for
a national bank which is generally 15% of unimpaired capital and surplus
(defined to include a bank's total capital for regulatory capital purposes plus
any loan loss allowances not included in regulatory capital). Under this
formula, the Bank would have been permitted to lend up to $4.4 million to any
one borrower at December 31, 2002. At December 31, 2002, the largest amount
outstanding to any one borrower and their related interests was $3.0 million.
LOAN COMMITMENTS. The Bank does not normally negotiate standby commitments for
the construction and purchase of real estate. Conventional loan commitments are
granted for a one-month period. The total amount of the Bank's outstanding
commitments to originate loans at December 31, 2002, was approximately $4.0
million, excluding undisbursed portions of loans in process. It has been the
Bank's experience that few commitments expire unfunded.
MATURITY OF LOAN PORTFOLIO. The following table sets forth certain information
at December 31, 2002 regarding the dollar amount of loans maturing in the Bank's
portfolio based on their contractual terms to maturity. Demand loans, loans
having no stated schedule of repayments and no stated maturity, and overdrafts
are reported as due in one year or less.
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Due within 1 Due after 1through Due more than
year after 5 years from 5 years from
December 31, 2002 December 31, 2002 December 31, 2002 Total
----------------- ------------------ ----------------- -----
Real estate loans--
Residential first mortgages $ 2,478 $ 10,717 $ 35,781 $ 48,976
Commercial 4,078 10,842 59,372 74,292
Construction 10,782 3,798 -- 14,580
Home equity and second mortgage 15,042 1,792 2,173 19,007
Commercial loans 24,907 5,040 -- 29,947
Consumer loans 3,188 10,139 302 13,629
-------- -------- -------- ---------
$ 60,475 $ 42,328 $ 97,628 $ 200,431
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The following table sets forth the dollar amount of all loans due after one year
from December 31, 2002 which have predetermined interest rates and have floating
or adjustable interest rates.
Floating or
Fixed Rates Adjustable Rates Total
----------- ---------------- -----
Real estate loans--
Residential first mortgages $ 27,329 $ 19,169 $ 46,498
Commercial 4,007 66,207 70,214
Construction 883 2,915 3,798
Home equity and second mortgage 3,965 -- 3,965
Commercial loans -- 5,040 5,040
Consumer loans 10,229 212 10,441
-------- -------- --------
$ 46,413 $ 93,543 $139,956
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DELINQUENCIES. The Bank's collection procedures provide that when a loan is 15
days delinquent, the borrower is contacted by mail and payment is requested. If
the delinquency continues, subsequent efforts will be made to contact the
delinquent borrower and obtain payment. If these efforts prove unsuccessful, the
Bank will pursue appropriate legal action including repossession of the
collateral and other actions as deemed necessary. In certain instances, the Bank
will attempt to modify the loan or grant a limited moratorium on loan payments
to enable the borrower to reorganize his financial affairs.
NON-PERFORMING ASSETS AND ASSET CLASSIFICATION. Loans are reviewed on a regular
basis and are placed on a non-accrual status when, in the opinion of management,
the collection of additional interest is doubtful. Residential mortgage loans
are placed on non-accrual status when either principal or interest is 90 days or
more past due unless they are adequately secured and there is reasonable
assurance of full collection of principal and interest. Consumer loans generally
are charged off when the loan becomes more than 120 days delinquent. Commercial
business and real estate loans are placed on non-accrual status when the loan is
90 days or more past due or when the loan's condition puts the timely repayment
of principal and interest in doubt. Interest accrued and unpaid at the time a
loan is placed on non-accrual status is charged against interest income.
Subsequent payments are either applied to the outstanding principal balance or
recorded as interest income, depending on management's assessment of the
ultimate collectibility of the loan.
8
Real estate acquired by the Bank as a result of foreclosure or by deed in lieu
of foreclosure is classified as foreclosed real estate until such time as it is
sold. When such property is acquired, it is recorded at its fair market value.
Subsequent to foreclosure, the property is carried at the lower of cost or fair
value less selling costs. Additional write-downs as well as carrying expenses of
the foreclosed properties are charged to expenses in the current period. The
Bank had foreclosed real estate with a fair market value of approximately $716
thousand at December 31, 2002.
FORECLOSED REAL ESTATE
The largest portion of the foreclosed real estate, $450 thousand, is related to
one development project. This development project was acquired in July 2001 by
deed in lieu of foreclosure and had an original carrying value of $1.3 million.
The property consisted of 54 acres in Charles County that the borrower planned
to develop into 150 single-family lots. After the borrower had received
preliminary approval for the project's first phase (consisting of 41 lots) in
July 1999, the County sought to retroactively impose more restrictive
requirements for preliminary approvals. The borrower had another project in the
County (not financed by the Bank) for which preliminary approval had not been
received. The borrower did not challenge the retroactive application of the new
rules to the subject parcel and attempted to secure preliminary approvals for
both projects under the new regime. When the second lender threatened
foreclosure on the other parcel, however, the borrower conveyed the development
project to the Bank by deed in lieu of foreclosure.
When the Bank acquired the property, it consulted with counsel who advised that
the prior grant of preliminary approval was binding on the County. In addition,
the County had announced that it would adopt a fee-based permitting scheme in
2003 that would facilitate the development of Phase 2 of the project. In light
of these circumstances, an independent appraisal determined that the property's
market value exceeded its carrying value. Accordingly, no valuation allowances
were established with respect to the property at that time.
After obtaining title, the Bank challenged the county's position that its
preliminary approval of the first phase was no longer in force and in June 2002,
secured a clarification in the rules that accepted the validity of the
preliminary approval. The Bank thereupon put the parcel out for bid and bids
received were substantially below the Bank's price target. Based on the results
of the bidding, the Bank determined that a valuation allowance of $776 thousand
was required to adjust the carrying value of the property to the $500 thousand
indicated by the bids. Subsequently, the Bank contacted other potential buyers
and entered into a sales agreement for the property. Terms of the agreement
called for an immediate purchase of Phase 1 of the project for $204 thousand.
The agreement also provided that Phase 2, consisting of 112 lots would be
purchased by the buyer as preliminary approval was received, at a price of $15
thousand per lot. Total sales price for Phase 2 would be $1.7 million and the
total sales price for both phases would be $1.9 million. Under the terms of the
agreement, the buyer is responsible for all development costs associated with
both phases. The buyer paid for all of Phase 1 in December 2002, and made a
minimal down payment on Phase 2. The sales agreement provides for a minimal (
$25 thousand) payment to the Bank should the buyer decide to not complete its
purchase of Phase 2. The Bank did not provide financing for the sales agreement
or subsequent development work. Based upon these facts and circumstances the
Bank recognized the sale of Phase 1 and reduced the balance in foreclosed real
estate by a portion of the $204 thousand proceeds. The remainder of the sales
price was recognized as a partial recovery of the valuation allowance and profit
on the sale of the property. The Bank determined that no sales recognition on
the agreement to sell Phase 2 is appropriate at this time. The amount of the
remaining allowance and total carrying value of Phase 2 will be periodically
evaluated for possible impairment.
Another foreclosed property had been previously acquired by the Bank with an
original carrying value of $275,000. In evaluating the property for sale during
the second quarter of 2002, it was discovered that there was a special
geological formation known as a "vernal pool" on the property causing it to be
treated as wetland under state and federal law. Since the property could no
longer be developed as planned, the Bank
9
established a $250,000 valuation allowance to bring its carrying value down to a
nominal $25,000. Other properties in the foreclosed real estate section of the
balance sheet consist of various properties currently being marketed by the
Bank.
The following table sets forth information with respect to the Bank's
non-performing loans for the years indicated. During the years shown, the Bank
had no impaired loans within the meaning of Statement of Financial Accounting
Standards No. 114 and 118.
AT DECEMBER 31,
---------------------------------------------------------
2002 2001 2000 1999 1998
-------- ------- -------- ------- -------
(DOLLARS IN THOUSANDS)
Restructured Loans $ -- $ -- $ -- $ -- $ --
-------- ------- -------- ------- -------
Accruing loans which are contractually past
past due 90 days or more:
Real estate
Residential First Mortgage $ -- $ -- $ -- $ -- $ --
Commercial -- -- -- -- --
Construction and land development -- -- -- -- --
Home equity and second mortgage -- 25 102 171 196
Commercial -- -- -- -- --
Consumer -- -- -- -- --
-------- ------- -------- ------- -------
Total -- 25 102 171 196
-------- ------- -------- ------- -------
Loans accounted for on a nonaccrual basis:
Real estate
Residential First Mortgage $ 278 $ 134 $ -- $ 20 $ 126
Commercial -- -- -- -- --
Construction and land development -- -- -- -- --
Home equity and second mortgage 49 -- -- -- --
Commercial 269 -- -- -- 85
Consumer 1 70 7 198 58
-------- ------- -------- ------- -------
Total 597 204 7 218 269
-------- ------- -------- ------- -------
Total non-performing loans $ 597 $ 229 $ 109 $ 389 $ 465
======== ======= ======== ======= =======
Non-performing loans to total loans 0.30% 0.12% 0.06% 0.26% 0.34%
======== ======= ======== ======= =======
Allowance for loan losses to non-performing loans 387.60% 996.07% 1770.55% 424.94% 333.18%
======== ======= ======== ======= =======
For a detailed discussion of foreclosed real estate at December 31, 2002 see the
"Foreclosed Real Estate" section discussed previously.
10
During the year ended December 31, 2002, gross interest income of $66 thousand
would have been recorded on loans accounted for on a non-accrual basis if the
loans had been current throughout the period. During the year 2002, the Company
recognized $33 thousand in interest on these loans.
At December 31, 2002, there were no loans outstanding not reflected in the above
table as to which known information about possible credit problems of borrowers
caused management to have serious doubts as to the ability of such borrowers to
comply with present loan repayment terms.
The following table sets forth an analysis of activity in the Bank's allowance
for possible loan losses for the periods indicated.
AT DECEMBER 31,
-----------------------------------------------------
2002 2001 2000 1999 1998
------- ------- ------- ------- -------
(DOLLARS IN THOUSANDS)
Balance at beginning of period $ 2,282 $ 1,930 $ 1,653 $ 1,540 $ 1,310
======= ======= ======= ======= =======
Charge-offs:
Real estate
Residential first mortgage -- -- 56 -- --
Commercial -- -- -- -- --
Construction and land development 36 -- -- -- --
Home equity and second mortgage 21 -- -- -- --
Commercial 59 -- 33 102 --
Consumer 15 39 6 32 10
------- ------- ------- ------- -------
Total charge-offs: 131 39 95 134 10
------- ------- ------- ------- -------
Recoveries:
Real estate
Residential first mortgage -- -- -- -- --
Commercial -- -- -- -- --
Construction and land development -- -- -- -- --
Home equity and second mortgage -- -- -- -- --
Commercial -- -- -- -- --
Consumer 3 31 12 7 --
------- ------- ------- ------- -------
Total Recoveries 3 31 12 7 --
------- ------- ------- ------- -------
Net charge-offs 128 8 83 127 10
Provision for Possible Loan Losses 160 360 360 240 240
------- ------- ------- ------- -------
Balance at End of Period $ 2,314 $ 2,282 $ 1,930 $ 1,653 $ 1,540
======= ======= ======= ======= =======
Ratio of net charge-offs to average loans
outstanding during the year 0.06% 0.01% 0.05% 0.09% 0.01%
======= ======= ======= ======= =======
11
The following table allocates the allowance for loan losses by loan category at
the dates indicated. The allocation of the allowance to each category is not
necessarily indicative of future losses and does not restrict the use of the
allowance to absorb losses in any category.
AT DECEMBER 31,
------------------------------------------------------------------------------------
2002 2001 2000
---------------------------- ----------------------- -------------------------
PERCENT OF LOANS PERCENT OF LOANS PERCENT OF LOANS
IN EACH CATEGORY IN EACH CATEGORY IN EACH CATEGORY
AMOUNT TO TOTAL LOANS AMOUNT TO TOTAL LOANS AMOUNT TO TOTAL LOANS
------ -------------- ------ -------------- ------ ---------------
Real Estate Loans
Residential first mortgage $ 118 24.44% $ 160 31.26% $ 192 38.89%
Commercial 1,077 37.07% 923 33.39% 645 24.16%
Construction and land development 211 7.27% 355 9.23% 285 9.90%
Home equity and second mortgage 276 9.48% 373 9.46% 394 10.66%
Commercial loans 434 14.94% 186 9.44% 138 8.61%
Consumer loans 198 6.80% 285 7.22% 276 7.79%
------ ------ ------- ------ ------ ------
Total allowance for loan losses 2,314 100.00% 2,282 100.00% 1,930 100.01%
====== ====== ======= ====== ====== ======
AT DECEMBER 31,
------------------------------------------------------
1999 1998
---------------------------- -----------------------
PERCENT OF LOANS PERCENT OF LOANS
IN EACH CATEGORY IN EACH CATEGORY
AMOUNT TO TOTAL LOANS AMOUNT TO TOTAL LOANS
------ -------------- ------ --------------
Real Estate Loans
Residential first mortgage $ 632 44.42% $ 652 47.55%
Commercial 399 20.08% 281 14.60%
Construction and land development 164 11.49% 211 15.38%
Home equity and second mortgage 159 11.19% 166 12.07%
Commercial loans 178 6.72% 117 4.56%
Consumer loans 121 6.10% 113 5.84%
------ ------ ------ ------
Total allowance for loan losses 1,653 100.00% 1,540 100.00%
====== ====== ====== ======
The Bank closely monitors the loan payment activity of all its loans. A loan
loss provision is provided by a regular accrual. The Bank periodically reviews
the adequacy of the allowance for loan losses based on an analysis of the loan
portfolio, the Bank's historical loss experience, economic conditions in the
Bank's market area, and a review of selected individual loans. Loan losses are
charged off against the allowance when the uncollectibility is confirmed.
Subsequent recoveries, if any, are credited to the allowance. The Bank believes
it has established its existing allowance for loan losses in accordance with
generally accepted accounting principles and is in compliance with appropriate
regulatory guidelines. However, the establishment of the level of the allowance
for loan losses is highly subjective and dependent on incomplete information as
to the ultimate disposition of loans. Accordingly, there can be no assurance
that actual losses may vary from the amounts estimated or that the Bank's
regulators will not require the Bank to significantly increase or decrease its
allowance for loan losses, thereby affecting the Bank's financial condition and
earnings.
12
INVESTMENT ACTIVITIES
The Bank maintains a portfolio of investment securities to provide liquidity as
well as a source of earnings. The Bank's investment securities portfolio
consists primarily of mortgage-backed and other securities issued by U.S.
Government-sponsored enterprises ("GSEs") including FHLMC, FNMA, SLMA and the
FHLB System. The Bank also has smaller holdings of privately issued
mortgage-backed securities, U.S. Treasury obligations, and other equity and debt
securities. As a member of the Federal Reserve and FHLB Systems, the Bank is
also required to invest in the stock of the Federal Reserve Bank of Richmond and
FHLB of Atlanta, respectively.
The following table sets forth the carrying value of the Company's investment
securities portfolio and FHLB of Atlanta and Federal Reserve Bank stock at the
dates indicated. At December 31, 2002, their market value was $47.4 million.
AT DECEMBER 31,
------------------------------------------
2002 2001 2000
-------- ------- -------
(IN THOUSANDS)
Asset-backed securities:
FHLMC and FNMA $ 29,200 $26,084 $30,577
Other 7,930 8,993 16,855
-------- ------- -------
Total asset-backed Secutiries 37,130 35,077 47,432
FHLMC, FNMA, SLMA and FHLB notes -- -- 7,912
FHLMC and FNMA Stock 734 727 764
Mutual Funds 3,962 -- --
Treasury bills 300 300 200
Other Investments 2,542 1,989 1,514
-------- ------- -------
Total investment securities 44,668 38,093 57,822
FHLB and Federal Reserve Bank stock 2,737 3,036 3,036
-------- ------- -------
Total investment securities and FHLB and
Federal Reserve Bank stock $ 47,405 $41,129 $60,858
======== ======= =======
13
The maturities and weighted average yields for investment securities available
for sale and held to maturity at December 31, 2002 are shown below.
AFTER ONE AFTER FIVE
ONE YEAR OR LESS THROUGH FIVE YEARS THROUGH TEN YEARS AFTER TEN YEARS
------------------ ------------------ ------------------ -----------------
CARRYING AVERAGE CARRYING AVERAGE CARRYING AVERAGE CARRYING AVERAGE
VALUE YIELD VALUE YIELD VALUE YIELD VALUE YIELD
-------- ------- -------- ------- -------- ------- -------- -------
(DOLLARS IN THOUSANDS)
Investment securities available
for sale:
Corporate equity securities $ 509 7.50% $ -- $ -- $ --
Asset-backed securities 18,216 5.50% 15,067 5.88% 823 6.45% 2,318 6.12%
Mutual Funds 3,962 2.52% -- -- --
------- ---- ------- ---- ------
Total investment securities
available for sale $22,687 4.59% $15,067 5.88% $823 6.45% $2,318 6.12%
======= ==== ======= ==== ==== ==== ====== ====
Investment securities held-to-
maturity:
Treasury bills $ 300 1.22% $ -- $ -- $ --
Other investments -- 2,542 5.98% -- --
------- ------- ---- ------
Total investment securities
held-to-maturity $ 300 1.22% $ 2,542 5.98% $ -- $ --
======= ==== ======= ==== ==== ======
The Bank's investment policy provides that securities that will be held for
indefinite periods of time, including securities that will be used as part of
the Bank's asset/liability management strategy and that may be sold in response
to changes in interest rates, prepayments and similar factors, are classified as
available for sale and accounted for at fair value. Management's intent is to
hold securities reported at amortized cost to maturity. Certain of the Company's
securities are issued by private issuers (defined as an issuer which is not a
government or a government sponsored entity). The Company generally limits its
exposure to private issuers to total investments from any one issuer to less
than 10% of equity. For further information regarding the Company's investment
securities, see Note 2 of Notes to Consolidated Financial Statements.
DEPOSITS AND OTHER SOURCES OF FUNDS
GENERAL. The funds needed by the Bank to make loans are primarily generated by
deposit accounts solicited from the communities surrounding its main office and
seven branches in the southern Maryland area. Consolidated total deposits were
$203,025,112 as of December 31, 2002. The Bank uses borrowings from the FHLB of
Atlanta and other sources to supplement funding from deposits.
DEPOSITS. The Bank's deposit products include regular savings accounts
(statements), money market deposit accounts, demand deposit accounts,
interest-bearing demand deposit accounts, IRA and SEP accounts, Christmas club
accounts and certificates of deposit. Variations in service charges, terms and
interest rates are used to target specific markets. Ancillary products and
services for deposit customers include safe deposit boxes, money orders and
travelers checks, night depositories, automated clearinghouse transactions, wire
transfers, ATMs, and telephone banking. The Bank is a member of JEANIE, Cirrus
and STAR ATM networks. The Bank has occasionally used deposit brokers to obtain
funds. At year end 2002, no brokered deposits were held.
14
The following table sets forth for the periods indicated the average balances
outstanding and average interest rates for each major category of deposits.
FOR THE YEAR ENDED DECEMBER 31,
----------------------------------------------------------------------------
2002 2001 2000
-------------------- -------------------- --------------------
AVERAGE AVERAGE AVERAGE AVERAGE AVERAGE AVERAGE
BALANCE RATE BALANCE RATE BALANCE RATE
------- ------- ------- ------- ------- -------
(Dollars in thousands)
Savings $ 23,334 0.86% $ 19,723 2.01% $ 20,051 2.37%
Interest-bearing demand and money
market accounts 73,668 0.47% 72,052 2.35% 59,720 3.58%
Certificates of deposit 70,885 4.10% 70,453 5.45% 69,592 5.32%
-------- ---- -------- ---- -------- ----
Total interest-bearing deposits 167,887 2.06% 162,228 3.65% 149,363 4.23%
Noninterest-bearing demand deposits 21,631 13,691 10,961
-------- -------- --------
$189,518 1.82% $175,919 3.37% $160,324 3.94%
======== ==== ======== ==== ======== ====
The following table indicates the amount of the Bank's certificates of deposit
and other time deposits of more than $100,000 by time remaining until maturity
as of December 31, 2002.
CERTIFICATES
MATURITY PERIOD OF DEPOSIT
--------------- --------------
(IN THOUSANDS)
Three months or less ....... $ 5,137
Three through six months.... 8,665
Six through twelve months... 2,654
Over twelve months ......... 2,334
-------
Total ............... $18,790
=======
BORROWINGS. Deposits are the primary source of funds for the Bank's lending and
investment activities and for its general business purposes. The Bank uses
advances from the FHLB of Atlanta to supplement its supply of lendable funds and
to meet deposit withdrawal requirements. Advances from the FHLB are secured by
the Bank's stock in the FHLB, a portion of the Bank's residential mortgage loans
and its eligible investments. Generally the Bank's ability to borrow from the
FHLB of Atlanta is limited by its available collateral and also by an overall
limitation of 35% of assets. Other short-term debt consists of notes payable to
the U.S. Treasury on Treasury, Tax and Loan accounts. Long-term borrowings
consist of adjustable-rate advances with rates based upon LIBOR, fixed-rate
advances, and convertible advances. Information about borrowings for the years
indicated (which consisted almost entirely of FHLB advances) is as follows:
AT OR FOR THE
YEAR ENDED DECEMBER 31,
------------------------------
2002 2001 2000
---- ---- ----
(DOLLARS IN THOUSANDS)
Long term amounts outstanding at end of period $ 48,170 $ 48,650 $ 41,400
Weighted average rate on outstanding long-term 4.99% 5.41% 5.91%
Short-term borrowing outstanding at end of period 752 1,813 13,551
Weighted average rate on outstanding short-term 0.89% 1.83% 6.35%
Maximum outstanding short-term debt at any month end 6,500 15,725 35,100
Average outstanding short-term debt 680 6,213 25,810
Approximate average rate paid on short term debt (1) 1.04% 5.75% 6.62%
15
For more information regarding the Bank's borrowings, see Note7of Notes to
Consolidated Financial Statements.
SUBSIDIARY ACTIVITIES
Under the Maryland Financial Institutions Code, commercial banks may invest in
service corporations and in other subsidiaries that offer the public a
financial, fiduciary or insurance service. In April 1997, the Bank formed a
wholly owned subsidiary, Community Mortgage Corporation of Tri-County, to offer
mortgage banking, brokerage, and other services to the public. This corporation
was inactive until 2001. At that time, the Bank transferred a property which was
acquired by deed in lieu of foreclosure to this subsidiary in order to complete
development of this parcel. In August 1999, the Bank formed a wholly owned
subsidiary, Tri-County Investment Corporation to hold and manage a portion of
the Bank's investment portfolio.
COMPETITION
The Bank faces strong competition in the attraction of deposits and in the
origination of loans. Its most direct competition for deposits and loans comes
from other banks, savings and loan associations, and federal and state credit
unions located in its primary market area. There are currently 15 FDIC-insured
depository institutions operating in the Tri-County area including subsidiaries
of several regional and super-regional bank holding companies. According to
statistics compiled by the FDIC, the Bank was ranked sixth in deposit market
share in the Tri-County area as of June 30, 2001, the latest date for which such
data is available. The Bank faces additional significant competition for
investors' funds from mutual funds, brokerage firms, and other financial
institutions.
The Bank competes for loans by providing competitive rates, flexibility of
terms, and service. It competes for deposits by offering depositors a wide
variety of account types, convenient office locations, and competitive rates.
Other services offered include tax-deferred retirement programs, brokerage
services, safe deposit boxes, and miscellaneous services. The Bank has used
direct mail, billboard and newspaper advertising to increase its market share of
deposits, loans and other services in its market area. It provides ongoing
training for its staff in an attempt to ensure high quality service.
SUPERVISION AND REGULATION
REGULATION OF THE BANK
GENERAL. The Bank is a Maryland commercial bank and its deposit accounts are
insured by the SAIF. The Bank is a member of the Federal Reserve and FHLB
Systems. The Bank is subject to supervision, examination and regulation by
Commissioner of Financial Regulation of the State of Maryland (the
"Commissioner") and the Board of Governors of the Federal Reserve System (the
"FRB") and to Maryland and federal statutory and regulatory provisions governing
such matters as capital standards, mergers and establishment of branch offices.
The Bank is required to file reports with the Commissioner and the FRB
concerning its activities and financial condition and will be required to obtain
regulatory approvals prior to entering into certain transactions, including
mergers with, or acquisitions of, other depository institutions.
As an institution with federally insured deposits, the Bank is subject to
various regulations promulgated by the FRB, including Regulation B (Equal Credit
Opportunity), Regulation D (Reserve Requirements), Regulation E (Electronic Fund
Transfers), Regulation P (Privacy), Regulation Z (Truth in Lending), Regulation
CC (Availability of Funds and Collection of Checks) and Regulation DD (Truth in
Savings).
The system of regulation and supervision applicable to the Bank establishes a
comprehensive framework for the operations of the Bank and is intended primarily
for the protection of the FDIC and the depositors of the
16
Bank. Changes in the regulatory framework could have a material effect on the
Bank and its respective operations that in turn, could have a material effect on
the Company.
SARBANES-OXLEY ACT OF 2002. On July 30, 2002, the Sarbanes-Oxley Act of 2002
(the "Act") was signed into law which mandated a variety of reforms intended to
address corporate and accounting fraud. The Act provides for the establishment
of a new Public Company Accounting Oversight Board ("PCAOB"), which will enforce
auditing, quality control and independence standards for firms that audit
Securities Exchange Commission ("SEC")-reporting companies and will be funded by
fees from all SEC-reporting companies. The Act imposes higher standards for
auditor independence and restricts provision of consulting services by auditing
firms to companies they audit. Any non-audit services being provided to an audit
client will require preapproval by the Company's audit committee members. In
addition, certain audit partners must be rotated periodically. The Act requires
chief executive officers and chief financial officers, or their equivalent, to
certify to the accuracy of periodic reports filed with the SEC, subject to civil
and criminal penalties if they knowingly or willfully violate this certification
requirement. In addition, under the Act, counsel will be required to report
evidence of a material violation of the securities laws or a breach of fiduciary
duty by a company to its chief executive officer or its chief legal officer,
and, if such officer does not appropriately respond, to report such evidence to
the audit committee or other similar committee of the board of directors or the
board itself.
Longer prison terms will also be applied to corporate executives who violate
federal securities laws, the period during which certain types of suits can be
brought against a company or its officers has been extended, and bonuses issued
to top executives prior to restatement of a company's financial statements are
now subject to disgorgement if such restatement was due to corporate misconduct.
Executives are also prohibited from trading during retirement plan "blackout"
periods, and loans to company executives are restricted. In addition, a
provision directs that civil penalties levied by the SEC as a result of any
judicial or administrative action under the Act be deposited in a fund for the
benefit of harmed investors. Directors and executive officers must also report
most changes in their ownership of a company's securities within two business
days of the change.
The Act also increases the oversight and authority of audit committees of
publicly traded companies. Audit committee members must be independent and are
barred from accepting consulting, advisory or other compensatory fees from the
issuer. In addition, all SEC-reporting companies must disclose whether at least
one member of the committee is a "financial expert" (as such term is defined by
the SEC rules) and if not, why not. Audit committees of publicly traded
companies will have authority to retain their own counsel and other advisors
funded by the company. Audit committees must establish procedures for the
receipt, retention and treatment of complaints regarding accounting and auditing
matters and procedures for confidential, anonymous submission of employee
concerns regarding questionable accounting or auditing matters.
Beginning six months after the SEC determines that the PCAOB is able to carry
out its functions, it will be unlawful for any person that is not a registered
public accounting firm ("RPAF") to audit an SEC-reporting company. Under the
Act, a RPAF is prohibited from performing statutorily mandated audit services
for a company if such company's chief executive officer, chief financial
officer, comptroller, chief accounting officer or any person serving in
equivalent positions has been employed by such firm and participated in the
audit of such company during the one-year period preceding the audit initiation
date. The Act also prohibits any officer or director of a company or any other
person acting under their direction from taking any action to fraudulently
influence, coerce, manipulate or mislead any independent public or certified
accountant engaged in the audit of the Company's financial statements for the
purpose of rendering the financial statement's materially misleading. The Act
also requires the SEC to prescribe rules requiring inclusion of an internal
control report and assessment by management in the annual report to
shareholders. The Act requires the RPAF that issues the audit report to attest
to and report on management's assessment of the Company's internal controls. In
addition, the Act requires that each financial report required to be prepared in
accordance with (or reconciled to) generally accepted accounting principles and
filed with the SEC reflect all material correcting adjustments that are
identified by a RPAF in accordance with generally accepted accounting principles
and the rules and regulations of the SEC.
17
Although the Company anticipates it will incur additional expense in complying
with the provisions of the Act and the related rules, management does not expect
that such compliance will have a material impact on the Company's financial
condition or results of operations.
CAPITAL ADEQUACY. The FRB has established guidelines with respect to the
maintenance of appropriate levels of capital by bank holding companies and state
member banks, respectively. The regulations impose two sets of capital adequacy
requirements: minimum leverage rules, which require bank holding companies and
member banks to maintain a specified minimum ratio of capital to total assets,
and risk-based capital rules, which require the maintenance of specified minimum
ratios of capital to "risk-weighted" assets.
The regulations of the FRB require bank holding companies and state member
banks, respectively, to maintain a minimum leverage ratio of "Tier 1 capital"
(as defined in the risk-based capital guidelines discussed in the following
paragraphs) to total assets of 3.0%. Although setting a minimum 3.0% leverage
ratio, the capital regulations state that only the strongest bank holding
companies and banks, with composite examination ratings of 1 under the rating
system used by the federal bank regulators, would be permitted to operate at or
near such minimum level of capital. All other bank holding companies and banks
are expected to maintain a leverage ratio of at least 1% to 2% above the minimum
ratio, depending on the assessment of an individual organization's capital
adequacy by its primary regulator. Any bank or bank holding company experiencing
or anticipating significant growth would be expected to maintain capital well
above the minimum levels. In addition, the FRB has indicated that whenever
appropriate, and in particular when a bank holding company is undertaking
expansion, seeking to engage in new activities or otherwise facing unusual or
abnormal risks, it will consider, on a case-by-case basis, the level of an
organization's ratio of tangible Tier 1 capital (after deducting all
intangibles) to total assets in making an overall assessment of capital.
The risk-based capital rules of the FRB require bank holding companies and state
member banks, respectively, to maintain minimum regulatory capital levels based
upon a weighting of their assets and off-balance sheet obligations according to
risk. Risk-based capital is composed of two elements: Tier 1 capital and Tier 2
capital. Tier 1 capital consists primarily of common stockholders' equity,
certain perpetual preferred stock (which must be noncumulative in the case of
banks), and minority interests in the equity accounts of consolidated
subsidiaries; less all intangible assets, except for certain servicing assets,
purchased credit card relationships, deferred tax assets and credit enhancing
interest-only strips. Tier 2 capital elements include, subject to certain
limitations, the allowance for losses on loans and leases; perpetual preferred
stock that does not qualify as Tier 1 capital and long-term preferred stock with
an original maturity of at least 20 years from issuance; hybrid capital
instruments, including perpetual debt and mandatory convertible securities; and
subordinated debt and intermediate-term preferred stock.
The risk-based capital regulations assign balance sheet assets and credit
equivalent amounts of off-balance sheet obligations to one of four broad risk
categories based principally on the degree of credit risk associated with the
obligor. The assets and off-balance sheet items in the four risk categories are
weighted at 0%, 20%, 50% and 100%. These computations result in the total
risk-weighted assets. The risk-based capital regulations require all banks and
bank holding companies to maintain a minimum ratio of total capital (Tier 1
capital plus Tier 2 capital) to total risk-weighted assets of 8%, with at least
4% as Tier 1 capital. For the purpose of calculating these ratios: (i) Tier 2
capital is limited to no more than 100% of Tier 1 capital; and (ii) the
aggregate amount of certain types of Tier 2 capital is limited. In addition, the
risk-based capital regulations limit the allowance for loan losses includable as
capital to 1.25% of total risk-weighted assets.
FRB regulations and guidelines additionally specify that state member banks with
significant exposure to declines in the economic value of their capital due to
changes in interest rates may be required to maintain higher risk-based capital
ratios. The federal banking agencies, including the FRB, have proposed a system
for measuring and assessing the exposure of a bank's net economic value to
changes in interest rates. The federal banking agencies, including the FRB, have
stated their intention to propose a rule establishing an explicit capital charge
for interest rate risk based upon the level of a bank's measured interest rate
risk exposure after more experience has been gained with the proposed
measurement process. FRB regulations do
18
not specifically take into account interest rate risk in measuring the capital
adequacy of bank holding companies.
The FRB has issued regulations which classify state member banks by capital
levels and which authorize the FRB to take various prompt corrective actions to
resolve the problems of any bank that fails to satisfy the capital standards.
Under such regulations, a well-capitalized bank is one that is not subject to
any regulatory order or directive to meet any specific capital level and that
has or exceeds the following capital levels: a total risk-based capital ratio of
10%, a Tier 1 risk-based capital ratio of 6%, and a leverage ratio of 5%. An
adequately capitalized bank is one that does not qualify as well-capitalized but
meets or exceeds the following capital requirements: a total risk-based capital
ratio of 8%, a Tier 1 risk-based capital ratio of 4%, and a leverage ratio of
either (i) 4% or (ii) 3% if the bank has the highest composite examination
rating. A bank not meeting these criteria is treated as undercapitalized,
significantly undercapitalized, or critically undercapitalized depending on the
extent to which the bank's capital levels are below these standards. A state
member bank that falls within any of the three undercapitalized categories
established by the prompt corrective action regulation will be subject to severe
regulatory sanctions. As of December 31, 2002, the Bank was well capitalized as
defined by the FRB's regulations.
BRANCHING. Maryland law provides that, with the approval of the Commissioner,
Maryland banks may establish branches within the State of Maryland without
geographic restriction and may establish branches in other states by any means
permitted by the laws of such state or by federal law. The Riegle-Neal Act
authorizes the FRB to approve interstate branching de novo by state banks, only
in states which specifically allow for such branching. The Riegle-Neal Act also
required the appropriate federal banking agencies to prescribe regulations which
prohibit any out-of-state bank from using the interstate branching authority
primarily for the purpose of deposit production. These regulations include
guidelines to ensure that interstate branches operated by an out-of-state bank
in a host state are reasonably helping to meet the credit needs of the
communities which they serve.
DIVIDEND LIMITATIONS. Pursuant to the Maryland Financial Institutions Code,
Maryland banks may only pay dividends from undivided profits or, with the prior
approval of the Commissioner, their surplus in excess of 100% of required
capital stock. The Maryland Financial Institutions Code further restricts the
payment of dividends by prohibiting a Maryland bank from declaring a dividend on
its shares of common stock until its surplus fund equals the amount of required
capital stock or, if the surplus fund does not equal the amount of capital
stock, in an amount in excess of 90% of net earnings.
Without the approval of the FRB, a state member bank may not declare or pay a
dividend if the total of all dividends declared during the year exceeds its net
income during the current calendar year and retained net income for the prior
two years. The Bank is further prohibited from making a capital distribution if
it would not be adequately capitalized thereafter. In addition, the Bank may not
make a capital distribution that would reduce its net worth below the amount
required to maintain the liquidation account established for the benefit of its
depositors at the time of its conversion to stock form.
DEPOSIT INSURANCE. The Bank is required to pay semi-annual assessments based on
a percentage of its insured deposits to the FDIC for insurance of its deposits
by the Savings Association Insurance Fund ("SAIF"). Under the Federal Deposit
Insurance Act, the FDIC is required to set semi-annual assessments for
SAIF-insured institutions to maintain the designated reserve ratio of the SAIF
at 1.25% of estimated insured deposits or at a higher percentage of estimated
insured deposits that the FDIC determines to be justified for that year by
circumstances raising a significant risk of substantial future losses to the
SAIF. In the event that the SAIF should fail to meet its statutory reserve
ratio, the FDIC would be required to set semi-annual assessment rates for SAIF
members that are sufficient to increase the reserve ratio to 1.25% within one
year or in accordance with such other schedule that the FDIC adopts by
regulation to restore the reserve ratio in not more than 15 years.
Under the risk-based deposit insurance assessment system adopted by the FDIC,
the assessment rate for an insured depository institution depends on the
assessment risk classification assigned to the institution by the
19
FDIC, which is determined by the institution's capital level and supervisory
evaluations. Based on the data reported to regulators for the date closest to
the last day of the fourth month preceding the semi-annual assessment period,
institutions are assigned to one of three capital groups -- "well capitalized,
adequately capitalized or undercapitalized." Within each capital group,
institutions are assigned to one of three subgroups on the basis of supervisory
evaluations by the institution's primary supervisory authority and such other
information as the FDIC determines to be relevant to the institution's financial
condition and the risk posed to the deposit insurance fund. Under the current
assessment schedule, well-capitalized banks with the best supervisory ratings
are not required to pay any premium for deposit insurance. All SAIF-insured
banks, however, are required to pay assessments to the FDIC to help fund
interest payments on certain bonds issued by the Financing Corporation, an
agency established by the federal government to finance takeovers of insolvent
thrifts.
TRANSACTIONS WITH AFFILIATES. A state member bank or its subsidiaries may not
engage in "covered transactions" with any one affiliate in an amount greater
than 10% of such bank's capital stock and surplus, and for all such transactions
with all affiliates a state member bank is limited to an amount equal to 20% of
capital stock and surplus. All such transactions must also be on terms
substantially the same, or at least as favorable, to the bank or subsidiary as
those provided to a non-affiliate. The term "covered transaction" includes the
making of loans, purchase of assets, issuance of a guarantee and similar other
types of transactions. An affiliate of a state member bank is any company or
entity which controls or is under common control with the state member bank and,
for purposes of the aggregate limit on transactions with affiliates, any
subsidiary that would be deemed a financial subsidiary of a national bank. In a
holding company context, the parent holding company of a state member bank (such
as the Company) and any companies which are controlled by such parent holding
company are affiliates of the state member bank. The BHCA further prohibits a
depository institution from extending credit to or offering any other services,
or fixing or varying the consideration for such extension of credit or service,
on the condition that the customer obtain some additional service from the
institution or certain of its affiliates or not obtain services of a competitor
of the institution, subject to certain limited exceptions.
LOANS TO DIRECTORS, EXECUTIVE OFFICERS AND PRINCIPAL STOCKHOLDERS. Loans to
directors, executive officers and principal stockholders of a state member bank
must be made on substantially the same terms as those prevailing for comparable
transactions with persons who are not executive officers, directors, principal
stockholders or employees of the bank unless the loan is made pursuant to a
compensation or benefit plan that is widely available to employees and does not
favor insiders. Loans to any executive officer, director and principal
stockholder together with all other outstanding loans to such person and
affiliated interests generally may not exceed 15% of the bank's unimpaired
capital and surplus and all loans to such persons may not exceed the
institution's unimpaired capital and unimpaired surplus. Loans to directors,
executive officers and principal stockholders, and their respective affiliates,
in excess of the greater of $25,000 or 5% of capital and surplus (up to
$500,000) must be approved in advance by a majority of the board of directors of
the bank with any "interested" director not participating in the voting. State
member banks are prohibited from paying the overdrafts of any of their executive
officers or directors unless payment is made pursuant to a written,
pre-authorized interest-bearing extension of credit plan that specifies a method
of repayment or transfer of funds from another account at the bank. In addition,
loans to executive officers may not be made on terms more favorable than those
afforded other borrowers and are restricted as to type, amount and terms of
credit.
REGULATION OF THE COMPANY
GENERAL. The Company, as the sole shareholder of the Bank, is a bank holding
company and registered as such with the FRB. Bank holding companies are subject
to comprehensive regulation by the FRB under the Bank Holding Company Act of
1956, as amended (the "BHCA"), and the regulations of the FRB. As a bank holding
company, the Company is required to file with the FRB annual reports and such
additional information as the FRB may require, and is subject to regular
examinations by the FRB. The FRB also has extensive enforcement authority over
bank holding companies, including, among other things, the ability to assess
civil money penalties, to issue cease and desist or removal orders and to
require that a holding
20
company divest subsidiaries (including its bank subsidiaries). In general,
enforcement actions may be initiated for violations of law and regulations and
unsafe or unsound practices.
Under the BHCA, a bank holding company must obtain FRB approval before: (i)
acquiring, directly or indirectly, ownership or control of any voting shares of
another bank or bank holding company if, after such acquisition, it would own or
control more than 5% of such shares (unless it already owns or controls the
majority of such shares); (ii) acquiring all or substantially all of the assets
of another bank or bank holding company; or (iii) merging or consolidating with
another bank holding company.
Effective September 29, 1995, the Riegle-Neal Interstate Banking and Branching
Efficiency of 1994 (the "Riegle-Neal Act") authorized the FRB to approve an
application of an adequately capitalized and adequately managed bank holding
company to acquire control of, or acquire all or substantially all of the assets
of, a bank located in a state other than such holding company's home state,
without regard to whether the transaction is prohibited by the laws of any
state. The FRB may not approve the acquisition of a bank that has not been in
existence for the minimum time period (not exceeding five years) specified by
the statutory law of the host state. The Riegle-Neal Act also prohibits the FRB
from approving such an application if the applicant (and its depository
institution affiliates) controls or would control more than 10% of the insured
deposits in the United States or 30% or more of the deposits in the target
bank's home state or in any state in which the target bank maintains a branch.
The Riegle-Neal Act does not affect the authority of states to limit the
percentage of total insured deposits in the state which may be held or
controlled by a bank or bank holding company to the extent such limitation does
not discriminate against out-of-state banks or bank holding companies.
Individual states may also waive the 30% state-wide concentration limit
contained in the Riegle-Neal Act. Under Maryland law, a bank holding company is
prohibited from acquiring control of any bank if the bank holding company would
control more than 30% of the total deposits of all depository institutions in
the State of Maryland unless waived by the Commissioner of Financial Regulation.
Additionally, the federal banking agencies are authorized to approve interstate
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 opted out of 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. The
State of Maryland did not pass such a law during this period. Interstate
acquisitions of branches will be permitted only if the law of the state in which
the branch is located permits such acquisitions. Interstate mergers and branch
acquisitions will also be subject to the nationwide and statewide insured
deposit concentration amounts described above.
The BHCA also prohibits a bank holding company, with certain exceptions, from
acquiring direct or indirect ownership or control of more than 5% of the voting
shares of any company which is not a bank or bank holding company, or from
engaging directly or indirectly in activities other than those of banking,
managing or controlling banks, or providing services for its subsidiaries. The
principal exceptions to these prohibitions involve certain non-bank activities
which, by statute or by FRB regulation or order, have been identified as
activities closely related to the business of banking or managing or controlling
banks. The list of activities permitted by the FRB includes, among other things,
operating a savings institution, mortgage company, finance company, credit card
company or factoring company; performing certain data processing operations;
providing certain investment and financial advice; underwriting and acting as an
insurance agent for certain types of credit-related insurance; leasing property
on a full-payout, non-operating basis; selling money orders, travelers' checks
and United States Savings Bonds; real estate and personal property appraising;
providing tax planning and preparation services; and, subject to certain
limitations, providing securities brokerage services for customers.
Effective with the enactment of the Gramm-Leach-Bliley Act (the "G-L-B Act") on
November 12, 1999, bank holding companies whose financial institution
subsidiaries are well capitalized and well managed and have satisfactory
Community Reinvestment Act records can elect to become "financial holding
companies" which are permitted to engage in a broader range of financial
activities than are permitted to bank holding companies. Financial holding
companies are authorized to engage in, directly or indirectly, financial
21
activities. A financial activity is an activity that is: (i) financial in
nature; (ii) incidental to an activity that is financial in nature; or (iii)
complementary to a financial activity and that does not pose a safety and
soundness risk. The G-L-B Act includes a list of activities that are deemed to
be financial in nature. Other activities also may be decided by the FRB to be
financial in nature or incidental thereto if they meet specified criteria. A
financial holding company that intends to engage in a new activity to acquire a
company to engage in such an activity is required to give prior notice to the
FRB. If the activity is not either specified in the G-L-B Act as being a
financial activity or one that the FRB has determined by rule or regulation to
be financial in nature, the prior approval of the FRB is required.
The Maryland Financial Institutions Code prohibits a bank holding company from
acquiring more than 5% of any class of voting stock of a bank or bank holding
company without the approval of the Commissioner of Financial Regulation except
as otherwise expressly permitted by federal law or in certain other limited
situations. The Maryland Financial Institutions Code additionally prohibits any
person from acquiring voting stock in a bank or bank holding company without 60
days' prior notice to the Commissioner if such acquisition will give the person
control of 25% or more of the voting stock of the bank or bank holding company
or will affect the power to direct or to cause the direction of the policy or
management of the bank or bank holding company. Any doubt whether the stock
acquisition will affect the power to direct or cause the direction of policy or
management shall be resolved in favor of reporting to the Commissioner. The
Commissioner may deny approval of the acquisition if the Commissioner determines
it to be anti-competitive or to threaten the safety or soundness of a banking
institution. Voting stock acquired in violation of this statute may not be voted
for five years.
DIVIDENDS. The FRB has issued a policy statement on the payment of cash
dividends by bank holding companies, which expresses the FRB's view that a bank
holding company should pay cash dividends only to the extent that the company's
net income for the past year is sufficient to cover both the cash dividends and
a rate of earning retention that is consistent with the company's capital needs,
asset quality and overall financial condition. The FRB also indicated that it
would be inappropriate for a company experiencing serious financial problems to
borrow funds to pay dividends. Furthermore, under the prompt corrective action
regulations adopted by the FRB pursuant to FDICIA, the FRB may prohibit a bank
holding company from paying any dividends if the holding company's bank
subsidiary is classified as "undercapitalized".
Bank holding companies are required to give the FRB prior written notice of any
purchase or redemption of its outstanding equity securities if the gross
consideration for the purchase or redemption, when combined with the net
consideration paid for all such purchases or redemptions during the preceding 12
months, is equal to 10% or more of the their consolidated retained earnings. The
FRB may disapprove such a purchase or redemption if it determines that the
proposal would constitute an unsafe or unsound practice or would violate any
law, regulation, FRB order, or any condition imposed by, or written agreement
with, the FRB.
CAPITAL REQUIREMENTS. The FRB has established capital requirements, similar to
the capital requirements for state member banks described above, for bank
holding companies with consolidated assets of $150 million or more. As of
December 31, 2002, the Company's levels of consolidated regulatory capital
exceeded the FRB's minimum requirements.
PERSONNEL
As of December 31, 2002, the Bank had 82 full-time employees and 14 part-time
employees. The employees are not represented by a collective bargaining
agreement. The Bank believes its employee relations are good.
22
ITEM 2. PROPERTIES
- -------------------
The following table sets forth the location of the Bank's offices, as well as
certain additional information relating to these offices as of December 31,
2002.
YEAR
FACILITY LEASED APPROXIMATE
OFFICE COMMENCED OR SQUARE
LOCATION OPERATION OWNED FOOTAGE
- -------- --------- ------ -----------
MAIN OFFICE
3035 Leonardtown Road 1974 Owned 16,500
Waldorf, Maryland
BRANCH OFFICES
22730 Three Notch Rd. 1992 Owned 2,500
California, Maryland
25395 Point Lookout Rd. 1961 Owned 2,500
Leonardtown, Maryland
101 Drury Drive 2001 Owned 2,645
La Plata, Maryland
10321 Southern Md. Blvd. 1991 Leased 1,400
Dunkirk, Maryland
8010 Matthews Road 1996 Owned 2,500
Bryans Road, Maryland
20 St. Patrick's Drive 1998 Leased (Land) 2,840
Waldorf, Maryland Owned (Building)
30165 Three Notch Road 2001 Leased (Land) 2,500
Charlotte Hall, Maryland Owned (Building)
ITEM 3. LEGAL PROCEEDINGS
- --------------------------
Neither the Company, the Bank, nor any subsidiary is engaged in any legal
proceedings of a material nature at the present time. From time to time the Bank
is a party to legal proceedings in the ordinary course of business.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
- ------------------------------------------------------------
No matters were submitted to a vote of security holders during the fourth
quarter of the fiscal year ended December 31, 2002.
23
PART II
ITEM 5. MARKET FOR THE REGISTRANT'S COMMON STOCK AND RELATED SECURITY HOLDER
MATTERS
- --------------------------------------------------------------------------------
MARKET INFORMATION. Effective January 30, 2002, bid and asked quotes and last
sale information became available for the Company's common stock on the OTC
Bulletin Board under the symbol "TCFC." Prior to that time, there was no
established trading market for the Common Stock and bid and asked quotes were
not regularly available. The following table sets forth high and low bid
quotations reported on the OTC Bulletin for the Common Stock for each quarter
during 2002. These quotes reflect inter-dealer prices without retail mark-up,
mark-down or commission and may not necessarily reflect actual transactions.
2002 High Low
---- ---
Fourth Quarter $39.38 $36.50
Third Quarter 37.00 30.25
Second Quarter 30.25 28.00
First Quarter 28.50 23.40
The Company has maintained a list of persons who have expressed an interest in
buying or selling the Common Stock and has made this information available to
persons seeking to sell or buy shares, as the case may be. During 2002, a total
of 14,107 shares traded, with a high price of $39.00 and a low price of $28.50.
The weighted average price was $35.94. The Company expects to continue
maintaining a list of potential buyers and sellers.
HOLDERS. As of March 3, 2003, the number of stockholders was 532 and the total
outstanding shares were 767,649.
DIVIDENDS. The Company has paid annual cash dividends since 1994. During fiscal
year 2002 and 2001, the Company paid cash dividends of $0.50 and $0.40,
respectively. On February 28, 2003, the Board of Directors declared a $0.55 per
share cash dividend to be distributed on April 7, 2003 to holders of record as
of March 24, 2003.
The Company's ability to pay dividends is governed by the policies and
regulations of the FRB which prohibit the payment of dividends under certain
circumstances involving the bank holding company's financial condition and
capital adequacy. The Company's ability to pay dividends is also dependent on
the receipt of dividends from the Bank.
Federal regulations impose certain limitations on the payment of dividends and
other capital distributions by the Bank. The Bank's ability to pay dividends is
governed by the Maryland Financial Institutions Code and the regulations of the
FRB. Under the Maryland Financial Institution Code, a Maryland bank (1) may only
pay dividends from undivided profits or, with prior regulatory approval, its
surplus in excess of 100% of required capital stock and (2) may not declare
dividends on its common stock until its surplus funds equals the amount of
required capital stock or, if the surplus fund does not equal the amount of
capital stock, in an amount in excess of 90% of net earnings.
Without the approval of the FRB, a state member bank may not declare or pay a
dividend if the total of all dividends declared during the year exceeds its net
income during the current calendar year and retained net income for the prior
two years. The Bank is further prohibited from making a capital distribution if
it would not be adequately capitalized thereafter. In addition, the Bank may not
make a capital distribution that would reduce its net worth below the amount
required to maintain the liquidation account established for the benefit of its
depositors at the time of its conversion to stock form.
24
ITEM 6. SELECTED FINANCIAL DATA
- --------------------------------
The following table presents consolidated selected financial data for the
Company and its subsidiaries for each of the periods indicated. Dividends and
earnings per share have been adjusted to give retroactive effect to stock splits
and stock dividends accounted for as stock splits.
YEAR ENDED DECEMBER 31,
-----------------------------------------------------------
(DOLLARS IN THOUSANDS EXCEPT PER SHARE DATA)
2002 2001 2000 1999 1998
---- ---- ---- ---- ----
OPERATIONS DATA:
Net Interest Income $ 10,794 $ 9,757 $ 8,862 $ 8,412 $ 8,125
Provision for Loan Losses 160 360 360 240 240
Noninterest Income 1,847 1,402 1,373 1,271 1,421
Noninterest Expense 9,446 6,995 6,332 6,276 5,467
Net Income $ 1,968 $ 2,486 $ 2,336 $ 2,153 $ 2,382
SHARE DATA:
Basic Net Income Per Common Share $ 2.58 $ 3.24 $ 2.98 $ 2.75 $ 3.00
Diluted Net Income Per Common Share 2.45 3.11 2.85 2.59 2.79
Cash Dividends Paid Per Common Share $ 0.50 $ 0.40 $ 0.30 $ 0.20 0.13
Weighted Average Common
Shares Outstanding:
Basic 761,417 766,927 784,605 782,950 793,458
Diluted 804,122 798,787 821,139 832,283 853,145
FINANCIAL CONDITION DATA:
Total Assets $282,128 $261,957 $248,339 $222,897 $206,863
Loans Receivable, Net 197,449 193,450 172,090 146,710 132,646
Total Deposits 203,025 183,117 167,806 155,742 151,815
Long and Short Term Debt 48,922 50,463 54,951 44,798 33,434
Total Stockholders' Equity $ 26,873 $ 25,586 $ 23,430 $ 21,115 20,975
PERFORMANCE RATIOS:
Return on Average Assets 0.72% 0.97% 1.00% 1.00% 1.20%
Return on Average Equity 7.50% 10.09% 10.65% 10.23% 11.87%
Net Interest Margin 4.18% 4.02% 3.98% 4.11% 4.21%
Efficiency Ratio 74.73% 62.68% 61.86% 64.81% 57.27%
Dividend Payout Ratio 20.04% 12.44% 10.13% 7.29% 4.10%
CAPITAL RATIOS:
Average Equity to Average
Assets 9.53% 9.64% 9.37% 9.79% 10.10%
Leverage Ratio 9.53% 9.64% 9.61% 9.86% 10.28%
Total Risk-Based Capital Ratio 13.75% 14.08% 13.53% 17.23% 18.27%
ASSET QUALITY RATIOS:
Allowance for Loan Losses to
Total Loans 1.15% 1.16% 1.10% 1.11% 1.14%
Nonperforming Loans to Total Loans 0.30% 0.12% 0.06% 0.26% 0.34%
Allowance for Loan Losses to
Nonperforming Loans 387.60% 996.07% 1770.55% 424.94% 331.18%
Net Charge-offs to Average Loans 0.06% 0.01% 0.05% 0.09% 0.01%
25
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
- --------------------------------------------------------------------------------
OVERVIEW
Since its conversion to a commercial bank charter in 1997, the Bank has sought
to increase total assets as well as the percentage of assets represented by
certain targeted loan types. The Bank feels that its ability to offer fast,
flexible and local decision-making in the commercial, commercial real estate,
and consumer loan areas will continue to attract significant new loans and spur
asset growth. Since December 31, 1997, total loan assets have increased by $76
million or 62%, with increases concentrated in commercial real estate,
commercial, and consumer lending. The Bank's local focus and targeted marketing
is also directed towards increasing its balances of consumer and business
deposit accounts such as interest-bearing and noninterest bearing checking
accounts, money market accounts, and other transaction-oriented accounts. The
Bank believes that increases in these account types will lessen the Bank's
dependence on time deposits such as certificates of deposit to fund loan growth.
Although management believes that the strategy outlined above will increase
financial performance over time, we recognize that products such as commercial
lending and transaction accounts will increase the Bank's noninterest expense
also. We also recognize that certain lending and deposit products also increase
the possibility of losses from credit and other risks.
FORWARD-LOOKING STATEMENTS
When used in this discussion and elsewhere in this Annual Report on Form 10-K,
the words or phrases "will likely result," "are expected to," "will continue,"
"is anticipated," "estimate," "project" or similar expressions are intended to
identify "forward-looking statements" within the meaning of the Private
Securities Litigation Reform Act of 1995. The Company cautions readers not to
place undue reliance on any such forward-looking statements, which speak only as
of the date made, and to advise readers that various factors, including regional
and national economic conditions, unfavorable judicial decisions, substantial
changes in levels of market interest rates, credit and other risks of lending
and investment activities and competitive and regulatory factors could affect
the Company's financial performance and could cause the Company's actual results
for future periods to differ materially from those anticipated or projected.
The Company does not undertake and specifically disclaims any obligation to
update any forward-looking statements to reflect occurrence of anticipated or
unanticipated events or circumstances after the date of such statements.
CRITICAL ACCOUNTING POLICIES
The Company's consolidated financial statements are prepared in accordance with
accounting principles generally accepted in the United States of America
("GAAP") and the general practices of the United States banking industry.
Application of these principles requires management to make estimates,
assumptions, and judgments that affect the amounts reported in the financial
statements and accompanying notes. These estimates, assumptions and judgments
are based on information available as of the date of the financial statements;
accordingly, as this information changes, the financial statements could reflect
different estimates, assumptions, and judgments. Certain policies inherently
have a greater reliance on the use of estimates, assumptions and judgments and
as such have a greater possibility of producing results that could be materially
different than originally reported. Estimates, assumptions, and judgments are
necessary when assets and liabilities are required to be recorded at fair value,
when a decline in the value of an asset not carried on the financial statements
at fair value warrants an impairment write-down or valuation reserve to be
established, or when an asset or liability needs to be recorded contingent upon
a future event. Carrying assets and liabilities at fair value inherently results
in more financial statement volatility. The fair values and the information used
to record valuation adjustments for certain assets and liabilities are based
either on quoted market prices or are provided by other third-party sources,
when available. When these sources are not available, management makes estimates
based upon what it considers to be the best available information.
26
The allowance for loan losses is an estimate of the losses that may be sustained
in our loan portfolio. The allowance is based on two principles of accounting:
(a) Statement on Financial Accounting Standards ("SFAS") 5, "Accounting for
Contingencies", which requires that losses be accrued when they are probable of
occurring and are estimable and (b) SFAS No. 114, "Accounting by Creditors for
Impairment of a Loan", which requires that losses be accrued when it is probable
that the Company will not collect all principal and interest payments according
to the contractual terms of the loan. The loss, if any, is determined by the
difference between the loan balance and the value of collateral, the present
value of expected future cash flows, or values observable in the secondary
markets.
Our loan loss allowance balance is an estimate based upon management's
evaluation of its loan portfolio. Generally the allowance is comprised of a
specific and a nonspecific component. The specific component consists of
management's evaluation of certain loans and their underlying collateral. Loans
are examined to determine the specific allowance based upon their payment
history, economic conditions specific to the loan or borrower, or other factors
that would impact the borrower's ability to repay the loan on its contractual
basis. Management assesses the ability of the borrower to repay the loan based
upon any information available. Depending on the assessment of the borrower's
ability to pay the loan as well as the type, condition, and amount of
collateral, management will establish an allowance amount specific to this loan.
In establishing a nonspecific loan loss amount , management analyzes the current
composition of the loan portfolio including changes in the amount and type of
loans. Management also examines the Bank's history of write-offs and recoveries
within each loan category. The state of the local and national economy is also
considered. Based upon these factors the Bank's loan portfolio is categorized
and a possible loss factor is applied to each category. These loss factors may
be higher or lower than the Bank's actual recent average losses in any
particular loan category, particularly in loan categories where the Bank is
rapidly increasing the size of its portfolio. Based upon these factors the Bank
will adjust the loan loss allowance by increasing or decreasing the provision
for loan losses.
Management has significant discretion in making the judgments inherent in the
determination of the provision and allowance for loan losses, including in
connection with the valuation of collateral, a borrower's prospects of
repayment, and in establishing allowance factors on the nonspecific component of
the allowance. Changes in allowance factors will have a direct impact on the
amount of the provision, and a corresponding effect on net income. Errors in
management's perception and assessment of the global factors and their impact on
the portfolio could result in the allowance not being adequate to cover losses
in the portfolio, and may result in additional provisions or charge-offs. For
additional information regarding the allowance for credit losses, refer to Notes
1 and 3 to the Consolidated Financial Statements and the discussion under the
caption "Provision for Loan Losses" below.
In addition to the loan loss allowance, the Company also maintains a valuation
allowance on its foreclosed real estate assets. As with the allowance for loan
losses the valuation allowance on foreclosed real estate is based on SFAS No. 5,
"Accounting for Contingencies," as well as SFAS Nos. 144 "Accounting for the
Impairment or Disposal of Long-Lived Assets." These statements require that the
Company establish a valuation allowance when it has determined that the carrying
amount of a foreclosed asset exceeds its fair value. Fair value of a foreclosed
asset is measured by the cash flows expected to be realized from its subsequent
disposition. These cash flows should be reduced for the costs of selling or
otherwise disposing of the asset.
In estimating the cash flow from the sale of foreclosed real estate, management
must make significant assumptions regarding the timing and amount of cash flows.
In cases where the real estate acquired is undeveloped land, management must
gather the best available evidence regarding the market value of the property,
including appraisals, cost estimates of development, and broker opinions. Due to
the highly subjective nature of this evidence, as well as the limited market,
long time periods involved, and substantial risks, cash flow estimates are
highly subjective and subject to change. Errors regarding any aspect of the
costs or proceeds of developing , selling, or otherwise disposing of foreclosed
real estate could result in the
27
allowance being inadequate to reduce carrying costs to fair value and may
require an additional provision for valuation allowances.
COMPARISON OF RESULTS OF OPERATIONS FOR THE YEARS ENDED DECEMBER 31, 2002, 2001
AND 2000
GENERAL. For the year ended December 31, 2002, the Company reported consolidated
net income of $1,967,821 ($2.58 basic and $2.45 fully diluted earnings per
share) compared to consolidated net income of $2,485,535 ($3.24 basic and $3.11
fully diluted earnings per share) for the year ended December 31, 2001, and
consolidated net income of $2,336,196 ($2.98 basic and $2.85 fully diluted
earnings per share) for the year ended December 31, 2000. The decrease in net
income for 2002 compared to 2001 was attributable to several factors including
the establishment of a valuation allowance on foreclosed real estate in 2002; a
core data systems conversion in 2002; and the increase in other noninterest
expenses in 2002. These negative factors were partially offset by an increase in
net interest income, a decrease in provision for loan losses, and an increase in
noninterest income. For the year ended December 31, 2002, net interest income
was $10,793,626 compared to $9,756,865 for the year ended December 31, 2001, an
increase of $1,036,761 or 10.63%. The Company also increased total noninterest
income to $1,847,061 in 2002 from $1,401,520 in 2001, an increase of $445,541or
31.79%. Noninterest expenses increased to $9,445,866 for the year ended December
31, 2002, compared to $6,994,500 an increase of $2,451,366 or 35.05%. Income
before income taxes decreased to $3,034,821 for the year ended December 31,
2002, compared to $3,803,885 for the year ended December 31, 2001, a decrease of
$769,064 or 20.22%. Income tax expense for 2002 decreased to $1,067,000 from
$1,318,350 for the year ended December 31, 2001.
For the year ended December 31, 2001, net interest income was $9,756,865
compared to $8,862,072 for the year ended December 31, 2000, an increase of
$894,793 or 10.1%. The Company also increased total noninterest income to
$1,401,520 in 2001 from $1,372,988 in 2000, an increase of $28,532 or 2.1%.
Noninterest expenses increased to $6,994,500 for the year ended December 31,
2001, compared to $6,331,864 an increase of $662,636 or 10.5%. Income before
income taxes increased to $3,803,885 for the year ended December 31, 2001,
compared to $3,543,196 for the year ended December 31, 2000, an increase of
$260,689 or 7.4%. Income tax expense for 2001 increased to $1,318,350 from
$1,207,000 for the year ended December 31, 2000.
NET INTEREST INCOME. The primary component of the Company's net income is its
net interest income which is the difference between income earned on assets and
interest paid on the deposits and borrowings used to fund them. Net interest
income is determined by the spread between the yields earned on the Company's
interest-earning assets and the rates paid on interest-bearing liabilities as
well as the relative amounts of such assets and liabilities. Net interest
income, divided by average interest-earning assets, represents the Company's net
interest margin.
Consolidated net interest income for the year ended December 31, 2002 was
$10,793,626 compared to $9,756,865 for the year ended December 31, 2001 and
$8,862,072 for the year ended December 31, 2000. The $1,036,761 increase in the
most recent year was due to decreases in both interest income and interest
expense with the decrease in interest expense of $2,789,183 only partially
offset by the decrease in interest income of $1,752,422. For the year ended
December 31, 2001, the $894,793 increase was due to an increase of $225,114 in
interest income combined with a decrease of $669,679 in interest expense for the
same period. Changes in the components of net interest income due to changes in
average balances of assets and liabilities and to changes caused by changes in
interest rates are presented in the rate volume analysis below.
During 2002, the Company's interest rate spread increased slightly because the
Bank was able to decrease the relative share of its assets invested in
investments and move these assets into higher yielding loans. The Bank was also
able to continue its shift from lower yielding loan types to higher yielding
loan types. The Bank was able to reduce its borrowing and deposit costs to a
greater extent than decreases in loan rates, and the Bank was able to increase
the share of its funding provided by deposits as opposed to borrowings.
28
The following table presents information on the average balances of the
Company's interest-earning assets and interest-bearing liabilities and interest
earned or paid thereon for the past three fiscal years. Average balances are
computed on the basis of month-end balances.
FOR THE YEAR ENDED DECEMBER 31,
-------------------------------------------------------------------------
2002 2001
-------------------------------- --------------------------------
AVERAGE AVERAGE
AVERAGE YIELD/ AVERAGE YIELD/
BALANCE INTEREST COST BALANCE INTEREST COST
------- -------- ------- ------- -------- -------
Interest-earning assets:
Loan portfolio (1) $ 195,280 $ 14,221 7.28% $ 184,370 $ 15,223 8.26%
Cash and investment securities 60,637 2,541 4.19% 58,276 3,291 5.65%
--------- -------- ------ --------- -------- ------
Total interest-earning assets 255,917 16,762 6.55% 242,646 18,514 7.63%
--------- -------- ------ --------- -------- ------
Interest-bearing liabilities:
Savings deposits and escrow $ 189,518 $ 3,453 1.82% $ 175,919 $ 5,935 3.37%
FHLB advances and other
borrowings 48,487 2,515 5.19% 52,387 2,822 5.39%
--------- -------- ------ --------- -------- ------
238,005 5,968 2.51% $ 228,306 8,757 3.84%
========= ======== ====== ========= ======== ======
Net interest income $ 10,794 $ 9,757
======== =======
Interest rate spread 4.04% 3.79%
====== ======
Net yield on interest-earning assets 4.18% 4.02%
====== ======
Ratio of average interest-earning
assets to average interest bearing
liabilities 107.53% 106.28%
====== ======
FOR THE YEAR ENDED DECEMBER 31,
---------------------------------
2000
---------------------------------
AVERAGE
AVERAGE YIELD/
BALANCE INTEREST COST
------- -------- --------
Interest-earning assets:
Loan portfolio $ 159,989 $ 13,950 8.72%
Cash and investment securities 62,673 4,340 6.92%
--------- -------- ------
Total interest-earning assets 222,662 18,290 8.21%
--------- -------- ------
Interest-bearing liabilities:
Savings deposits and escrow $ 160,324 $ 6,315 3.94%
FHLB advances and other
borrowings 49,664 3,113 6.26%
--------- -------- ------
$ 209,988 9,428 4.49%
========= ======== ======
Net interest income $ 8,862
========
Interest rate spread 3.72%
======
Net yield on interest-earning assets 3.98%
======
Ratio of average interest-earning
assets to average interest bearing
liabilities 106.04%
======
_________
(1) Average balance includes non-accrual loans.
29
The table below sets forth certain information regarding changes in interest
income and interest expense of the Bank for the periods indicated. For each
category of interest-earning asset and interest-bearing liability, information
is provided on changes attributable to: (1) changes in volume (changes in volume
multiplied by old rate); and (2) changes in rate (changes in rate multiplied by
old volume). Changes in rate-volume (changes in rate multiplied by the change in
volume) have been allocated to changes due to volume.
YEAR ENDED DECEMBER 31
-----------------------------------------------------------------------
2002 VS. 2001 2001 VS. 2000
------------------------------- --------------------------------
INCREASE (DECREASE) INCREASE (DECREASE)
DUE TO DUE TO
------------------------------- --------------------------------
VOLUME RATE TOTAL VOLUME RATE TOTAL
------ -------- -------- ------- -------- -------
(IN THOUSANDS)
Interest income:
Loan portfolio $ 801 $ (1,803) $ (1,002) $ 2,126 $ (853) $ 1,273
Interest-earning cash and
investment portfolio 99 (849) (750) (304) (745) (1,049)
----- -------- -------- ------- -------- -------
Total interest-earning assets $ 900 $ (2,652) $ (1,752) $ 1,822 $ (1,598) $ 224
===== ======== ======== ======= ======== =======
Interest expense:
Savings deposits and escrows $ 241 $ (2,723) $ (2,482) $ 614 $ (994) $ (380)
FHLB advances and other
borrowings (201) (106) (307) 170 (461) (291)
----- -------- -------- ------- -------- -------
$ 40 $ (2,829) $ (2,789) $ 784 $ (1,455) $ (671)
===== ======== ======== ======= ======== =======
PROVISION FOR LOAN LOSSES. Provision for loan losses for the year ended December
31, 2002 was $160,000 compared to $360,000 for December 31, 2001 and 2000. The
lower provision for loan losses in 2002 is due to the relatively small increase
in the size of the loan portfolio and the continued low level of loan
charge-offs. The loan loss allowance and the provision for loan losses is
determined based upon an analysis of individual loans and the application of
certain loss factors to different loan categories. Individual loans are analyzed
for impairment as the facts and circumstances warrant. In addition, a
nonspecific component of the loan loss allowance is added based on a review of
the portfolio's size and composition. At December 31, 2002 the allowance for
loan loss equaled 388% of non-accrual and past due loans compared to 996% and
1,771% at December 31, 2001 and 2000, respectively. During the year ended
December 31, 2002, the Company recorded net charge-offs of $127 thousand (.06%
of average loans) compare d to $8 thousand (0.01% of average loans) compared to
$83 thousand (0.05% of average loans) in net charge-offs during the years ended
December 31, 2001 and 2000.
NONINTEREST INCOME. Noninterest income increased to $1,847,061 for the year
ended December 31, 2002 compared to $1,401,520, for the prior year, an increase
of 31.79%. Noninterest income for the year ended December 31, 2001 represented
an increase of 2.1% from the December 31, 2000 total of $1,372,988. Changes in
noninterest income over the past three years have been the result of wide
fluctuations in certain noninterest income categories, (gain on sale of loans,
gain on sale of investments, loan fees) and an increase in service charges from
1999 to 2000. Gain on sale of investments was $184,704 in 2000. In 2001and 2002,
the Company had no investment sales or income from sales. Gain on sale of loans
held-for-sale has been highly variable reflecting the overall interest rate
environment. As rates decrease, the Bank's volume of fixed rate mortgage lending
increases, which in turn provides a higher volume of loan sales and gains. In
2001,
30
interest rates decreased from 2000 levels and income from gain on sale of
mortgage loans increased to $187,304. In 2002, interest rates decreased further
and income from gain on sale of mortgage loans again increased to $499,304. In
percentage terms gain on sale of loans held for sale increased by 119% from 2000
to 2001, and 167% from 2001 to 2002. Loan appraisal, credit and miscellaneous
charges are also highly variable; from 2000 to 2001, these charges increased to
$226,641 an increase of 196.9%. In 2002, these charges decreased to $179,006 a
decrease of 21% despite a high volume of loan transactions. This decrease was
caused by the market trends towards low and no cost loan products. Service
charges and fees are primarily generated by the Bank's ability to attract and
retain transaction-based deposit accounts. Service charges and fees increased to
$1,041,662 for the year ended December 31, 2002 as compared to $953,496 and
$996,884 in the two prior years. The increase for the year ended December 31,
2002 from the prior year was $88,166, or 9.3% while the decrease for the year
ended December 31, 2001 from the prior year was $43,388, or 4.4%. The Company
hopes to increase its service charge and fee revenues in the future by
increasing the level of transaction-based accounts. Finally, other noninterest
income increased from 2000 to 2001 and increased from 2001 to 2002. For the year
ended December 31, 2002, other noninterest income was $127,089, an increase from
the prior year total of $34,079.
NONINTEREST EXPENSES. Noninterest expenses for the year ended December 31, 2002
totaled $9,445,866, an increase of $2,451,366 or 35.1% from the prior year.
Salary and employee benefits increased by 10.5% to $4,222,006 for the year ended
December 31, 2002 compared to $3,821,330 for the prior year. The increase
reflects growth in the Company's workforce to fully staff branches as well as an
increasing need for highly skilled employees due to the higher complexity level
of the Bank's business. Occupancy expense increased to $831,148 compared to
$689,575 and $615,809 in the two prior years. This increase was due to certain
needed repairs and maintenance at several of the Company's locations, upgrades
to the facilities for the new core data system, and Charlotte Hall location
being open for a full year. Advertising increased from 2001 levels to $338,216
for the year ended December 31, 2002 compared to $301,975 and $246,619 in the
two prior years. Most advertising costs were incurred attempting to build our
transaction deposit base. Data processing expense increased to $568,095 from the
prior year total of $291,399, an increase of 95%. The Bank incurred significant
costs related to its conversion in this category in 2002. These costs included
training, consulting, and transition fees related to the conversion process. The
increase in data processing expense is also reflective of the Company's
additional transaction based deposit accounts and an increase in overall deposit
volume. Loss on disposal of obsolete equipment totaled $65,104 in 2002. These
expenses related to the write-off of certain equipment that could not support
the new core system. Depreciation of furniture, fixtures, and equipment
increased from $241,714 in 2000, to $263,535 in 2001, to $339,184 in 2002. The
increase from 2000 to 2001 reflects the Bank's opening of certain locations and
the subsequent increase in the amount of premises purchased. In 2002, certain
asset lives were adjusted to better reflect useful lives of equipment, which
increased current expense. Telephone communications expenses increased to
$345,559 in 2002 from $127,958 in 2001, and $109,537 in 2000. The increased
expense in 2002 was primarily attributable to the conversion and change in data
systems which required an increase in the amount and complexity of phone
communication lines. The Bank also uses certain phone lines to transmit data to
its service bureau, which has also increased costs. In 2002, the Bank recorded a
valuation allowance of $972,889 on its foreclosed real estate. For further
explanation of this item see the discussion in the foreclosed asset section. ATM
expenses increased to $312,200 from $254,175, an increase of $58,025 or 22%.
This increase was due to an increase in ATM's, as well as higher transaction
volume at ATM's caused by an increase in the Bank's transaction account
business. Office supplies increased to $290,636 from $253,545 in 2001, an
increase of $37,091 or 15%. This increase was caused by a the increase in the
Banks deposit and loan activity particularly in transaction accounts. Office
equipment expenses also increased to $217,171 from $211,316, an increase of
$35,855 or 17%. The increase was due to the expansion of the Branch network as
well as the increased volume of business. Finally other expenses were $913,658
in 2002, increasing from $779,692 in 2001, and $536,474 in 2000. The increase in
other expenses is reflective of the increases in the Bank's size and volume of
transactions over this period.
INCOME TAX EXPENSE. During the year ended December 31, 2002, the Company
recorded income tax expense of $1,067,000 compared to expenses of $1,318,350 and
$1,207,000 in the two prior years. The
31
Company's effective tax rates for the years ended December 31, 2002, 2001, and
2000 were 35.2%, 34.7% and 34.1%, respectively. The slight increase in the tax
rate during 2002 was primarily attributable to an increase in certain
non-deductible costs. The increase in the tax rate during 2001 was primarily
attributable to an increase in the state income tax burden. In 2000 taxes were
substantially reduced because income earned on investment securities held by the
Bank's passive investment corporation subsidiary, Tri-County Investment
Corporation ("TCIC"), was not subject to state income tax. In 2001 and 2002,
reductions in the assets invested in TCIC as well as the interest rate earned on
these investments reduced the amount of income sheltered from state income tax,
increasing the effective tax rate.
COMPARISON OF FINANCIAL CONDITION AT DECEMBER 31, 2002 AND 2001
The Company's total assets increased $20,216,405, or 7.7%, to $282,173,695 as of
December 31, 2002 from $261,957,290 at December 31, 2001. The increase in assets
was primarily in cash and interest bearing deposits with banks which increased
by $11,408,651 or 80.8% to $25,536,783. The increase was due to the large
amounts of securities and loan balances which prepaid in 2002. The lack of
attractive long term investments caused the Bank to invest the proceeds of these
prepayments in short term assets. In addition, the Bank chose to sell, rather
than add to its portfolio substantially all fixed rate residential first
mortgages settled in 2002, which increased cash balances while reducing loans.
Other investments including securities available for sale and held to maturity
as well as stock in the Federal Home Loan and Federal Reserve Banks increased by
$6,162,559 in 2002 to $47,404,670 from $41,242,111 in 2001. As noted above
prepayments on securities increased due to the low interest rate environment.
Although the Bank purchased securities throughout the year, total balances
increased only marginally as $33,115,668 in securities purchases were
substantially offset by prepayments.
Loans held for sale decreased from $2,354,315 in the prior year to $1,262,667.
The balance of this account is subject to a high amount of variability. Net
loans receivable increased by $3,999,271 or 2.1% to $197,449,282 in 2002
compared with $193,450,011 in 2001. Large increases in commercial real estate
and commercial lines of credit offset a decrease in residential first mortgage
balances. Commercial real estate and commercial lines of credit grew because the
Bank focused on these lines as target markets and the Bank keeps substantially
all of these loans in its portfolio. Commercial lines of credit grew to
$29,947,326 in 2002 an increase of $11,408,117 or 61.5% from $18,539,209 in
2001. Commercial real estate loan balances grew to $74,291,593 in 2002 an
increase of $8,674,676 or 13.2% from $65,616,917 in 2001. These large increases
were offset by a large decrease in the balance of residential first mortgages to
$48,975,989 in 2002 from $61,429,647 in 2001 a decrease of $12,453,658 or 20.3%.
As noted above, residential first mortgages declined due to increasing rates of
prepayment and the Bank's sale of most of the residential first mortgages that
it settled in 2002.
Premises and equipment increased $303,547 primarily due to upgrades of computer
equipment and offices, the opening of an additional branch, and the conversion
to a new data core system. Substantial amounts of equipment to support the core
data conversion were acquired during the year. Foreclosed real estate decreased
primarily as the result of the establishment of a valuation allowance on certain
foreclosed properties. Other assets increased $525,528 primarily due to an
increase in certain prepaid tax accounts.
Deposits increased to $203,025,112 at December 31, 2002 compared to $183,116,534
for the prior year. The total increase of 10.9% was concentrated in certain
transaction-based account types. Noninterest-bearing demand deposits increased
to $33,045,310 at December 31, 2002 from the prior year's total of $17,738,065,
an increase of $15,307,245, or 86.3%. Interest-bearing demand deposits increased
to $22,440,453 at year end compared with $20,842,088, an increase of $1,598,365,
or 7.7%. Savings deposits increased by $10,307,533 or 50.6% to $30,675,167 from
$20,367,634. Certificates of deposit grew to $77,082,464 from $70,360,762 an
increase of $6,721,702, or 9.6%. These increases were offset by a decrease in
money market deposits to $39,781,718 at December 31, 2002 from $53,807,885 at
December 31, 2001, a decrease of $14,026,167, or 26.1%. The Company had
relatively small changes in short and long term debt and other liabilities in
2002.
32
The Company experienced a $1,286,307, or 5.0%, increase in stockholders' equity
for the year ended December 31, 2002. The increase in stockholders' equity was
attributable to the retention of earnings from the period less cash dividends ,
option exercises and ESOP activity. These increases in equity were partially
offset by repurchases of common stock totaling $443,568 and a decrease in other
comprehensive income.
ASSET/LIABILITY MANAGEMENT
Net interest income, the primary component of the Company's net income, arises
from the difference between the yield on interest-earning assets and the cost of
interest-bearing liabilities and the relative amounts of such assets and
liabilities. The Company manages its assets and liabilities by coordinating the
levels of and gap between interest-rate sensitive assets and liabilities to
control changes in net interest income and in the economic value of its equity
despite changes in market interest rates.
Among other tools used to monitor interest rate risk is a "gap" report which
measures the dollar difference between the amount of interest-earning assets and
interest-bearing liabilities subject to repricing within a given time period.
Generally, during a period of rising interest rates, a negative gap position
would adversely affect net interest income, while a positive gap would result in
an increase in net interest income. While, conversely, during a period of
falling interest rates, a negative gap would result in an increase in net
interest income and a positive gap would adversely affect net interest income.
The following sets forth the Bank's gap position at December 31, 2002:
33
OVER 3 TO 12 OVER 1
0-3 MONTHS MONTHS THROUGH 5 YEARS OVER 5 YEARS
(AMOUNTS IN THOUSANDS)
Assets:
Cash and due from banks $ 10,357 $ -- $ -- $ --
Interest-bearing deposits 15,180 -- -- --
Securities 9,493 14,072 17,901 3,202
Loans held for sale 1,263 -- -- --
Loans 29,630 30,845 43,328 97,628
-------- -------- -------- --------
Total Assets $ 65,923 $ 44,917 $ 61,229 $100,830
======== ======== ======== ========
Liabilities
Noninterest bearing deposits $ 33,045 $ -- -- $ --
Interest bearing demand deposits 22,440 -- -- --
Money market deposits 39,782 -- -- --
Savings 30,675 -- -- --
Certificates of deposit 14,899 34,131 $ 28,052 --
Short-term debt 752 -- -- --
Long-term debt 88 15,162 7,000 25,920
-------- -------- -------- --------
Total Liabilities $141,681 $ 49,293 $ 35,052 $ 25,920
======== ======== ======== ========
Gap $(75,758) $ (4,376) $ 26,177 $ 74,910
Cumulative Gap $(75,758) $(80,134) $(53,957) $ 20,953
Cumulative Gap as a percentage of
total assets -26.85% -28.40% -19.12% 7.42%
The foregoing analysis assumes that the Bank's assets and liabilities move with
rates at their earliest repricing opportunities based on final maturity.
Mortgage-backed securities are assumed to mature during the period in which they
are estimated to prepay and it is assumed that loans and other securities are
not called nor do they prepay prior to maturity. Certificates of deposit and IRA
accounts are presumed to reprice at maturity. NOW and savings accounts are
assumed to reprice within three months although it is the Company's experience
that such accounts may be less sensitive to changes in market rates.
As noted above the Bank, has a substantial excess of liabilities over assets
repricing or maturing within one year. This would indicate that the Bank's net
interest income would decline if interest rates were to increase. A decrease in
net interest income as a result of a general increase in rates is likely, but
the Bank has the ability to moderate the effect of a general increase in
interest rates by controlling increases in rates on transaction accounts, using
available cash to reduce the amounts in particularly rate sensitive liability
accounts, and increasing total assets through increased leverage. In addition,
the analysis above substantially understates the amount of loan prepayments the
Bank has historically experienced even in periods of rising interest rates.
34
LIQUIDITY AND CAPITAL RESOURCES
The Company currently has no business other than that of the Bank and does not
currently have any material funding commitments. The Company's principal sources
of liquidity are cash on hand and dividends received from the Bank. The Bank is
subject to various regulatory restrictions on the payment of dividends.
The Bank's principal sources of funds for investments and operations are net
income, deposits from its primary market area, principal and interest payments
on loans, interest received on investment securities and proceeds from maturing
investment securities. Its principal funding commitments are for the origination
or purchase of loans and the payment of maturing deposits. Deposits are
considered the primary source of funds supporting the Bank's lending and
investment activities. The Bank also uses borrowings from the FHLB of Atlanta to
supplement deposits. The amount of FHLB advances available to the Bank is
limited to the lower of 35% of Bank assets or the amount supportable by eligible
collateral including FHLB stock, current residential first mortgage loans, and
certain securities.
The Bank's most liquid assets are cash, cash equivalents, and interest-bearing
deposits which are comprised of cash on hand, amounts due from financial
institutions, and interest-bearing deposits. The levels of such assets are
dependent on the Bank's operating financing and investment activities at any
given time. The variations in levels of cash and cash equivalents are influenced
by deposit flows and anticipated future deposit flows.
Cash, cash equivalents, and interest-bearing deposits as of December 31, 2002,
totaled $25,536,783, an increase of $11,408,651 (80.8%) from the December 31,
2001 total of $14,128,132. This increase was primarily in interest-bearing
deposits at other financial institutions which totaled $15,179,851at December
31, 2002 compared to $7,678,158 at the end of 2001. Cash and cash equivalents
increased to $10,356,932 from $6,449,974 at December 31, 2001, primarily due to
an increase in balances invested in short term mutual funds.
The Company's principal sources of cash flows are its financing activities
including deposits and borrowings. During the year 2002, all financing
activities provided $17,747,865 million in cash compared to $9,823,609 during
2001 and $21,591,397 during 2000. The increase in cash flows from financing
activities during the most recent period was principally due to an increase in
deposit growth in 2002. During 2002, net deposit growth was $19,908,378 compared
to $15,310,535 in 2001. In 2002, short and long term borrowing used $1,541,019
in cash compared to $4,487,586 in cash used in 2001. The Company also receives
cash from its operating activities which provided $4,523,228 million in cash
during 2002, compared to cash flows of $5,012,228 and $4,068,169 during 2001 and
2000, respectively. The decrease in operating cash flows during 2002 was
primarily due to a decrease in the net activity in selling loans held for sale.
In 2001, the purchase and sale of loans held for sale provided $2,186,619
compared to $1,590,952 in 2002.
The Company's principal use of cash has been in investing activities including
its investments in loans for portfolio, investment securities and other assets.
During the year ended December 31, 2002, the Company invested a total of
$18,364,135 in its investing activities compared to $9,750,117 in 2001 and
$28,556,739 in 2000. The principal reason for the increase in cash used in
investing Factivities was an increase in the purchase of investments over the
proceeds of sales, redemptions, and principal reductions.
Federal banking regulations require the Company and the Bank to maintain
specified levels of capital. At December 31, 2002 the Company was in compliance
with these requirements with a leverage ratio of 9.53%, a Tier 1 risk-based
capital ratio of 12.60% and total risk-based capital ratio of 13.75%. At
December 31, 2002, the Bank met the criteria for designation as a
well-capitalized depository institution under FRB regulations.
35
IMPACT OF INFLATION AND CHANGING PRICES
The consolidated financial statements and notes thereto presented herein have
been prepared in accordance with generally accepted accounting principles, which
require the measurement of financial position and operating results in terms of
historical dollars without considering the changes in the relative purchasing
power of money over time due to inflation. Unlike most industrial companies,
nearly all of the Company's assets and liabilities are monetary in mature. As a
result, interest rates have a greater impact on the Company's performance than
do the effects of general levels of inflation. Interest rates do not necessarily
move in the same direction or to the same extent as the prices of goods and
services.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
- -------------------------------------------------------------------
Not applicable since the registrant is a small business issuer.
36
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
- ----------------------------------------------------
The Company's financial statements and supplementary data appear in this Annual
Report beginning on the page immediately following Item 15 hereof.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
- --------------------------------------------------------------------------------
Not applicable.
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
- ------------------------------------------------------------
The information contained under the section captioned "Proposal I -- Election of
Directors" in the Company's definitive proxy statement for the Company's 2003
Annual Meeting of Stockholders (the "Proxy Statement") is incorporated herein by
reference.
The executive officers of the Company are as follows:
MICHAEL L. MIDDLETON (55 years old) is President and Chief Executive Officer of
the Company and the Bank. He joined the Bank in 1973 and served in various
management positions until 1979 when he became president of the Bank. Mr.
Middleton is a Certified Public Accountant and holds a Masters of Business
Administration. As President and Chief Executive Officer of the Bank, Mr.
Middleton is responsible for the overall operation of the Bank pursuant to the
policies and procedures established by the Board of Directors. Since January
1996, Mr. Middleton has served on the Board of Directors of the Federal Home
Loan Bank of Atlanta, most recently as Vice Chairman, and also serves as its
Board Representative to the Council of Federal Home Loan Banks.
C. MARIE BROWN (60 years old) has been employed with the Bank since 1972 and has
served as Chief Operating Officer since 1999. Prior to her appointment as Chief
Operating Officer, Ms. Brown served as Senior Vice President of the Bank. She is
a supporter of the Handicapped and Retarded Citizens of Charles County, of Zonta
and serves on various administrative committees of the Hughesville Baptist
Church and the board of the Charles County Chapter of the American Red Cross.
H. BEAMAN SMITH (57 years old) was the Treasurer of the Company in 1998 and
became Secretary-Treasurer in January 1999 and has been the president of
Accoware, a computer software company, since 1989. Prior to that time, Mr. Smith
was a majority owner of the Smith's Family Honey Company in Bryans Road,
Maryland. Mr. Smith is a Vice President of Fry Plumbing Company of Washington,
D.C., a Trustee of the Ferguson Foundation, a member of the Bryans Road Sports
Council and the Treasurer of the Mayaone Association.
GREGORY C. COCKERHAM (48 years old) joined the Bank in November 1988 and has
served as Chief Lending Officer since 1996. Prior to his appointment as Senior
Vice President, Mr. Cockerham served as Vice President of the Bank. Mr.
Cockerham has been in banking for 22 years. He is a Paul Harris Fellow with the
Rotary Club of Charles County and serves on various civic boards in the County.
WILLIAM J. PASENELLI (44 years old) joined the Bank as Chief Financial Officer
in April 2000. Prior to joining the Bank, Mr. Pasenelli had been Chief Financial
Officer of Acacia Federal Savings Bank, Annandale, Virginia since 1987. Mr.
Pasenelli is a member of the American Institute of Certified Public Accountants,
the DC Institute of Certified Public Accountants, and other civic groups.
37
ITEM 11. EXECUTIVE COMPENSATION
- --------------------------------
The information contained under the section captioned "Proposal I -- Election of
Directors -- Executive Compensation" in the Proxy Statement is incorporated
herein by reference.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND
RELATED STOCKHOLDER MATTERS
- --------------------------------------------------------------------------------
(a) SECURITY OWNERSHIP OF CERTAIN OWNERS
The information required by this item is incorporated herein by reference to the
sections captioned "Proposal I -- Election of Directors" and "Voting Securities
and Principal Holders Thereof" of the Proxy Statement.
(b) SECURITY OWNERSHIP OF MANAGEMENT
Information required by this item is incorporated herein by reference to the
section captioned "Proposal I -- Election of Directors" of the Proxy Statement.
(c) CHANGES IN CONTROL
Management of the Company knows of no arrangements, including any pledge by any
person of securities of the Company, the operation of which may at a subsequent
date result in a change in control of the registrant.
(d) EQUITY COMPENSATION PLANS
The Company has adopted a variety of compensation plans pursuant to which equity
may be awarded to participants including the Company's 1995 Stock Option and
Incentive Plan and the 1995 Stock Option Plan for Non-Employee Directors. The
Bank's Executive Incentive Compensation Plan provides for grants of options
under the 1995 Stock Option and Incentive Plan if certain performance criteria
are met.
The following table sets forth certain information with respect to the Company's
Equity Compensation Plans.
NUMBER OF SECURITIES REMAINING
AVAILABLE FOR FUTURE ISSUANCE
NUMBER OF SECURITIES TO BE ISSUED WEIGHTED-AVERAGE EXERCISE UNDER EQUITY COMPENSATION
UPON EXERCISE OF OUTSTANDING PRICE OF OUTSTANDING PLANS (EXCLUDING SECURITIES
PLAN CATEGORY OPTIONS, WARRANTS AND RIGHTS OPTIONS, WARRANTS AND RIGHTS REFLECTED IN COLUMN (A))
- ------------- --------------------------------- ---------------------------- -----------------------------
Equity compensation plans
approved by security holders 82,701 $20.71 46,839
Equity compensation plans not
approved by security holders (1) 14,900 25.65 6,642
Total (2) 97,601 21.46 55,281
__________
(1) Consists of the 1995 Stock Option Plan for Non-Employee Directors which
provides grants of non-incentive options to directors who are not employees
of the Company or its subsidiaries. Options are granted under the plan at
an exercise price equal to their fair market value at the date of grant and
have a term of ten years. Options are generally exercisable while an
optionee serves as a director or within one year thereafter.
(2) The 1995 Stock Option and Incentive Plan and 1995 Stock Option Plan for
Non-Employee Directors each provide for a proportionate adjustment to the
number of shares reserved thereunder in the event of a stock split, stock
dividend reclassification, recapitalization or similar event.
38
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
- --------------------------------------------------------
The information required by this item is incorporated herein by reference to the
section captioned "Proposal I -- Election of Directors" and "Transactions with
the Company and the Bank" of the Proxy Statement.
ITEM 14. CONTROLS AND PROCEDURES
- ---------------------------------
The Company's Chief Executive Officer and Chief Financial Officer have evaluated
the Company's disclosure controls and procedures (as such term is defined in
Rule 13a-14(c) under the Exchange Act) as of a date within 90 days of the date
of filing of this Form 10-K. Based upon such determination, the Company's Chief
Executive Officer and Chief Financial Officer have concluded that such controls
and procedures are effective to ensure that the information required to be
disclosed by the Company in the reports it files under the Exchange Act is
gathered, analyzed and disclosed with adequate timeliness.
There have been no significant changes in the Company's internal controls or in
other factors that could significantly affect internal controls subsequent to
the date of the evaluation described above.
PART IV
ITEM 15. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K
- --------------------------------------------------------------------------
(a) LIST OF DOCUMENTS FILED AS PART OF THIS REPORT
----------------------------------------------
(1) Financial Statements. The following is a list of the consolidated
financial statements which are being filed as part of this Annual Report on Form
10-K.
Page
----
Independent Auditors' Report 41
Consolidated Balance Sheets as of December 31, 2002 and 2001 42
Consolidated Statements of Income for the Years Ended December 31, 2002,
2001 and 2000 43
Consolidated Statements of Changes in Stockholders' Equity for the Years
Ended December 31, 2002, 2001 and 2000 44
Consolidated Statements of Cash Flows for the Years Ended December 31, 2002,
2001 and 2000 45
Notes to Consolidated Financial Statements 47
(2) Financial Statement Schedules. All schedules for which provision
is made in the applicable accounting regulations of the Securities and Exchange
Commission are omitted because of the absence of conditions under which they are
required or because the required information is included in the consolidated
financial statements and related notes thereto.
(3) Exhibits. The following is a list of exhibits filed as part of
this Annual Report on Form 10-K and is also the Exhibit Index.
3.1 Articles of Incorporation of Tri-County Financial Corporation*
3.2 Bylaws of Tri-County Financial Corporation *****
10.1 + Tri-County Financial Corporation 1995 Stock Option and
Incentive Plan, as amended **
10.2 + Tri-County Financial Corporation 1995 Stock Option Plan for
Non-Employee Directors, as amended ***
39
10.3 + Employment Agreements with Michael L. Middleton, as amended,
C. Marie Brown, as amended, and Gregory C. Cockerham ****
10.4 + Guaranty Agreements with Michael L. Middleton, C. Marie Brown
and Gregory C. Cockerham **
10.5 + Executive Incentive Compensation Plan **
10.6 + Employment Agreement with William J. Pasenelli **
10.7 + Retirement Plan for Directors **
10.8 + Split Dollar Agreements with Michael L. Middleton and C. Marie
Brown **
10.9+ Guaranty Agreement with William J. Pasenelli *****
10.10+ Split Dollar Agreement with William J. Pasenelli *****
21 Subsidiaries of the Registrant
23 Consent of Stegman & Company
99 Certification of Chief Executive Officer and Chief Financial
Officer pursuant to Section 906 of Sarbanes-Oxley Act of 2002
_______________
+ Management contract or compensatory plan required to be filed as an
exhibit pursuant to Item 14(c).
* Incorporated by reference to the Registrant's Registration Statement
on Form S-4 (No. 33-31287).
** Incorporated by reference to the Registrant's Form 10-K for the fiscal
year ended December 31, 2000.
*** Incorporated by reference to the Registrant's Registration Statement
on Form S-8 (File No. 333-70800).
**** Incorporated by reference to Registrant's Annual Report on Form 10-K
for the fiscal year ended December 31, 1998
***** Incorporated by reference to Registrant's Annual Report on Form 10-K
for the fiscal year ended December 31, 2001
(b) REPORTS ON FORM 8-K. No reports on Form 8-K have been filed during the
-------------------
last quarter of the fiscal year covered by this report.
(c) EXHIBITS. The exhibits required by Item 601 of Regulation S-K are
--------
either filed as part of this Annual Report on Form 10-K or
incorporated by reference herein.
(d) FINANCIAL STATEMENTS AND SCHEDULES EXCLUDED FROM ANNUAL REPORT. There
---------------------------------------------------------------
are no other financial statements and financial statement schedules
which were excluded from the Annual Report pursuant to Rule
14a-3(b)(1) which are required to be included herein.
40
Audit Committee of the
Board of Directors and Stockholders
Tri-County Financial Corporation
We have audited the accompanying consolidated balance sheets of Tri-County
Financial Corporation as of December 31, 2002 and 2001, and the related
consolidated statements of income, changes in stockholders' equity and cash
flows for each of the three years in the period ended December 31, 2002. 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 auditing standards generally
accepted in the United States of America. Those standards require that we plan
and perform the audit to obtain reasonable assurance about whether the financial
statements are free of material misstatement. An audit includes examining, on a
test basis, evidence supporting the amounts and disclosures in the financial
statements. An audit also includes assessing the accounting principles used and
significant estimates made by management, as well as evaluating the overall
financial statement presentation. We believe that our audits provide a
reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above
present fairly, in all material respects, the consolidated financial position of
Tri-County Financial Corporation as of December 31, 2002 and 2001, and the
results of its operations and cash flows for each of the three years in the
period ended December 31, 2002, in conformity with accounting principles
generally accepted in the United States of America.
/s/ Stegman & Company
Baltimore, Maryland
February 28, 2003
41
TRI-COUNTY FINANCIAL CORPORATION
CONSOLIDATED BALANCE SHEETS
DECEMBER 31, 2002 AND 2001
ASSETS
2002 2001
Cash and due from banks $ 10,356,932 $ 6,449,974
Interest-bearing deposits with banks 15,179,851 7,678,158
Investment securities available for sale - at fair value 41,826,113 35,917,207
Investment securities held to maturity - at amortized cost 2,841,807 2,289,354
Stock in Federal Home Loan Bank and Federal Reserve Bank - at cost 2,736,750 3,035,550
Loans held for sale 1,262,667 2,354,315
Loans receivable - net of allowance for loan losses
of $2,314,074 and $2,281,581, respectively 197,449,282 193,450,011
Premises and equipment, net 5,736,395 5,432,848
Foreclosed real estate 716,014 1,800,569
Accrued interest receivable 1,042,453 1,049,401
Other assets 3,025,431 2,499,903
------------- -------------
TOTAL ASSETS $ 282,173,695 $ 261,957,290
============= =============
LIABILITIES AND STOCKHOLDERS' EQUITY
LIABILITIES:
Noninterest-bearing deposits $ 33,045,310 $ 17,738,165
Interest-bearing deposits 169,979,802 165,378,369
------------- -------------
Total deposits 203,025,112 183,116,534
Short-term borrowings 752,298 1,813,317
Long-term debt 48,170,000 48,650,000
Accrued expenses and other liabilities 3,353,520 2,790,981
------------- -------------
Total liabilities 255,300,930 236,370,832
------------- -------------
STOCKHOLDERS' EQUITY:
Common stock - par value $.01; authorized - 15,000,000 shares;
issued 759,778 and 756,805 shares, respectively 7,598 7,568
Additional paid in capital 7,716,906 7,545,590
Retained earnings 18,817,615 17,678,367
Accumulated other comprehensive income 493,691 555,513
Unearned ESOP shares (163,045) (200,580)
------------- -------------
Total stockholders' equity 26,872,765 25,586,458
------------- -------------
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $ 282,173,695 $ 261,957,290
============= =============
See notes to consolidated financial statements
42
TRI-COUNTY FINANCIAL CORPORATION
CONSOLIDATED STATEMENTS OF INCOME
FOR THE YEARS ENDED DECEMBER 31, 2002, 2001, AND 2000
2002 2001 2000
---- ---- ----
INTEREST INCOME:
Interest and fees on loans $ 14,221,247 $ 15,223,463 $ 13,950,200
Taxable interest and dividends on investment securites 2,436,361 3,215,164 4,237,326
Interest on deposits with banks 104,646 76,049 102,036
------------ ------------ ------------
Total interest income 16,762,254 18,514,676 18,289,562
------------ ------------ ------------
INTEREST EXPENSE:
Interest on deposits 3,453,443 5,935,478 6,314,871
Interest on short term borrowings 7,634 259,558 1,418,146
Interest on long term debt 2,507,551 2,562,775 1,694,473
------------ ------------ ------------
Total interest expenses 5,968,628 8,757,811 9,427,490
------------ ------------ ------------
NET INTEREST INCOME 10,793,626 9,756,865 8,862,072
PROVISION FOR LOAN LOSSES 160,000 360,000 360,000
NET INTEREST INCOME AFTER PROVISION FOR LOAN LOSSES 10,633,626 9,396,865 8,502,072
------------ ------------ ------------
NONINTEREST INCOME:
Loan appraisal, credit, and miscellaneous charges 179,006 226,641 76,326
Net gain on sale of loans held for sale 499,304 187,304 85,716
Net gain on sales of investment securities -- -- 184,704
Service charges 1,041,662 953,496 996,884
Other 127,089 34,079 29,358
------------ ------------ ------------
Total noninterest income 1,847,061 1,401,520 1,372,988
------------ ------------ ------------
NONINTEREST EXPENSE:
Salary and employee benefits 4,222,006 3,821,330 3,643,865
Occupancy expense 831,148 689,575 615,809
Advertising 338,216 301,975 246,619
Data processing expense 568,095 291,399 255,792
Loss on disposal of obsolete equipment 65,104 -- --
Depreciation of furniture, fixtures, and equipment 339,184 263,535 241,714
Telephone communications 345,559 127,958 109,537
Valuation allowance on foreclosed real estate 972,889 -- --
ATM expenses 312,200 254,175 340,532
Office supplies 290,636 253,545 156,260
Office equipment expenses 247,171 211,316 185,262
Other 913,658 779,692 536,474
------------ ------------ ------------
Total noninterest expenses 9,445,866 6,994,500 6,331,864
------------ ------------ ------------
INCOME BEFORE INCOME TAXES 3,034,821 3,803,885 3,543,196
Income tax expense 1,067,000 1,318,350 1,207,000
------------ ------------ ------------
NET INCOME $ 1,967,821 $ 2,485,535 $ 2,336,196
============ ============ ============
INCOME PER COMMON SHARE
Basic $2.58 $3.24 $2.98
Diluted 2.45 3.11 2.85
See notes to consolidated financial statements
43
TRI-COUNTY FINANCIAL CORPORATION
CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY
FOR THE YEARS ENDED DECEMBER 31, 2002, 2001, AND 2000
Accumulated
Other Unearned
Common Paid-in Retained Comprehensive ESOP
Stock Capital Earnings Income (Loss) Shares Total
------ ------- -------- ------------- --------- -----
BALANCES, JANUARY 1, 2000 $ 7,882 $ 7,447,240 $ 14,555,324 $ (718,498) $(176,565) $ 21,115,383
Comprehensive income:
Net Income -- -- 2,336,196 -- -- 2,336,196
Unrealized gains on investment
securities net of tax of $310,083 603,569 603,569
------------
Total comprehensive income 2,939,765
Cash dividend $0.30 per share -- -- (236,595) -- -- (236,595)
Excess of fair market value over cost
of leveraged ESOP shares released -- 12,964 -- -- -- 12,964
Exercise of stock options 50 40,661 -- -- -- 40,711
Repurchase of common stock (173) -- (479,217) -- -- (479,390)
Net change in unearned ESOP shares 18 -- -- -- 36,966 36,984
------- ----------- ------------ --------- --------- ------------
BALANCES, DECEMBER 31, 2000 7,777 7,500,865 16,175,708 (114,929) (139,599) 23,429,822
Comprehensive income:
Net Income -- -- 2,485,535 -- -- 2,485,535
Unrealized gains on investment
securities net of tax of $343,599 -- -- -- 670,442 -- 670,442
------------
Total comprehensive income 3,155,977
Cash dividend $0.40 per share -- -- (309,204) -- -- (309,204)
Excess of fair market value over cost
of leveraged ESOP shares released -- 12,964 -- -- -- 12,964
Exercise of stock options 56 31,761 -- -- -- 31,817
Repurchase of common stock (248) -- (673,672) -- -- (673,920)
Net change in unearned ESOP shares (17) -- -- -- (60,981) (60,998)
------- ----------- ------------ --------- --------- ------------
BALANCES, DECEMBER 31, 2001 7,568 7,545,590 17,678,367 555,513 (200,580) 25,586,458
Comprehensive income:
Net Income -- -- 1,967,821 -- -- 1,967,821
Unrealized gains on investment
securities net of tax of $24,455 -- -- -- (61,822) -- (61,822)
------------
Total comprehensive income 1,905,999
Cash dividend $0.50 per share -- -- (385,129) -- -- (385,129)
Excess of fair market value over cost
of leveraged ESOP shares released -- 10,445 -- -- -- 10,445
Exercise of stock options 133 160,871 -- -- -- 161,004
Repurchase of common stock (123) -- (443,444) (443,567)
Net change in unearned ESOP shares 20 -- -- -- 37,535 37,555
------- ----------- ------------ --------- --------- ------------
BALANCES, DECEMBER 31, 2002 $ 7,598 $ 7,716,906 $ 18,817,615 $ 493,691 $(163,045) $ 26,872,765
======= =========== ============ ========= ========= ============
See notes to consolidated financial statements
44
TRI-COUNTY FINANCIAL CORPORATION
CONSOLIDATED STATEMENTS OF CASH FLOWS
FOR THE YEARS ENDED DECMBER 31, 2002, 2001, AND 2000
2002 2001 2000
---- ---- ----
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income $ 1,967,821 $ 2,485,535 $ 2,336,196
Adjustments to reconcile net income to net
cash provided by operating activities:
Valuation allowance on foreclosed real estate 972,889 -- --
Provision for loan losses 160,000 360,000 360,000
Depreciation and amortization 445,558 396,400 348,110
Net amortization of premium/discount on
mortgage backed securities and investments 48,426 66,146 (86,909)
Deferred income tax benefit (399,000) (205,000) (118,000)
Decrease (increase) in accrued interest receivable 6,948 304,257 (207,138)
Decrease in deferred loan fees (90,291) (18,131) (31,732)
Increase in accrued expenses and other liabilities 562,539 638,249 911,013
Decrease (increase) in other assets (319,625) (1,006,157) 323,234
Loss (gain) on disposal of premises and equipment 76,315 (8,386) --
Gain on sale of investment securities -- -- (184,704)
Origination of loans held for sale (23,376,262) (9,752,097) (1,966,774)
Proceeds from sale of loans held for sale 24,967,214 11,938,716 2,470,589
Gain on sales of loans held for sale (499,304) (187,304) (85,716)
------------ ------------ ------------
Net cash provided by operating activities 4,523,228 5,012,228 4,068,169
------------ ------------ ------------
CASH FLOWS FROM INVESTING ACTIVITIES:
Net increase in interest-bearing deposits with banks (7,501,693) (1,702,844) (2,912,035)
Purchase of investment securities available for sale (30,740,615) (2,246,225) (6,023,907)
Proceeds from sale, redemption or principal payments
of investment securities available for sale 24,692,742 23,423,736 6,927,513
Purchase of investment securities held to maturity (2,375,053) (1,345,703) (893,649)
Proceeds from maturities or principal payments
of investment securities held to maturity 1,822,600 770,717 1,128,333
Net redemption (purchase) of FHLB and Federal Reserve stock 298,800 -- (747,850)
Loans originated or acquired (86,078,892) (96,149,353) (70,415,720)
Principal collected on loans 82,009,912 70,448,931 44,707,731
Purchase of premises and equipment (1,106,504) (1,334,396) (327,155)
Proceeds from disposal of premises and equipment 281,084 8,963 --
Sale (acquisition) of foreclosed real estate 333,484 (1,623,943) --
------------ ------------ ------------
Net cash used in investing activities (18,364,135) (9,750,117) (28,556,739)
------------ ------------ ------------
45
TRI-COUNTY FINANCIAL CORPORATION
CONSOLIDATED STATEMENTS OF CASH FLOWS (Continued)
FOR THE YEARS ENDED DECMBER 31, 2002, 2001, AND 2000
2002 2001 2000
---- ---- ----
CASH FLOWS FROM FINANCING ACTIVITIES:
Net increase in deposits $ 19,908,578 $ 15,310,535 $ 12,064,199
Net (decrease) increase in short-term borrowings (1,061,019) (11,737,586) 152,525
Dividends paid (385,129) (309,204) (236,595)
Exercise of stock options 161,004 31,817 40,711
Net change in unearned ESOP shares 47,999 (48,033) 49,948
Repurchase of common stock (443,568) (673,920) (479,391)
Proceeds from long-term borrowings 920,000 12,250,000 30,000,000
Payments of long-term borrowings (1,400,000) (5,000,000) (20,000,000)
------------ ------------ ------------
Net cash provided by financing activities 17,747,865 9,823,609 21,591,397
INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS 3,906,958 5,085,720 (2,897,173)
CASH AND CASH EQUIVALENTS AT BEGINNING OF YEAR 6,449,974 1,364,254 4,261,427
------------ ------------ ------------
CASH AND CASH EQUIVALENTS AT END OF YEAR $ 10,356,932 $ 6,449,974 $ 1,364,254
============ ============ ============
Supplementary cash flow information:
Cash paid during the year for:
Interest $ 6,225,058 $ 9,015,483 $ 8,737,746
Income taxes 2,110,500 1,431,000 925,000
Noncash transfer from loans to foreclosed real estate -- 1,276,070 --
See notes to consolidated financial statements.
46
TRI-COUNTY FINANCIAL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR THE YEARS ENDED DECEMBER 31, 2002, 2001 AND 2000
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Basis of Presentation and Consolidation
---------------------------------------
The consolidated financial statements include the accounts of
Tri-County Financial Corporation and its wholly owned subsidiary, Community Bank
of Tri-County (the "Bank") and the Bank's wholly owned subsidiaries, Tri-County
Investment Corporation and Community Mortgage Corporation of Tri-County
(collectively, the "Company"). All significant intercompany balances and
transactions have been eliminated in consolidation. The accounting and reporting
policies of the Company conform with accounting principles generally accepted in
the United States of America and to general practices within the banking
industry. Certain reclassifications have been made to amounts previously
reported to conform with classifications made in 2002.
Use of Estimates
----------------
In preparing consolidated financial statements in conformity with
accounting principles generally accepted in the United States of America,
management is required to make estimates and assumptions that affect the
reported amounts of assets and liabilities as of the date of the balance sheet
and 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, and the valuation of foreclosed
real estate and deferred tax assets.
Nature of Operations
--------------------
The Company, through its bank subsidiary, conducts full service
commercial banking operations throughout the Southern Maryland area. Its primary
financial deposit products are savings, transaction, and term certificate
accounts. Its primary lending products are mortgage loans on residential,
construction and commercial real estate and various types of consumer and
commercial lending.
Significant Group Concentrations of Credit
------------------------------------------
Most of the Company's activities take place in the Southern
Maryland area comprising St. Mary's, Charles, and Calvert counties. Note 2
discusses the types of securities the Company invests in. Note 3 discusses the
type of lending that the Company engages in. The Company does not have any
significant concentration to any one customer or industry.
47
Cash and Cash Equivalents
-------------------------
For purposes of the consolidated statements of cash flows, the
Company considers all highly liquid debt instruments with original maturities
when purchased of three months or less to be cash equivalents. These instruments
are presented as cash and due from banks.
Investment Securities
---------------------
Investment securities that are held principally for resale in the
near term are classified as trading assets and are recorded at fair value with
changes in fair value recorded in earnings. The Company had no trading assets
during the periods presented. Debt securities that management has the positive
intent and ability to hold to maturity are classified as "held-to-maturity" and
recorded at amortized cost. Securities not classified as held to maturity or
trading, including equity securities with readily determinable fair values are
classified as "available-for-sale" and recorded at fair value, with unrealized
gains and losses excluded from earnings and reported net of deferred taxes in
other comprehensive income, a separate component of stockholders' equity.
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 held-to-maturity and available-for-sale securities below their cost
that are deemed to be other than temporary are reflected in earnings as realized
losses. Gains and losses on the sales of securities are recorded on the trade
date and are determined using the specific identification method.
The Company invests in Federal Home Loan Bank and Federal Reserve
Bank stock which are considered restricted as to marketability.
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.
Loans Receivable
----------------
The Company grants mortgage, commercial, and consumer loans to
customers. A substantial portion of the loan portfolio is represented by loans
throughout Southern Maryland. 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 payoff 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.
48
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 the process of collection. Consumer loans are charged-off no
later than 120 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 from 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
principal and interest amounts contractually due are brought current and future
payments are reasonably assured.
Allowance for Loan Losses
-------------------------
The allowance for loan losses is established as probable 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
that the uncollectibility of a loan balance is confirmed. Subsequent recoveries,
if any, are credited to the allowance.
The allowance for loan losses is evaluated on a regular basis by
management and is based upon management's periodic review of the collectibility
of the loans in light of historical experience, the nature and volume of the
loan portfolio, adverse situations that may affect the borrower's ability to
repay, estimated value of any underlying collateral and prevailing economic
conditions. This evaluation is inherently subjective as it requires estimates
that are susceptible to significant revision as more information becomes
available.
The allowance for loan loss consists of a specific component and
a nonspecific component. The components of allowance for loan losses represent
an estimation done pursuant to either SFAS No. 5 "Accounting for Contingencies",
or SFAS No. 114 "Accounting by Creditors for Impairment of a Loan". The specific
component of the allowance for loan losses reflects expected losses resulting
from analysis developed through specific credit allocations for individual loans
and historical loss experience for each loan category. The specific credit
allocations are based on a regular analysis of all loans over a fixed-dollar
amount where the internal credit rating is at or below a predetermined
classification. The historical loan loss element is determined statistically
using a loss migration analysis that examines loss experience and the related
internal gradings of loans charged-off. The loss migration analysis is performed
quarterly and loss factors are updated regularly based on actual experience. The
specific component of the allowance for loan losses also includes management's
determination of the amounts necessary for concentrations and changes in
portfolio mix and volume.
The nonspecific portion of the allowance is determined based on
management's assessment of general economic conditions, as well as specific
economic factors in the individual markets in which the Company operates. This
determination inherently involves a higher risk of uncertainty and considers
current risk factors that may not have yet manifested themselves in the
Company's historical loss factors used to determine the specific component of
the allowance and it recognizes knowledge of the portfolio may be incomplete.
49
A loan is evaluated for impairment when, based on current
information and events, it is probable that the Company 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.
Loans that experience insignificant payment delays and payment shortfalls are
reviewed 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 observable market price, or the
fair value of the collateral if the loan is collateral dependent. Large groups
of smaller homogeneous loans are collectively evaluated for impairment.
Accordingly, the Company does not separately identify individual consumer and
residential loans for impairment disclosures.
Mortgage Servicing Assets
-------------------------
Mortgage servicing assets are recognized as separate assets when
rights are acquired through purchase or through sale of mortgages or mortgage
servicing rights. Capitalized servicing rights are reported in other assets and
are amortized into noninterest income in proportion to, and over the period of,
the estimated future net servicing income of the underlying financial assets.
Servicing assets are evaluated for impairment based upon the fair value of the
rights as compared to amortized cost. Impairment is determined by stratifying
rights by predominant characteristics, when available, such as interest rates
and terms. Fair value is determined using prices for similar assets with similar
characteristics, when available, or based upon discounted cash flows using
market based assumptions. Impairment is recognized through a valuation allowance
for an individual stratum, to the extent that fair value is less than the
capitalized amount for the stratum.
Premises and Equipment
----------------------
Land is carried at cost. Premises and equipment are carried at
cost, less accumulated depreciation computed by the straight-line method over
the estimated useful lives of the assets which are as follows:
Buildings and improvements 15-50 years
Furniture and equipment 3-15 years
Automobiles 5 years
Foreclosed Real Estate
----------------------
Assets acquired through, or in lieu of, loan foreclosure are held
for sale and are initially recorded at fair value at the date of foreclosure,
establishing a new cost basis. Subsequent to foreclosure, valuations are
periodically performed by management and the assets are carried at the lower of
carrying amount or fair value less cost to sell. Revenue and expenses from
operations and changes in the valuation allowance are included in noninterest
expense.
50
Income Taxes
------------
The Company files a consolidated federal income tax return with
its subsidiaries. Deferred 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.
Earnings Per Share
------------------
Basic earnings per common 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 potential dilutive 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.
Stock-Based Compensation
------------------------
Stock based compensation is recognized using the intrinsic value
method. For disclosure purposes, pro forma net income and earnings per share
effects are provided as if the fair value method had been applied.
New Accounting Standards
------------------------
Accounting for Stock-Based Compensation: In December 2002, the
Financial Accounting Standards Board issued SFAS No. 148, "Accounting for
Stock-Based Compensation - Transition and Disclosure", which provides guidance
on how to transition from the intrinsic value method of accounting for
stock-based employee compensation under Accounting Principles Board Opinion
("APB") 25 to SFAS No. 123's fair value method of accounting, if a company so
elects. The Company has not elected to change its method of accounting for stock
based compensation so the provisions of SFAS 148 had no effect on the results of
operations.
Accounting for Long-lived Assets: SFAS No. 144, "Accounting for
the Impairment or Disposal of Long-Lived Assets", was issued in October 2001 and
addresses how and when to measure impairment on long-lived assets and how to
account for long-lived assets that an entity plans to dispose of either through
sale, abandonment, exchange, or distribution to owners. The statement's
provisions supersede SFAS No. 121, Accounting for the Impairment of Long-Lived
Assets and for Long-Lived Assets to Be Disposed of, which addressed asset
impairment, and certain provisions of APB Opinion 30 related to reporting the
effects of the disposal of a business segment and requires expected future
operating losses from discontinued operations to be recorded in the period in
which the losses are incurred rather than the measurement date. Under SFAS No.
144, more dispositions may qualify for discontinued operations treatment in the
income statement. The provisions of SFAS No. 144 became effective for the
Company on January 1, 2002, and did not have a material impact on results of
operations, financial position, or liquidity.
51
2. INVESTMENT SECURITIES
The amortized cost and estimated fair values of securities with gross
unrealized losses and gains are:
December 31, 2002
-----------------------------------------------------------
Gross Gross
Amortized Unrealized Unrealized Estimated Fair
Cost Gains Losses Values
---- ----- ------ ------
Asset-backed securities issued by:
GSE's $ 28,597,630 $ 601,972 $ -- $ 29,199,602
Other 7,826,724 104,014 919 7,929,819
------------ --------- -------- ------------
Total debt securities available for sale 36,424,354 705,986 919 37,129,421
Corporate equity securities 509,010 244,971 20,000 733,981
Mutual Funds 3,962,711 -- -- 3,962,711
------------ --------- -------- ------------
Total securities available for sale $ 40,896,075 $ 950,957 $ 20,919 $ 41,826,113
============ ========= ======== ============
Securities held-to-maturity
U.S. Government obligations $ 300,000 $ -- $ 1,760 $ 298,240
Other investments 2,541,807 16,269 -- 2,558,076
------------ --------- -------- ------------
Total securities held-to-maturity $ 2,841,807 $ 16,269 $ 1,760 $ 2,856,316
============ ========= ======== ============
December 31, 2001
-----------------------------------------------------------
Gross Gross
Amortized Unrealized Unrealized Estimated Fair
Cost Gains Losses Values
---- ----- ------ ------
Asset-backed securities issued by:
GSE's $ 25,603,305 $ 564,133 $ 82,495 $ 26,084,943
Other 8,846,200 147,777 516 8,993,461
------------ --------- -------- ------------
Total debt securities available for sale 34,449,505 711,910 83,011 35,078,404
Corporate equity securities 509,010 218,212 -- 727,222
Mutual Funds 111,581 -- -- 111,581
------------ --------- -------- ------------
Total securities available for sale $ 35,070,096 $ 930,122 $ 83,011 $ 35,917,207
============ ========= ======== ============
Securities held-to-maturity
U.S. Government obligations $ 300,000 $ -- $ 500 $ 299,500
Other investments 1,989,354 -- -- 1,989,354
------------ --------- -------- ------------
Total securities held-to-maturity $ 2,289,354 $ -- $ 500 $ 2,288,854
============ ========= ======== ============
Mutual Funds investments detailed above consist of short duration mutual funds
whose market value approximated amortized cost. Other investments consist of
certain CD strip instruments whose market value is estimated based on market
returns on similar risk and maturity instruments because no active market exists
for these instruments. At December 31, 2002 and 2001, U.S. Government
obligations with a carrying value of $300,000 were pledged to secure public unit
deposits and for other purposes required or permitted by law. In addition, at
December 31, 2002 and 2001, certain other securities with a carrying value of
$5,047,000 and $3,413,300, respectively were pledged to secure certain deposits.
At December
52
31, 2002, securities with a carrying value of $38,200,000 were pledged as
collateral for advances from the Federal Home Loan Bank of Atlanta.
The scheduled maturities of securities at December 31, 2002 are as follows:
Available for Sale Held to Maturity
-------------------------------- -----------------------------
Amortized Fair Amortized Fair
Cost Value Cost Value
-------------------------------- -----------------------------
Within one year $ 3,962,711 $ 3,962,711 $ 300,000 $ 298,240
Over one year through five years -- -- 2,541,807 2,558,076
Over five years through ten years -- -- -- --
-------------------------------- -----------------------------
3,962,711 3,962,711 $2,841,807 $2,856,316
Mortgage-backed securities 36,424,354 37,129,421 -- --
-------------------------------- -----------------------------
$40,387,065 $41,092,132 $2,841,807 $2,856,316
================================ =============================
Proceeds from the sales of investment securities available for sale during
2002, 2001, and 2000 were $0, $0, and $186,900, respectively. Gross gains in the
years ending December 31, 2002, 2001, and 2000 were $0, $0, and $184,704
respectively. Gross losses for the years ending December 31, 2002, 2001, and
2000 were $-0-, $0, and $0, respectively. Asset-backed securities are comprised
of mortgage-backed securities as well as mortgage derivative securities such as
collateralized mortgage obligations and real estate mortgage investment
conduits. In certain cases, the Bank will purchase securities of a single
private issuer, defined as an issuer which is not a government or government
sponsored entity, in total amounts in excess of 10% of stockholders' equity. The
Bank only does so when satisfied that such concentrations pose no threat to the
Bank's safety or soundness. The Bank had no holdings of private issuers in
excess of 10% of capital at December 31, 2002.
53
3. LOANS RECEIVABLE
Loans receivable at December 31, 2002 and 2001 consist of the following:
2002 2001
---- ----
Commercial real estate $ 74,291,593 $ 65,616,917
Residential first mortgages 48,975,989 61,429,647
Residential construction 14,578,702 18,136,008
Second mortgage loans 19,007,265 18,580,099
Commercial lines of credit 29,947,326 18,539,209
Consumer loans 13,630,086 14,187,608
------------- -------------
200,430,961 196,489,488
------------- -------------
Less:
Deferred loan fees 667,605 757,896
Allowance for loan loss 2,314,074 2,281,581
------------- -------------
2,981,679 3,039,477
------------- -------------
$ 197,449,282 $ 193,450,011
============= =============
The following table sets forth the activity in the allowance for loan
losses:
2002 2001 2000
---- ---- ----
Balance January 1, $2,281,581 $1,929,531 $1,653,290
Add:
Provision charged to operations 160,000 360,000 360,000
Recoveries 2,795 31,417 12,034
Less:
Charge-offs 130,302 39,367 95,793
---------- ---------- ----------
Balance, December 31 $2,314,074 $2,281,581 $1,929,531
========== ========== ==========
No loans included within the scope of SFAS No. 114 were identified as being
impaired at December 31, 2002 or 2001 and for the years then ended.
54
Loans on which the recognition of interest has been discontinued, which
were not included within the scope of SFAS No. 114, amounted to approximately
$597,000, $207,000, and $7,000 at December 31, 2002, 2001, and 2000,
respectively. If interest income had been recognized on nonaccrual loans at
their stated rates during 2002, 2001, and 2000, interest income would have been
increased by approximately $33,033, $10,480, and $913, respectively. Interest
income of $33,320, $12,914 and $8,912 was recognized for these loans in 2002,
2001 and 2000.
Included in loans receivable at December 31, 2002 and 2001, is $1,022,846
and $1,223,840 due from officers and directors of the Bank. These loans are made
in the ordinary course of business at substantially the same terms and
conditions as those prevailing at the time for comparable transactions with
outsiders and are not considered to involve more than the normal risk of
collectibility. Activity in loans outstanding to officers and directors is
summarized as follows:
2002 2001
---- ----
Balance, beginning of year $ 1,223,840 $ 536,005
New loans made during year 60,001 1,150,460
Repayments made during year (260,995) (462,625)
----------- -----------
Balance, end of year $ 1,022,846 $ 1,223,840
=========== ===========
4. LOAN SERVICING
Loans serviced for others and not reflected in the balance sheets are
$73,205,838 and $68,287,344 at December 31, 2002 and 2001, respectively.
Servicing loans for others generally consists of collecting mortgage payments,
maintaining escrow accounts, disbursing payments to investors and foreclosure
processing. Loan servicing income is recorded on the accrual basis and includes
servicing fees from investors and certain charges collected from borrowers, such
as late payment fees. Mortgage servicing rights capitalized during 2002, 2001,
and 2000 totaled $298,096, $182,119, and $45,365, respectively.
Amortization of mortgage servicing rights totaled $48,000, $144,000, and
$144,000, respectively. Net servicing rights assets totaled $780,408, $525,075,
and $486,956 at December 31, 2002, 2001, and 2000, respectively.
55
5. FORECLOSED ASSETS
Foreclosed assets are presented net of an allowance for losses. An analysis of
the allowance for losses on foreclosed assets is as follows:
Years ended December 31,
-----------------------------------
2002 2001 2000
---- ---- ----
Balance at beginning of year $ -- $ -- $ --
Provision for losses 972,899 -- --
Charge-offs
Recoveries -- -- --
-------- ------ -------
Balance at end of year $972,899 $ -- $ --
======== ====== =======
Expenses applicable to foreclosed assets include the following:
Years ended December 31,
------------------------------------
2002 2001 2000
---- ---- ----
Net gain on sale of foreclosed real estate (64,755) -- --
Provision for losses 972,889 -- --
Operating expenses 12,176 6,253 5,728
--------- ------- -------
$ 920,310 $ 6,253 $ 5,728
========= ======= =======
56
6. PREMISES AND EQUIPMENT
A summary of premises and equipment at December 31, 2002 and 2001 is as
follows:
2002 2001
---- ----
Land $ 1,399,311 $ 1,731,941
Building and improvements 4,322,963 3,642,101
Furniture and equipment 2,367,380 2,824,015
Automobiles 111,881 103,144
----------- -----------
Total cost 8,201,535 8,301,201
Less accumulated depreciation 2,465,141 2,868,353
----------- -----------
Premises and equipment, net $ 5,736,394 $ 5,432,848
=========== ===========
Certain bank facilities are leased under various operating leases. Rent
expense was $211,200, $242,387, and $168,921 in 2002, 2001 and 2000,
respectively. Future minimum rental commitments under noncancellable operating
leases are as follows:
2003 $181,812
2004 181,362
2005 180,912
2006 180,462
2007 179,562
Thereafter 322,224
----------
Total $1,226,334
==========
57
7. DEPOSITS
Deposits outstanding at December 31 consist of:
2002 2001
---- ----
Noninterest-bearing demand $ 33,045,310 $ 17,738,165
Interest-bearing:
Demand 22,440,453 20,842,088
Money market deposits 39,781,718 53,807,885
Savings 30,675,167 20,367,634
Certificates of deposit 77,082,464 70,360,762
------------ ------------
Total interest-bearing 169,979,802 165,378,369
------------ ------------
Total deposits $203,025,112 $183,116,534
============ ============
The aggregate amount of time deposits in denominations of $100,000 or more
at December 31, 2002 and 2001 were $18,790,000 and $17,018,000, respectively.
At December 31, 2002, the scheduled maturities of time deposits are as follows
(in 000's):
2003 $49,031
2004 12,688
2005 4,867
2006 10,496
-------
$77,082
=======
8. SHORT TERM BORROWINGS AND LONG-TERM DEBT
The Bank's long-term debt consists of advances from the Federal Home Loan
Bank of Atlanta. The Bank classifies debt based upon original maturity, and does
not reclassify debt to short term status during its life. These include fixed
rate, adjustable rate, and convertible advances. Rates and maturities on these
advances are as follows:
Fixed Adjustable Fixed Rate
Rate Rate Convertible
----- ---- -----------
2002
Highest Rate 5.43% 2.49% 6.25%
Lowest Rate 1.00% 2.49% 4.62%
Weighted Average Rate 4.69% 2.49% 5.42%
Matures through 2022 2005 2011
2002
Highest Rate 5.43% 5.79% 6.25%
Lowest Rate 1.13% 5.31% 4.62%
Weighted Average Rate 4.69% 5.69% 5.42%
Matures through 2022 2002 2011
58
The Bank's fixed rate debt generally consists of advances with monthly
interest payments and principal due at maturity. The Bank's adjustable rate
long-term debt adjusts quarterly based upon a margin over the three month London
Interbank Offered Rate ("LIBOR"). The margin is set at 80 basis points. The debt
has a minimum interest of .80% and a maximum rate of 5.30%. The Bank's fixed
rate, convertible, long-term debt is callable by the issuer, after an initial
period ranging from six months to five years. These advances become callable on
dates ranging from 2002 to 2005. Depending on the specific instrument, the
instrument is callable either continuously after the initial period (Bermuda
option) or only at the date ending the initial period (European). The
contractual maturities of long-term debt are as follows:
December 31,
2002 2001
--------------------------------------------------------------- -----------
Fixed Adjustable Fixed Rate
Rate Rate Covertible Total Total
---- ---- ---------- ----- -----
Due in 2002 $ -- $ -- $ -- $ -- $ 6,400,000
Due in 2003 88,000 -- -- 88,000 10,088,000
Due in 2004 88,000 -- -- 88,000 88,000
Due in 2005 74,000 5,000,000 10,000,000 15,074,000 74,000
Due in 2006 7,000,000 -- -- 7,000,000 7,000,000
Due in 2007 -- -- -- -- --
Thereafter 920,000 -- 25,000,000 25,920,000 25,000,000
---------- ---------- ----------- ----------- -----------
$8,170,000 $5,000,000 $35,000,000 $48,170,000 $48,650,000
========== ========== =========== =========== ===========
From time to time, the Bank also has daily advances outstanding, which are
classified as short-term debt. These advances are repayable at the Bank's option
at any time and reprice daily. These advances totaled $0 and $1,000,000 at
December 31, 2002 and 2001, respectively. The rate on the short term debt at
December 31, 2001 was 1.83%.
Under the terms of an Agreement for Advances and Security Agreement with
Blanket Floating Lien (the "Agreement"), the Company maintains eligible
collateral consisting of 1 - 4 unit residential first mortgage loans, discounted
at 75% of the unpaid principal balance, equal to 100% at December 31, 2001, of
its total outstanding long and short term Federal Home Loan Bank advances.
During 2001, the Bank entered into an addendum to the Agreement that expanded
the types of eligible collateral under the Agreement to include certain
commercial real estate and second mortgage loans. These loans are subject to
eligibility rules, and collateral values are discounted at 50% of the unpaid
loan principal balance. In addition, only 50% of total collateral for Federal
Home Loan Bank advances may consist of commercial real estate loans. In addition
the Bank has pledged its Federal Home Loan Bank stock of $2,662,500 and
securities with a carrying value of $38,500,000 as additional collateral for its
advances. Based upon our understanding of current borrowing rules at the Federal
Home Loan Bank of Atlanta, the Bank is limited to total advances of up to 40% of
assets or $113 million. The Bank had sufficient collateral to borrow this
amount.
Other short-term debt consists of notes payable to the U.S. Treasury, which
are Federal treasury
59
tax and loan deposits accepted by the Bank and remitted on demand to the Federal
Reserve Bank. At December 31, 2002 and 2001, such borrowings were $752,298 and
$813,317, respectively. The Bank pays interest on these balances at a slight
discount to the federal funds rate. The notes are secured by investment
securities with an amortized cost of approximately $786,700 and $786,700 at
December 31, 2002 and 2001, respectively.
9. INCOME TAXES
Income tax was as follows:
2002 2001 2000
---- ---- ----
Current
Federal $1,312,000 $1,409,350 $1,307,000
State 154,000 114,000 18,000
---------- ---------- ----------
1,466,000 1,523,350 1,325,000
---------- ---------- ----------
Deferred
Federal (327,000) (168,000) (97,000)
State (72,000) (37,000) (21,000)
---------- ---------- ----------
(399,000) (205,000) (118,000)
---------- ---------- ----------
Total Income Tax Expense $1,067,000 $1,318,350 $1,207,000
========== ========== ==========
Total income tax expense differed from the amounts computed by applying the
federal income tax rate of 34% to income before income taxes as a result of the
following:
2002 2001 2000
-------------------------- ---------------------------- ---------------------------
Percent of Percent of Percent of
Pre Tax Pre Tax Pre Tax
Amount Income Amount Income Amount Income
-------------------------- ---------------------------- ---------------------------
Expected income tax expense at
federal tax rate $ 1,031,839 34.0% $ 1,293,321 34.0% $ 1,205,000 34.0%
State taxes net of federal benefit 61,666 2.0% 77,000 2.0% - 0.0%
Nondeductible expenses 20,908 0.7% 5,233 0.1% 14,000 0.4%
Other (47,413) -1.6% (57,204) -1.4% (12,000) -0.3%
----------- ---- ----------- ---- ----------- ----
$ 1,067,000 35.1% $ 1,318,350 34.7% $ 1,207,000 34.1%
=========== ==== =========== ==== =========== ====
60
The net deferred tax assets in the accompanying balance sheets include the
following components:
2002 2001
---- ----
Deferred tax assets:
Deferred fees $ 22,147 $ 44,566
Allowance for loan losses 795,953 768,525
Deferred compensation 118,709 102,568
Valuation allowance on foreclosed real estate 375,730 --
---------- ---------
1,312,539 915,659
---------- ---------
Deferred tax liabilities:
FHLB stock dividends 152,896 153,866
Depreciation 97,505 98,328
Unrealized gain on investment
securities available for sale 267,144 291,599
---------- ---------
517,545 543,793
---------- ---------
$ 794,994 $ 371,866
========== =========
Retained earnings at December 31, 2002, include approximately $1.2 million
of bad debt deductions allowed for federal income tax purposes (the "base year
tax reserve") for which no deferred income tax has been recognized. If, in the
future, this portion of retained earnings is used for any purpose other than to
absorb bad debt losses, it would create income for tax purposes only and income
taxes would be imposed at the then prevailing rates. The unrecorded income tax
liability on the above amount was approximately $458,000 at December 31, 2002.
Prior to January 1, 1996, the Bank computed its tax bad debt deduction
based upon the percentage of taxable income method as defined by the Internal
Revenue Code. The bad debt deduction allowable under this method equaled 8% of
taxable income determined without regard to the bad debt deduction and with
certain adjustments. The tax bad debt deduction differed from the bad debt
expense used for financial accounting purposes.
In August 1996, the Small Business Job Protection Act (the "Act") repealed
the percentage of taxable income method of accounting for bad debts effective
for years beginning after December 31, 1995. The Act required the Bank to change
its method of computing reserves for bad debts to the experience method. This
method is available to banks with assets less than $500 million and allows the
Bank to maintain a tax reserve for bad debts and to take bad debt deductions for
reasonable additions to the reserve. As a result of this change, the Bank has to
recapture into income a portion of its existing tax bad debt reserve. This
recapture occurs ratably over a six-taxable year period, beginning with the 1998
tax year. For financial reporting purposes, this recapture does not result in
additional tax expense as the Bank adequately provided deferred taxes in prior
years. Furthermore, this change does not require the Bank to recapture its base
year tax reserve.
61
10. COMMITMENTS AND CONTINGENCIES
The Bank is party to financial instruments with off-balance-sheet risk in
the normal course of business to meet the financing needs of its customers.
These financial instruments are commitments to extend credit. These instruments
may, but do not necessarily, involve, to varying degrees, elements of credit and
interest rate risk in excess of the amount recognized in the balance sheets. The
Bank's exposure to credit loss in the event of nonperformance by the other party
to the financial instrument is represented by the contractual amount of those
instruments. The Bank uses the same credit policies in making commitments as it
does for on-balance-sheet loans receivable.
As of December 31, 2002 and 2001, in addition to the undisbursed portion of
loans receivable of approximately $3,996,000 and $6,031,000, respectively, the
Bank had outstanding loan commitments approximating $3,783,900 and $1,926,500,
respectively.
Standby letters of credit written are conditional commitments issued by the
Bank to guarantee the performance of a customer to a third party. These
guarantees are issued primarily to support construction borrowing arrangements.
The credit risk involved in issuing letters of credit is essentially the same as
that involved in extending loan facilities to customers. The Bank holds cash or
a secured interest in real estate as collateral to support those commitments for
which collateral is deemed necessary. Standby letters of credit outstanding
amounted to $9,322,655 and $5,698,000 at December 31, 2002 and 2001,
respectively. In addition to the commitments noted above, customers had
approximately $23,090,000 and $10,123,000 available under lines of credit at
December 31, 2002 and 2001, respectively.
62
11. STOCK OPTION AND INCENTIVE PLAN
The Company has a stock option and incentive plan to attract and retain
personnel and provide incentive to employees to promote the success of the
business. In addition, the Company has a stock option plan for its directors. At
December 31, 2001, 61,081 shares of stock have been authorized and are available
for grants of options under the plans. The exercise price for options granted is
set at the discretion of the Board, but is not less than the market value of the
shares as of the date of grant. An option's maximum term is ten years and the
options generally vest immediately upon issuance.
The Company applies APB Opinion 25 and related Interpretations in
accounting for the stock option plan. Accordingly, no compensation cost has been
recognized. Had compensation cost for the Company's stock option plan been
determined based upon fair values at the grant dates for awards under the plan
consistent with the method prescribed by SFAS Nos. 123 and 148, the Company's
net income and earnings per share would have been adjusted to the pro forma
amounts indicated below:
2002 2001 2000
---- ---- ----
Net income, as reported $ 1,967,821 $ 2,485,535 $ 2,336,119
Less pro forma stock-based compensation expense determined
under the fair value method, net of related tax effects (217,187) (226,251) (66,040)
----------- ----------- -----------
Pro forma net income $ 1,750,634 $ 2,259,284 $ 2,270,079
=========== =========== ===========
Earnings per share as reported
Basic $ 2.58 $ 3.24 $ 2.98
Diluted 2.45 3.11 2.85
Pro forma earnings per share
Basic 2.30 2.95 2.89
Diluted 2.18 2.83 2.76
For the purpose of computing the pro forma amounts indicated above, the
fair value of each option on the date of grant is estimated using the
Black-Scholes option pricing model with the following weighted-average
assumptions used for the grants:
2001 2001 2000
---- ---- ----
Dividend Yield 1.41% 1.30% 0.75%
Expected volatility 35.00% 15.00% 15.00%
Risk - free interest rate 4.82% 4.91% 5.85%
Expected lives (in years) 10 10 10
Weighted average fair value $ 17.24 $ 11.06 $ 12.28
63
The following tables summarize activity in the plan:
2002 2001 2000
--------------------- -------------------- -------------------
Weighted Weighted Weighted
Average Average Average
Exercise Exercise Exercise
Shares Price Shares Price Shares Price
--------------------- -------------------- -------------------
Outstanding at beginning of year 99,679 $18.99 91,036 $16.89 91,184 $12.61
Granted 12,595 31.67 20,448 26.57 9,179 26.66
Exercised (14,078) 12.92 (7,105) 10.28 (7,790) 14.61
Forfeitures (595) 26.26 (4,700) 24.41 (1,537) 25.25
------- ------- -------
Outstanding at end of year 97,601 $21.46 99,679 $18.99 91,036 $16.89
======= ====== ======= ====== ======= ======
Options outstanding are all currently exercisable and are summarized as follows:
Weighted
Average Weighted
Number Remaining Average
Outstanding Contractual Exercise
12/31/2002 Life Price
----------- ----------- --------
31,645 3 years $10.28
20,647 6 years 24.24
7,665 7 years 26.60
17,732 8 years 26.64
14,950 9 years 26.71
4,962 10 years 39.00
------
97,601 $21.46
======
12. EMPLOYEE BENEFIT PLANS
The Bank has an Employee Stock Ownership Plan (ESOP) which covers
substantially all of the Bank's employees. The ESOP acquires stock of the Bank's
parent corporation, Tri-County Financial Corporation. The Company accounts for
its ESOP in accordance with AICPA Statement of Position 93-6. Accordingly,
unencumbered shares held by the ESOP are treated as outstanding in computing
earnings per share. Shares issued to the ESOP but pledged as collateral for
loans obtained to provide funds to acquire the shares are not treated as
outstanding in computing earnings per share. Dividends on ESOP shares are
recorded as a reduction of retained earnings. The ESOP may acquire in the open
market up to 195,700 shares. At December 31, 2002, the Plan owns 55,195 shares.
64
The Company also has a 401(k) plan. The Bank matches a portion of the
employee contributions. This ratio is determined annually by the Board of
Directors. Currently one-half of an employee's first 6% deferral is matched. As
of January 1, 2003, the Company will match one-half of the employee's 8%
deferral. All employees who have completed one year of service and have reached
the age of 21 are covered under this defined contribution plan. Contributions
are determined at the discretion of management and the Board of Directors. For
the years ended December 31, 2002, 2001, and 2000, the Company charged $108,000,
$93,000, and $90,000, against earnings to fund the Plans.
In addition, the Bank has a separate nonqualified retirement plan for
non-employee directors. Directors are eligible for a maximum benefit of $3,500 a
year for ten years following retirement from the Board of Community Bank of Tri
County. The maximum benefit is earned at 15 years of service as a non-employee
director. Full vesting occurs after 2 years of service. Expense recorded for
this plan was $11,034, $7,071, and $19,042 for the years ending December 31,
2002, 2001, and 2000 respectively.
13. REGULATORY MATTERS
The Company and the Bank are subject to various regulatory capital
requirements administered by the federal and state banking agencies. Failure to
meet minimum capital requirements can initiate certain mandatory and possible
additional discretionary actions by regulators that, if undertaken, could have a
direct material effect on the Company's and the Bank's financial statements.
Under capital adequacy guidelines and the regulatory framework for prompt
corrective action, the Bank must meet specific capital guidelines that involve
quantitative measures of the Bank's assets, liabilities and certain
off-balance-sheet items as calculated under regulatory accounting practices. The
Bank's capital amounts and classification are also subject to qualitative
judgments by the regulators about components, risk weightings, and other
factors.
Quantitative measures established by regulation to ensure capital adequacy
require the Company and the Bank to maintain minimum amounts and ratios (set
forth in the table below) of tangible and core capital (as defined in the
regulations) to total adjusted assets (as defined), and of risk-based capital
(as defined) to risk-weighted assets (as defined). Management believes, as of
December 31, 2002, that the Company and the Bank meet all capital adequacy
requirements to which they are subject.
As of December 31, 2002, the most recent notification from the Federal
Reserve categorized the Bank as well-capitalized under the regulatory framework
for prompt corrective action. To be categorized as well-capitalized, the Bank
must maintain minimum total risk-based, Tier 1 risk-based, and Tier 1 leverage
ratios as set forth in the table. There are no conditions or events since that
notification that management believes have changed the Company's or the Bank's
category.
The Company's and the Bank's actual capital amounts and ratios for 2002 and
2001 are presented in the tables below:
65
To be considered well
Required for capital capitalized under prompt
Actual adequacy purposes corrective action
------ --------------------- ------------------------
At December 31, 2002
Total capital (to risk weighted assets)
The Company $ 28,769 13.77% $ 16,715 8.00%
The Bank $ 26,966 12.96% $ 16,647 8.00% $ 20,809 10.00%
Tier 1capital (to risk weighted assets)
The Company $ 26,379 12.63% $ 8,357 4.00%
The Bank $ 24,576 11.81% $ 5,324 4.00% $ 12,485 6.00%
Tier 1capital (to average assets)
The Company $ 26,379 9.53% $ 11,069 4.00%
The Bank $ 24,576 8.96% $ 10,966 4.00% $ 13,708 5.00%
At December 31, 2001
Total capital (to risk weighted assets)
The Company $ 27,314 14.08% $ 15,511 8.00%
The Bank $ 25,799 13.26% $ 15,570 8.00% $ 19,462 10.00%
Tier 1capital (to risk weighted assets)
The Company $ 24,841 12.81% $ 7,756 4.00%
The Bank $ 23,517 12.08% $ 7,785 4.00% $ 11,677 6.00%
Tier 1capital (to average assets)
The Company $ 24,841 9.64% $ 10,311 4.00%
The Bank $ 23,517 9.46% $ 9,944 4.00% $ 12,430 5.00%
14. EARNINGS PER SHARE
The calculations of basic and diluted earnings per share are as follows:
2002 2001 2000
---------- ---------- ----------
Basic earnings per share
Net income $1,967,821 $2,485,535 $2,336,196
Average common shares outstanding 761,417 766,927 784,605
Net income per common share - basic $ 2.58 $ 3.24 $ 2.98
Diluted earnings per share
Net income $1,967,821 $2,485,535 $2,336,196
Average common shares outstanding 761,417 766,927 784,605
Stock option adjustment 42,705 31,860 36,534
Average common shares outstanding - diluted 804,122 798,787 821,139
Net income per common share - diluted $ 2.45 $ 3.11 $ 2.85
For the year ended December 31, 2002 options for 4,962 shares of common stock
were excluded from computing diluted earnings per share because their effects
were antidilutive. No antidilutive options were outstanding at December 31, 2001
or 2000.
15. FAIR VALUE OF FINANCIAL INSTRUMENTS
The estimated fair value amounts have been determined by the Company using
available market information and appropriate valuation methodologies. However,
considerable judgment is necessarily required to interpret market data to
develop the estimates of fair value. Accordingly, the
66
estimates presented herein are not necessarily indicative of the amounts the
Company could realize in a current market exchange. The use of different market
assumptions and/or estimation methodologies may have a material effect on the
estimated fair value amounts. Therefore, any aggregate unrealized gains or
losses should not be interpreted as a forecast of future earnings or cash flows.
Furthermore, the fair values disclosed should not be interpreted as the
aggregate current value of the Company.
December 31, 2002 December 31, 2001
------------------------ --------------------------
Estimated Estimated
Carrying Fair Carrying Fair
Amount Value Amount Value
------ ----- ------- -----
Assets:
Cash and cash equivalents $10,356,932 $10,356,932 $ 6,449,974 $ 6,449,974
Interest bearing deposits with banks 15,179,851 15,179,851 7,678,158 7,678,158
Investment securities and stock in FHLB
and FRB 47,404,670 47,419,179 41,242,111 41,242,111
Loans receivable, net 197,449,282 200,839,805 193,450,011 199,325,377
Loans held for sale 1,262,667 1,287,920 2,354,315 2,354,315
Liabilities:
Savings, NOW, and money market accounts 125,942,648 125,942,648 112,755,772 112,755,862
Time certificates 77,082,464 78,811,495 70,360,762 71,827,020
Long-term debt and other borrowed funds 48,922,298 53,801,600 50,463,317 52,340,500
At December 31, 2002 and 2001, the Company had outstanding loan commitments
and standby letters of credit of $13.1 million and $7.6 million, respectively.
Based on the short-term lives of these instruments, the Company does not believe
that the fair value of these instruments differs significantly from their
carrying values.
Valuation Methodology
---------------------
Cash and Cash Equivalents - For cash and cash equivalents, the
carrying amount is a reasonable estimate of fair value.
Investment Securities - Fair values are based on quoted market
prices or dealer quotes. If a quoted market price is not available, fair value
is estimated using quoted market prices for similar securities.
Mortgage-Backed Securities - Fair values are based on quoted
market prices or dealer quotes. If a quoted market price is not available, fair
value is estimated using quoted market prices for similar securities.
Loans Receivable and Loans Held for Sale - For conforming
residential first-mortgage loans, the market price for loans with similar
coupons and maturities was used. For nonconforming loans with maturities similar
to conforming loans, the coupon was adjusted for credit risk. Loans which did
not have quoted market prices were priced using the discounted cash flow method.
The discount rate used was the rate currently offered on similar products. Loans
priced using the discounted cash flow method included residential construction
loans, commercial real estate loans, and consumer loans. The estimated fair
value of loans held for sale is based on the terms of the related sale
commitments.
Deposits - The fair value of checking accounts, saving accounts,
and money market
67
accounts was the amount payable on demand at the reporting date.
Time Certificates - The fair value was determined using the
discounted cash flow method. The discount rate was equal to the rate currently
offered on similar products.
Long-Term Debt and Other Borrowed Funds - These were valued using
the discounted cash flow method. The discount rate was equal to the rate
currently offered on similar borrowings.
The fair value estimates presented herein are based on pertinent
information available to management as of December 31, 2002 and 2001. Although
management is not aware of any factors that would significantly affect the
estimated fair value amounts, such amounts have not been comprehensively
revalued for purposes of these financial statements since that date and,
therefore, current estimates of fair value may differ significantly from the
amount presented herein.
68
16. CONDENSED FINANCIAL STATEMENTS - PARENT COMPANY ONLY
Financial information pertaining only to Tri-County Financial Corporation is as
follows:
Balance Sheets
ASSETS
2002 2001
---- ----
Cash -noninterest bearing $ 301,927 $ 25,000
Cash -interest bearing 838,142 925,521
Other assets 884,984 691,208
Investment securities available for sale 32,436 111,582
Investment in wholly owned subsidiary 25,069,624 24,073,273
------------ ------------
TOTAL ASSETS $ 27,127,113 $ 25,826,584
============ ============
Current liabilities $ 254,348 $ 240,126
Stockholders' equity
Common stock 7,598 7,568
Surplus 7,716,906 7,545,590
Retained earnings 18,817,615 17,678,367
Unearned ESOP shares (163,045) (200,580)
Accumulated other comprehensive income 493,691 555,513
------------ ------------
TOTAL LIABILITIES AND STOCKHOLDERS EQUITY $ 27,127,113 $ 25,826,584
============ ============
Condensed Statements of Income:
Year Ended December 31,
-------------------------------------------
2002 2001 2000
---- ---- ----
Dividends from subsidiary $ 1,000,000 $ 2,250,000 $ 500,000
Interest income 18,644 26,929 27,510
Miscellaneous expenses (154,995) (167,787) (90,391)
Income before income taxes and equity in 863,649 2,109,142 437,119
undistributed net income of subsidiary
Federal and state income tax benefit 46,000 40,650 --
Equity in undistributed net income of subsidiary 1,058,172 335,743 1,899,077
----------- ----------- -----------
NET INCOME $ 1,967,821 $ 2,485,535 $ 2,336,196
=========== =========== ===========
69
Condensed Statements Cash Flows:
2002 2001 2000
---- ---- ----
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income $ 1,967,821 $ 2,485,535 $ 2,336,196
Adjustments to reconcile net income to net cash
provided by operating activities:
Equity in undistributed earnings of subsidiary (1,058,172) (335,743) (1,899,077)
Increase in current assets (193,776) (611,564) (39,398)
Increase in current liabilities 14,222 3,600 --
Net cash provided by operating activities 730,095 1,541,828 397,721
----------- ----------- -----------
CASH FLOWS FROM INVESTING ACTIVITIES:
Net (increase) decrease in interest-bearing deposits 87,379 (645,521) 439,068
Purchase of investment securities available for sale -- (76,903) (6,677)
Maturity or redemption of investment securities
available for sale 79,146 -- --
----------- ----------- -----------
Net cash provided (used) by investing activities 166,525 (722,424) 432,391
----------- ----------- -----------
CASH FLOWS FROM FINANCING ACTIVITIES:
Dividends paid (385,129) (309,204) (236,595)
Exercise of stock options 161,004 31,817 53,676
Net change in ESOP loan 48,000 (48,034) 36,984
Redemption of common stock (443,568) (673,920) (479,391)
----------- ----------- -----------
Net cash used in financing activities (619,693) (999,341) (625,326)
----------- ----------- -----------
INCREASE (DECREASE) IN CASH 276,927 (179,937) 204,786
CASH AT BEGINNING OF YEAR 25,000 204,937 151
----------- ----------- -----------
CASH AT END OF YEAR $ 301,927 $ 25,000 $ 204,937
=========== =========== ===========
70
17. QUARTERLY FINANCIAL RESULTS (UNAUDITED)
A summary of selected consolidated quarterly financial data for the two
years ended December 31, 2002 is reported as follows:
2002
---------------------------------------------------
Fourth Third Second First
Quarter Quarter Quarter Quarter
------- ------- ------- -------
Interest and dividend income $ 4,105,575 $ 4,281,934 $ 4,207,146 $ 4,167,599
Interest expense 1,438,465 1,484,376 1,495,799 1,549,988
----------- ----------- ----------- -----------
Net interest income 2,667,110 2,797,558 2,711,347 2,617,611
Provision for loan loss 30,000 30,000 30,000 70,000
----------- ----------- ----------- -----------
Net interest income after provision 2,637,110 2,767,558 2,681,347 2,547,611
Noninterest income 664,740 386,913 398,059 397,349
Noninterest expense 2,025,764 2,033,746 3,457,062 1,929,294
Income before income taxes 1,276,086 1,120,725 (377,656) 1,015,666
Provision for income taxes 446,000 391,000 (134,600) 364,600
Net income $ 830,086 $ 729,725 $ (243,056) $ 651,066
=========== =========== =========== ===========
Earnings per common share
Basic $ 1.09 $ 0.96 $ (0.32) $ 0.86
=========== =========== =========== ===========
Diluted $ 1.03 $ 0.91 $ (0.32) $ 0.82
=========== =========== =========== ===========
2001
--------------------------------------------------
Fourth Third Second First
Quarter Quarter Quarter Quarter
------- ------- ------- -------
Interest and dividend income $ 4,326,809 $ 4,630,360 $ 4,649,286 $ 4,908,221
Interest expense 1,821,087 2,132,804 2,316,701 2,487,219
----------- ----------- ----------- -----------
Net interest income 2,505,722 2,497,556 2,332,585 2,421,002
Provision for loan loss 90,000 90,000 90,000 90,000
----------- ----------- ----------- -----------
Net interest income after provision 2,415,722 2,407,556 2,242,585 2,331,002
Noninterest income 355,728 344,406 353,858 347,528
Noninterest expense 1,840,743 1,862,904 1,609,104 1,681,749
Income before income taxes 930,707 889,058 987,339 996,781
Provision for income taxes 312,650 322,000 335,700 348,000
Net income $ 618,057 $ 567,058 $ 651,639 $ 648,781
=========== =========== =========== ===========
Earnings per common share
Basic $ 0.83 $ 0.74 $ 0.84 $ 0.83
=========== =========== =========== ===========
Diluted $ 0.79 $ 0.71 $ 0.81 $ 0.80
=========== =========== =========== ===========
71
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) 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.
TRI-COUNTY FINANCIAL CORPORATION
Date: March 28, 2003 By:/s/ Michael L. Middleton
-------------------------------------
Michael L. Middleton
President and Chief Executive Officer
(Duly Authorized Representative)
Pursuant to the requirement of 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.
By: /s/ Michael L. Middleton By:/s/ William J. Pasenelli
----------------------------------- --------------------------------
Michael L. Middleton William J. Pasenelli
(Director, President and Chief (Chief Financial and Accounting
Executive Officer) Officer)
Date: March 28, 2003 Date: March 28, 2003
By: /s/ C. Marie Brown By:/s/ Herbert N. Redmond
----------------------------------- --------------------------------
C. Marie Brown Herbert N. Redmond, Jr.
(Director and Chief Operating Officer) (Director)
Date: March 28, 2003 Date: March 28, 2003
By: /s/ H. Beaman Smith By:/s/ W. Edelen Gough, Jr.
----------------------------------- --------------------------------
H. Beaman Smith W. Edelen Gough, Jr.
(Director and Secretary/Treasurer) (Director)
Date: March 28, 2003 Date: March 28, 2003
By: /s/ Louis P. Jenkins, Jr. By:/s/ A. Joseph Slater, Jr.
----------------------------------- --------------------------------
Louis P. Jenkins, Jr. A. Joseph Slater, Jr.
(Director) (Director)
Date: March 28, 2003 Date: March 28, 2003
CERTIFICATION
I, Michael L. Middleton, President and Chief Executive Officer of Tri-County
Financial Corporation, certify that:
1. I have reviewed this annual report on Form 10-K of Tri-County Financial
Corporation;
2. Based on my knowledge, this annual report does not contain any untrue
statement of a material fact or omit to state a material fact necessary to make
the statements made, in light of the circumstances under which such statements
were made, not misleading with respect to the period covered by this annual
report; and
3. Based on my knowledge, the financial statements, and other financial
information included in this annual report, fairly present in all material
respects the financial condition, results of operations and cash flows of the
registrant as of, and for, the periods presented in this annual report.
4. The registrant's other certifying officers and I are responsible for
establishing and maintaining disclosure controls and procedures (as defined in
Exchange Act Rules 13a-14 and 15d-14) for the registrant and have:
(a) Designed such disclosure controls and procedures to ensure that
material information relating to the registrant, including its
consolidated subsidiaries, is made known to us by others within those
entities, particularly during the period in which this quarterly
report is being prepared;
(b) Evaluated the effectiveness of the registrant's disclosure controls
and procedures as of a date within 90 days prior to the filing date of
this quarterly report (the "Evaluation Date"); and
(c) Presented in this quarterly report our conclusions about the
effectiveness of the disclosure controls and procedures based on our
evaluation as of the Evaluation Date;
5. The registrant's other certifying officers and I have disclosed, based on our
most recent evaluation, to the registrant's auditors and the audit committee of
the registrant's board or directors (or persons fulfilling the equivalent
functions):
(a) all significant deficiencies in the design or operation of internal
controls which could adversely affect the registrant's ability to
record, process, summarize and report financial data and have
identified for the registrant's auditors any material weaknesses in
internal controls; and
(b) any fraud, whether or not material, that involves management or other
employees who have a significant role in the registrant's internal
controls; and
6. The registrant's other certifying officers and I have indicated in this
quarterly report whether there were significant changes in internal controls or
in other factors that could significantly affect internal controls subsequent to
the date of our most recent evaluation, including any corrective actions with
regard to significant deficiencies and material weaknesses.
Date: March 28, 2003
/s/ Michael L. Middleton
--------------------------------------
Michael L. Middleton
President and Chief Executive Officer
(Principal Executive Officer)
CERTIFICATION
I, William J. Pasenelli, Chief Financial and Accounting Officer of Tri-County
Financial Corporation, certify that:
1. I have reviewed this annual report on Form 10-K of Tri-County Financial
Corporation;
2. Based on my knowledge, this annual report does not contain any untrue
statement of a material fact or omit to state a material fact necessary to make
the statements made, in light of the circumstances under which such statements
were made, not misleading with respect to the period covered by this annual
report; and
3. Based on my knowledge, the financial statements, and other financial
information included in this annual report, fairly present in all material
respects the financial condition, results of operations and cash flows of the
registrant as of, and for, the periods presented in this annual report.
4. The registrant's other certifying officers and I are responsible for
establishing and maintaining disclosure controls and procedures (as defined in
Exchange Act Rules 13a-14 and 15d-14) for the registrant and have:
(d) Designed such disclosure controls and procedures to ensure that
material information relating to the registrant, including its
consolidated subsidiaries, is made known to us by others within those
entities, particularly during the period in which this quarterly
report is being prepared;
(e) Evaluated the effectiveness of the registrant's disclosure controls
and procedures as of a date within 90 days prior to the filing date of
this quarterly report (the "Evaluation Date"); and
(f) Presented in this quarterly report our conclusions about the
effectiveness of the disclosure controls and procedures based on our
evaluation as of the Evaluation Date;
5. The registrant's other certifying officers and I have disclosed, based on our
most recent evaluation, to the registrant's auditors and the audit committee of
the registrant's board or directors (or persons fulfilling the equivalent
functions):
(c) all significant deficiencies in the design or operation of internal
controls which could adversely affect the registrant's ability to
record, process, summarize and report financial data and have
identified for the registrant's auditors any material weaknesses in
internal controls; and
(d) any fraud, whether or not material, that involves management or other
employees who have a significant role in the registrant's internal
controls; and
6. The registrant's other certifying officers and I have indicated in this
quarterly report whether there were significant changes in internal controls or
in other factors that could significantly affect internal controls subsequent to
the date of our most recent evaluation, including any corrective actions with
regard to significant deficiencies and material weaknesses.
Date: March 28, 2003
/s/ William J. Pasenelli
---------------------------------------
William J. Pasenelli
Chief Financial and Accounting Officer
(Principal Financial Officer)