UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
Form 10-K
For Annual and Transition Report Pursuant to Section 13 or 15(d)
of the Securities Exchange Act of 1934
[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 Number 0-49731
SEVERN BANCORP, INC.
(Exact name of registrant as specified in its charter)
MARYLAND 52-1726127
(State or other jurisdiction (I.R.S. Employer
of incorporation or organization) Identification Number)
1919 A West Street, Annapolis, Maryland 21401
- --------------------------------------- --------
(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code: (410) 268-4554
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
--------------------------------------
(Title of Class)
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes X No .
Indicate by check mark if disclosure of delinquent filers pursuant to
Item 405 of regulation S-K is not contained herein, and will not be contained,
to the best of registrant's knowledge, in definitive proxy 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]
The aggregate market value of the voting stock held by
non-affiliates of the registrant, based on the closing sale price of the
registrant's common stock on June 30, 2002 was $33,393,203 ($16.43 per share
based on shares of common stock outstanding).
As of March 17, 2003, there were issued and outstanding 4,142,592
shares of the registrant's common stock.
Documents Incorporated by Reference:
Portions of the definitive Proxy Statement (Part III).
Table of Contents
Section Page No.
PART I...................................................................................................1
Item 1. Business ......................................................................................1
Item 2. Properties .....................................................................................28
Item 3. Legal Proceedings...............................................................................28
Item 4. Submission of Matters to a Vote of Security Holders ............................................28
PART II ................................................................................................28
Item 5. Market for Registrant's Common Equity and Related Stockholder Matters...........................28
Item 6. Selected Financial Data ........................................................................29
Item 7. Management's Discussion and Analysis of Financial Condition
and Results of Operations .................................................................33
Item 7A. Quantitative and Qualitative Disclosures About Market Risk ....................................38
Item 8. Financial Statements and Supplementary Data ...................................................39
Item 9. Changes in and Disagreements with Accountants on
Accounting and Financial Disclosures ......................................................39
PART III ...............................................................................................39
Item 10. Directors and Executive Officers of the Registrant ...........................................39
Item 11. Executive Compensation .......................................................................39
Item 12. Security Ownership of Certain Beneficial Owners and Management ...............................40
Item 13. Certain Relationships and Related Transactions ...............................................40
Item 14. Controls and Procedures.......................................................................40
Item 15. Principal Accountant Fees and Services........................................................41
PART IV
Item 16. Exhibits, Financial Statements, Schedules and Reports on Form 8-K.............................41
Signatures .............................................................................................42
Certification ..........................................................................................44
Severn Bancorp
Financial Highlights
At the period ended: December 31,
2002 2001 2000 1999 1998
---- ---- ---- ---- ----
(dollars in thousands, except per share information)
Balance Sheet Data:
Total assets $ 458,415 $ 366,890 $ 293,230 $ 233,724 $ 220,417
Total loans, net 418,825 342,641 274,652 214,066 192,572
Total nonperforming assets 1,982 2,413 1,490 1,597 2,845
Deposits 377,925 286,918 229,312 186,204 175,341
Short-term borrowings - 17,000 18,000 2,000 6,000
Notes payable 34,000 25,000 16,000 22,000 18,000
Total liabilities 415,233 332,059 268,009 211,743 200,849
Stockholders' equity 43,181 34,831 25,221 21,981 19,567
Book value per share 9.46 7.60 6.58 5.59 4.85
For the period ended December 31,
2002 2001 2000 1999 1998
---- ---- ---- ---- ----
Operations Data:
Net interest income $ 19,603 $ 13,395 $ 10,884 $ 9,524 $ 8,528
Net interest income after provision for loan losses 18,933 12,687 10,293 9,020 7,976
Noninterest income 4,133 2,570 1,439 1,586 1,607
Noninterest expense 8,447 6,588 5,348 5,477 5,433
Net earnings 8,948 5,256 3,945 3,127 2,538
Basic earnings per share * 2.13 1.38 1.15 0.90 0.72
Diluted earnings per share * 2.13 1.37 1.12 0.84 0.70
Common Stock Cash dividends declared per share* 0.24 0.19 0.17 0.15 0.13
Common Stock dividends declared per share to
diluted earnings per share * 11.27% 13.87% 15.18% 17.86% 18.57%
Weighted number of shares outstanding basic * 4,092,188 3,647,451 3,237,888 3,230,940 3,226,545
Weighted number of shares outstanding diluted * 4,103,223 3,683,346 3,330,915 3,450,831 3,316,992
Performance Ratios:
Return on average assets 2.14% 1.55% 1.47% 1.38% 1.30%
Return on average equity 22.96% 17.55% 16.73% 14.91% 13.69%
Interest rate spread 4.59% 3.65% 3.75% 3.94% 4.09%
Net interest margin 4.86% 4.05% 4.17% 4.34% 4.50%
Noninterest expense to average assets 2.02% 1.95% 2.00% 2.43% 2.78%
Efficiency ratio 35.59% 41.27% 43.40% 49.30% 53.61%
* Retroactively adjusted to reflect three-for-one stock split declared February
19, 2002 and effective for shares outstanding as of March 1, 2002.
SPECIAL NOTE REGARDING FORWARD-LOOKING STATEMENTS
Severn Bancorp, Inc. ( "Bancorp") may from time to time make written or
oral "forward-looking statements", including statements contained in Bancorp's
filings with the Securities and Exchange Commission (including this annual
report on Form 10-K and the exhibits thereto), in its reports to stockholders
and in other communications by Bancorp, which are made in good faith by Bancorp
pursuant to the "safe harbor" provisions of the Private Securities Litigation
Reform Act of 1995.
In addition to the historical information contained herein, the
following discussion contains forward-looking statements that involve risks and
uncertainties. Bancorp operations and actual results could differ significantly
from those discussed in the forward-looking statements. Some of the factors that
could cause or contribute to such differences include, but are not limited to,
changes in the economy and interest rates in the nation and Bancorp's general
market area. The forward-looking statements contained herein include, but are
not limited to, those with respect to management's determination of the amount
of loan loss allowance; the effect of changes in interest rates; and changes in
deposit insurance premiums.
PART I
Item 1. Business
General
Severn Bancorp, Inc. is a savings and loan holding company that was
incorporated in Maryland in August 1990. It conducts business through three
subsidiaries: Severn Savings Bank, FSB (the "Bank"), its principal subsidiary;
Louis Hyatt, Inc., ("Hyatt Real Estate"), a real estate brokerage and property
management company, which it acquired in June 2001; and SBI Mortgage Company
("SBI"), which engages in the origination of mortgages not suitable to the Bank
such as mortgages to borrowers with credit backgrounds that the Bank does not
find suitable, or mortgages secured by properties that have a higher
loan-to-value ratio than the Bank customarily allows, and to a lesser extent,
owns investment real estate through subsidiary limited liability companies.
The Bank's primary lending market is Anne Arundel County, Maryland,
where it also offers savings products through its two branches. To a lesser
extent, it also lends to borrowers located in other parts of Maryland and in
Delaware and Northern Virginia.
As of December 31, 2002, Bancorp had total assets of $458,414,509 total
deposits of $377,925,041, and stockholders' equity of $43,181,377, for the year
ended December 31, 2002 net income was $8,948,220, of which $8,837,539 was net
income of the Bank.
Bancorp's internet address is www.severnbank.com. We make available
free of charge on www.severnbank.com our annual report on Form 10-K, quarterly
reports on Form 10-Q and current reports on Form 8-K, and amendments to those
reports filed or furnished pursuant to Section 13(a) or 15(d) of the Exchange
Act, as soon as reasonably practicable after we electronically file such
material with, or furnish it to, the SEC.
In addition, we will provide, at no cost, paper or electronic copies of
our reports and other filings made with the SEC. Requests should be directed to:
S. Scott Kirkley
Senior Vice President
Severn Bancorp, Inc.
1919A West Street
Annapolis, Maryland 21401
The information on the website listed above, is not and should not be
considered part of this annual report on Form 10-K and is not incorporated by
reference in this document. This website is and is only intended to be an
inactive textual reference.
Business of the Bank
Severn Savings Bank, FSB (the "Bank") was organized in 1946 in
Baltimore, Maryland as Pompei Permanent Building and Loan Association. It
relocated to Annapolis, Maryland in 1980 and its name was changed to Severn
Savings Association. Subsequently, the Bank obtained a federal charter and
changed its name to Severn Savings Bank, FSB. The Bank operates two full-service
branch offices, one administrative office and one accounting and servicing
office. The Bank operates as a federally charted savings bank whose principal
business is attracting deposits from the general public and investing those
funds in mortgage loans. The Bank also uses advances, or loans from the Federal
Home Loan Bank of Atlanta, to fund its mortgage activities. The Bank's revenues
are derived principally from interest earned on mortgage loans, fees charged in
connection with the loans and banking services, and gains realized from the sale
of mortgage loans. The Bank's primary sources of funds are deposits, advances
from the Federal Home Loan Bank of Atlanta, principal amortization and
prepayment of its loans. The principal executive offices of the Bank are
maintained at 1919 A West Street, Annapolis Maryland, 21401. Its telephone
number is 410-268-4554 and its e-mail address is mailman@severnbank.com.
In addition to its deposit and lending activities, the Bank offers title
insurance and real estate settlement services through its wholly owned
subsidiary, Homeowner's Title and Escrow Corporation ("Homeowner's").
The Bank also owns all of the common stock of Severn Preferred Capital
Corporation ("Severn Capital"), which was formed in 1997. Severn Capital is a
real estate investment trust that issued and has outstanding 200,002 shares of
Series A Preferred Stock. This preferred stock has an aggregate outstanding
balance of $4,000,040, which qualifies as regulatory capital of the Bank. The
Series A Preferred Stock pays a 9% annual non-cumulative dividend and is
callable at par, by the Bank, at any time.
The Thrift Industry
Thrift institutions are financial intermediaries which historically have
accepted savings deposits from the general public and, to a lesser extent,
borrowed funds from outside sources and invested those deposits and funds
primarily in loans secured by first mortgage liens on residential and other
types of real estate. Such institutions may also invest their funds in various
types of short- and long-term securities. The deposits of thrift institutions
are insured by the SAIF as administered by the FDIC, and these institutions are
subject to extensive regulations. These regulations govern, among other things,
the lending and other investment powers of thrift institutions, including the
terms of mortgage instruments these institutions are permitted to utilize, the
types of deposits they are permitted to accept, and reserve requirements.
The operations of thrift institutions, including those of the Bank, are
significantly affected by general economic conditions and by related monetary
and fiscal policies of the federal government and regulations and policies of
financial institution regulatory authorities, including the Board of Governors
of the Federal Reserve System and the OTS. Lending activities are influenced by
a number of factors including the demand for housing, conditions in the
construction industry, and availability of funds. Sources of funds for lending
activities include savings deposits, loan principal payments, proceeds from
sales of loans, and borrowings from the Federal Home Loan Bank and other
sources. Savings flows at thrift institutions such as the Bank are influenced by
a number of factors including interest rates on competing investments and levels
of personal income.
Earnings
The Bank's earnings depend primarily on the difference between income
from interest-earning assets such as loans and investments, and interest paid on
interest-bearing liabilities such as deposits and borrowings. The Bank typically
engages in long-term mortgage lending at fixed rates of interest, generally for
periods of up to 30 years, while accepting deposits for considerably shorter
periods. However, many of the Bank's long term fixed rate loans are sold in the
secondary market, resulting in gains on the sale of such loans by the Bank.
Generally, rapidly rising interest rates cause the cost of
interest-bearing liabilities to increase more rapidly than yields on
interest-earning assets, thereby adversely affecting the earnings of many thrift
institutions. While the industry has received expanded lending and borrowing
powers in recent years permitting different types of investments and mortgage
loans, including those with floating or adjustable rates and those with shorter
terms, earnings and operations are still highly influenced by levels of interest
rates and financial market conditions and by substantial investments in
long-term mortgage loans.
Competition
The Annapolis area has a high density of financial institutions, many
of which are significantly larger and have greater financial resources than the
Bank, and all of which are competitors of the Bank to varying degrees. The
Bank's competition for loans comes primarily from savings and loan associations,
savings banks, mortgage banking companies, insurance companies, and commercial
banks. Its most direct competition for deposits has historically come from
savings and loan associations, savings banks, commercial banks, and credit
unions. The Bank faces additional competition for deposits from short-term money
market funds and other corporate and government securities funds. The Bank also
faces increased competition from other financial institutions such as brokerage
firms and insurance companies for deposits. The Bank is a community-oriented
financial institution serving its market area with a wide selection of mortgage
loans. Management considers the Bank's reputation for financial strength and
customer service as its major competitive advantage in attracting and retaining
customers in its market area. The Bank also believes it benefits from its
community orientation.
Net Interest Income
Net interest income increases during periods when the spread is widened
between the Bank's weighted average rate at which new loans are originated and
the weighted average cost of interest-bearing liabilities. The Bank's ability to
originate loans is affected by market factors such as interest rates,
competition, consumer preferences, the supply of and demand for housing, and the
availability of funds.
The Bank has supplemented its interest income through purchases of
investments when appropriate. This activity generates positive interest rate
spreads on large principal balances with minimal administrative expense.
Interest Rate and Volume of Interest-Related Assets and Liabilities
Both changes in rate and changes in the composition of the Bank's
interest-earning assets and interest-bearing liabilities can have a significant
effect on net interest income.
For information regarding the total dollar amount of interest income
from interest-earning assets, the average yields, the amount of interest expense
from interest-bearing liabilities and the average rate, net interest income,
interest rate spread, and the net yield on interest-earning assets, refer to
page 34 of Management's Discussion and Analysis of Financial Condition and
Results of Operations contained herein.
For information regarding the combined weighted average effective
interest rate earned by the Bank on its loan portfolios and investments, the
combined weighted average effective cost of the Bank's deposits and borrowings,
the interest rate spread of the Bank, and the net yield on combined monthly
weighted average interest-earning assets of the Bank on its loan portfolios and
investments for the fiscal years ending December 31, 2002, 2001, and 2000, refer
to page 32 Average Balance Sheet Table contained herein.
For information concerning the extent to which changes in interest
rates and changes in volume of interest-related assets and liabilities have
affected the Bank's interest income and expense during the fiscal years ending
December 31, 2002, 2001, and 2000, refer to page 33 Rate Volume Table contained
herein.
Market Area
The Bank's market area for deposit gathering is primarily Anne Arundel
County, Maryland and nearby areas, since it has two branch locations, both of
which are located in Anne Arundel County. Anne Arundel County has a population
of approximately 500,000. The principal business of the Bank is attracting
deposits from the general public and investing those deposits, together with
other funds, in mortgage and consumer loans, mortgage-backed securities and
investment securities. The Bank's revenues are derived principally from interest
earned on mortgage, consumer and other loans, fees charged in connection with
loans and banking services, interest and dividends earned on other investments.
The Bank's primary sources of funds are deposits and loan interest, principal
amortization and prepayments.
The primary focus of the Bank's lending activities has been on first
mortgage loans secured by real estate for the purpose of purchasing,
refinancing, developing and constructing one-to-four family residences and
commercial properties in and near Anne Arundel County, Maryland. The Bank does
originate mortgage loans throughout the state of Maryland, Northern Virginia and
Delaware. The Bank is an active participant in the secondary market and sells
substantially all fixed rate long-term mortgages that it originates.
Loan Portfolio Composition
The following table sets forth the composition of the Bank's loan
portfolios by type of loan at the dates indicated. The table includes a
reconciliation of total net loans receivable, including loans available for
sale, after consideration of undisbursed portion of loans, deferred loan fees
and discounts, and allowance for losses on loans.
2002 2001 2000 1999 1998
--------------------- ----------------- ------------------- --------------------- ----------------
Amount Percent Amount Percent Amount Percent Amount Percent Amount Percent
------ ------- ------ ------- ------ ------- ------ ------- ------ -------
Real Estate Loans
Residential, one
to four family
units $180,397 36.58% $151,250 36.90% $137,498 41.95% $101,640 39.89% $ 99,056 43.58%
Residential,
multifamily 1,318 0.27% 1,065 0.26% 1,026 0.31% 991 0.39% 750 0.33%
Commercial and
industrial real
estate 95,298 19.33% 71,557 17.46% 54,024 16.48% 49,231 19.32% 40,555 17.84%
Construction and
land acquisition
and development
loans 191,197 38.77% 163,849 39.98% 117,325 35.80% 90,324 35.45% 78,454 34.51%
Land 20,109 4.08% 16,895 4.12% 11,390 3.48% 7,018 2.76% 6,387 2.81%
------------------------------------------------------------- --------------------- --------------------
Total real estate loans 488,319 99.03% 404,616 98.72% 321,263 98.02% 249,204 97.81% 225,202 99.07%
Other loans:
Business, commercial 3,894 0.79% 3,970 0.97% 5,592 1.71% 170 0.07% 582 0.26%
Consumer 870 0.18% 1,257 0.31% 885 0.27% 5,406 2.12% 1,533 0.67%
------------------------------------------------------------- --------------------- --------------------
Total other loans 4,764 0.97% 5,227 1.28% 6,477 1.98% 5,576 2.19% 2,115 0.93%
Total gross loans 493,083 100.00% 409,843 100.00% 327,740 100.00% 254,780 100.00% 227,317 100.00%
Unearned fees,
premiums & discounts,
net (2,674) (2,164) (2,149) (1,852) (1,699)
Loans in process (67,593) (61,685) (48,211) (36,715) (31,062)
Allowance for
loan loss (3,991) (3,353) (2,728) (2,147) (1,984)
----------- ---------- ----------- ----------- ------------
Total Loans net $418,825 $342,641 $274,652 $214,066 $192,572
=========== ========== =========== =========== ============
Lending Activities - Residential Mortgage Loans
General
The Bank originates mortgage loans of all types, including residential,
residential-construction, commercial-construction, commercial and land and
residential lot loans. To a lesser extent, the Bank also originates non-mortgage
loans, which include consumer, business and commercial loans. These loans
constitute a small part of the Bank's portfolio.
For the years ending December 31, 2002 and 2001, the Bank originated
$343,590,000 and $344,519,000 of mortgage loans, respectively.
Loan Origination Procedures
The following table contains information on the activity of Bancorp's
loans available for sale and its loans held for investment in its portfolio:
For the year ended December 31,
-------------------------------
2002 2001 2000
---- ---- ----
(dollars in thousands)
Available for Sale:
Beginning balance $ 7,499 $ 4,169 $ 2,989
Originations 110,565 63,565 38,024
Repurchases - 41 -
Repayments (48) - (25)
Deferred fees - 26 50
Net sales (100,535) (60,302) (36,869)
Transfers (to) from
available for sale - - -
------------------------------------------
Ending Balance $ 17,481 $ 7,499 $ 4,169
==========================================
Held for investment
Beginning balance $ 402,345 $ 323,571 $ 251,791
Originations and purchases 233,222 293,195 187,035
Repurchases - - -
Repayments/payoffs (159,965) (214,295) (115,444)
Sales - - -
Transfers (to) from
repossessed assets - (127) 189
------------------------------------------
Ending balance $ 475,602 $ 402,344 $ 323,571
==========================================
The Bank originates residential mortgage loans that are intended for
sale in the secondary market as well as loans that are to be held in the Bank's
investment portfolio. Loans sold in the secondary market are either sold
directly to the Federal Home Loan Mortgage Corporation ("FHLMC") or are sold to
other investors with which the Bank maintains a correspondent relationship.
These loans are made in conformity with standard underwriting criteria to assure
maximum eligibility for possible resale in the secondary market, and are
approved either by the Bank's underwriter or the correspondent's underwriter.
Loans considered for the Bank's portfolio are approved by the Bank's loan
committee, which is comprised of the Executive Vice President and the Senior
Vice President. Meetings of the loan committee are open to attendance by any
member of the Bank's Board of Directors who wishes to attend. The loan committee
reports to and consults with the Board of Directors in interpreting and applying
the Bank's lending policy.
Loans that are sold are typically long-term (15 or more years) loans
with fixed interest rates eligible for resale in the secondary market. Loans
retained for the Bank's portfolio include construction loans, commercial loans
and loans that periodically reprice or mature prior to the end of an amortized
term. Loans are generally sold with servicing released. However, as of December
31, 2002 the Bank was servicing $5,758,947 in loans for FHLMC and $18,175,891 in
loans for other investors.
The following table contains information, as of December 31, 2002, on
the percentage of fixed rate single-family loans serviced for others by the
Bank, by interest rate category.
Coupon range Percentage of Portfolio
- ------------ -----------------------
Less than 6.00% 23.26%
6.01 - 7.00% 32.21%
7.01 - 8.00% 34.90%
8.01 - 9.00% 7.11%
9.01 - 10.00% 2.52%
Over 10.01% 0.00%
-----------------------
100.00%
=======================
The Bank's mortgage loan approval process is intended to assess the
borrower's ability to repay the loan, the viability of the loan, and the
adequacy of the value of the property that will secure the loan. The authority
of the loan committee to approve loans is established by the Board of Directors
and currently is commensurate with the Bank's limitation on loans to one
borrower. The Bank's maximum amount of loans to one borrower currently is equal
to 15% of the Bank's unimpaired capital or $6,567,000 as of December 31, 2002.
Loans greater than this amount require participation by one or more additional
lenders. Letters of credit are subject to the same limitations as direct loans.
The Bank utilizes independent qualified appraisers approved by the Board of
Directors to appraise the properties securing its loans and requires title
insurance or title opinions so as to insure that the Bank has a valid lien on
the mortgaged real estate. The Bank requires borrowers to maintain fire and
casualty insurance on its secured properties.
The procedure for approval of construction loans is the same for
residential mortgage loans, except that the appraiser evaluates the building
plans, construction specifications, and estimates of construction costs. The
Bank also evaluates the feasibility of the proposed construction project and the
experience and track record of the developer. In addition, all construction
loans generally require a commitment from a third-party lender or from the Bank
for a permanent long-term loan to replace the construction loan upon completion
of construction.
Commercial Real Estate Loans
At December 31, 2002, the Bank's commercial real estate loan portfolio
totaled $95,298,000, or 19.33% of the Bank's total loan portfolio. All of the
Bank's commercial loans are secured by improved property such as office
buildings, retail strip shopping centers, industrial condominium units and other
small businesses most of which are located in the Bank's primary lending area.
The largest commercial real estate loan at December 31, 2002 was a $5,200,000
loan secured by two office buildings in Reston, Virginia. The loan is subject to
the partial personal guarantees of a principal of the borrower, and has
consistently performed in accordance with the terms of the debt instrument.
Loans secured by commercial real estate properties generally involve a
greater degree of risk than residential mortgage loans. Because payments on
loans secured by commercial real estate properties are often dependent on the
successful operation or management of the properties, repayment of these loans
may be subject to a greater extent to adverse conditions in the real estate
market or the economy.
Construction Loans
The Bank originates loans to finance the construction of one-to-four
family dwellings, and to a lesser extent, commercial real estate. It also
originates loans for the acquisition and development of unimproved property to
be used for residential and/or commercial purposes in cases where the Bank is to
provide the construction funds to improve the properties. As of December 31,
2002, the Bank had 524 construction loans outstanding in the aggregate amount of
$191,196,444.
Construction loan amounts are based on the appraised value of the
property and, for builder loans, a feasibility study as to the potential
marketability and profitability of the project. Construction loans generally
have terms of up to one year, with reasonable extensions as needed, and
typically have interest rates that float monthly at margins typically ranging
1/2 percent to 2 percent above the prime rate. In addition to builders'
projects, the Bank finances the construction of single family, owner-occupied
houses where qualified contractors are involved and on the basis of strict
written underwriting and construction loan guidelines. Construction loans are
structured either to be converted to permanent loans with the Bank upon the
expiration of the construction phase or to be paid off by financing from another
financial institution.
Construction loans afford the Bank the opportunity to increase the
interest rate sensitivity of its loan portfolio and to receive yields higher
than those obtainable on loans secured by existing residential properties. These
higher yields correspond to the higher risks associated with construction
lending. Construction loans involve additional risks attributable to the fact
that loan funds are advanced upon the security of the project under construction
that is of uncertain value prior to its completion. Because of the uncertainties
inherent in estimating construction costs as well as the market value of the
completed project and the effects of governmental regulation of real property,
it is relatively difficult to value accurately the total funds required to
complete a project and the related loan-to-value ratio. As a result,
construction lending often involves the disbursement of substantial funds with
repayment dependent, in part, on the ultimate success of the project rather than
the ability of the borrower or guarantor to repay principal and interest. If the
Bank is forced to foreclose on a project prior to or at completion, due to a
default, there can be no assurance that the Bank will be able to recover all of
the unpaid balance of the loan as well as related foreclosure and holding costs.
In addition, the Bank may be required to fund additional amounts to complete the
project and may have to hold the property for an unspecified period of time. The
Bank has attempted to address these risks through its underwriting procedures
and its limited amount of construction lending on multi-family and commercial
real estate properties.
It is the policy of the Bank to conduct physical inspections of each
property secured by a construction or rehabilitation loan for the purpose of
reporting upon the progress of the construction of improvements. These
inspections, referred to as "construction draw inspections," are to be performed
at the time of a request for an advance of construction funds. If no
construction advance has been requested, an inspection is made by a fee
inspector or senior officer of the institution on the subject property at least
quarterly.
Multi-Family Lending
The Bank occasionally originates multi-family loans with terms up to 30
years, but with rate adjustments or balloon payments generally at three to five
years. These loans are generally made in amounts up to 75% of the appraised
value of the secured property. In making these loans, the Bank bases its
underwriting decision primarily on the net operating income generated by the
real estate to support the debt service, the financial resources and income
level of the borrower, the borrower's experience in owning or managing similar
property, the marketability of the property and the Bank's lending experience
with the borrower. The Bank also typically receives a personal guarantee from
the borrower. As of December 31, 2002, $1,318,000, or 0.27% of the Bank's total
loan portfolio, consisted of multi-family residential loans.
Land and Residential Building Lots
Land loans include loans to developers for the development of
residential subdivisions and loans on unimproved lots primarily to individuals.
At December 31, 2002 the Bank had land and residential building lot loans
totaling $20,109,000, or 4.08% of the Bank's total loan portfolio. The largest
of these loans is for $3,400,000, and is secured by residentially zoned land in
Berlin, Maryland, and has performed in accordance with the terms of the debt
instrument. Land development loans typically are short-term loans; the duration
of these loans is typically not greater than three years. The interest rate on
land loans is generally at least 1% or 2% over the prime rate. The loan-to-value
ratio generally does not exceed 75%. Loans typically are made to customers of
the Bank and developers and contractors with whom the Bank has had previous
lending experience. In addition to the customary requirements for this type
loan, the Bank may also require a clean Phase I environmental study and
feasibility study to determine the profit potential of the development.
Consumer and Other Loans
The Bank also offers other loans, primarily business and commercial
loans. These are loans to businesses not secured by real estate although they
may be secured by equipment, securities, or other collateral. They constitute a
relatively small part of the Bank's business, and are typically offered to
customers with long-standing relationships with the Bank. At December 31, 2002,
$3,894,000, or 0.79%, of the loan portfolio consisted of business and commercial
loans. Approximately .18% of the loan portfolio is in consumer loans.
Loan Portfolio Cash Flows
The following table sets forth the estimated maturity of the Bank's loan
portfolios by type of loan at December 31, 2002. The estimated maturity reflects
contractual terms at December 31, 2002. Contractual principal repayments of
loans do not necessarily reflect the actual term of the Bank's loan portfolios.
The average life of mortgage loans is substantially less than their contractual
terms because of loan prepayments and because of enforcement of "due on sale"
clauses. The average life of mortgage loans tends to increase, however, when
current mortgage loan rates substantially exceed rates on existing mortgage
loans.
Due Due after
within 1 through Due after
one year 5 years 5 years Total
--------------- --------------- -------------- --------------
(dollars in thousands)
One to four family residential $ 14,058 $ 35,324 $ 131,015 $ 180,397
Multifamily 656 384 278 1,318
Commercial and industrial
real estate 14,249 23,367 57,682 95,298
Construction and land
acquisition
and development loans 168,232 22,965 - 191,197
Land 4,996 15,113 - 20,109
Commercial, non-real estate 395 522 2,977 3,894
Consumer 280 397 193 870
--------------- --------------- -------------- --------------
Total $ 202,866 $ 98,072 $ 192,145 $ 493,083
=============== =============== ============== ==============
The following table contains certain information as of December 31,
2002 relating to the loan portfolio of the Bank with the dollar amounts of loans
due after one year that have fixed and floating rates. All loans are shown
maturing based upon contractual maturities and include scheduled payments but
not possible prepayments.
Fixed Floating Total
--------------- --------------- -----------
(dollars in thousands)
One to four family residential $ 132,673 $ 33,666 $ 166,339
Multifamily 513 149 662
Commercial and industrial real
estate 52,630 28,419 81,049
Construction and land
acquisition
and development loans 18,533 4,432 22,965
Land 15,113 - 15,113
Commercial, non-real estate 2,647 852 3,499
Consumer 590 - 590
--------------- --------------- -------------
Total $ 222,699 $ 67,518 $ 290,217
=============== =============== =============
Loans to One Borrower
The aggregate amount of loans that the Bank may make to one borrower is
15% of the Bank's unimpaired capital and unimpaired surplus. The Bank's largest
loan is in the amount of $5,200,000 and is secured by two office buildings in
Reston Virginia. The second largest loan is in the amount of $3,850,000 and is
secured by residential property in Arnold, Maryland. The third largest loan is
in the amount of $3,400,000 and is secured by residentially zoned land in
Berlin, Maryland. All of these loans have fully performed since their inception.
Origination and Purchase and Sale of Loans
The Bank originates residential loans in conformity with standard
underwriting criteria to assure maximum eligibility for possible resale in the
secondary market. Although the Bank has authority to lend anywhere in the United
States, they have confined their loan origination activities to the states of
Maryland, Virginia and Delaware.
Loan originations are developed from a number of sources, primarily
from referrals from real estate brokers, builders, and existing and walk-in
customers. Severn Savings also utilizes the services of loan brokers in its
market area. Loan brokers are paid on a commission basis (generally 1% of the
loan amount) for loans brokered to the Bank.
The Bank's mortgage loan approval process is intended to assess the
borrower's ability to repay the loan, the viability of the loan, and the
adequacy of the value of the property that will secure the loan. The loan
committees of the Bank can approve residential and commercial loans ranging up
to $6,567,000 (the maximum amount of a loan to one borrower as of December 31,
2002). The Bank utilizes independent qualified appraisers approved by the Board
of Directors to appraise the properties securing its loans and requires title
insurance or title opinions so as to insure that the Bank has a valid lien on
the mortgaged real estate. The Bank requires borrowers to maintain fire and
casualty insurance on its secured properties.
The procedure for approval of construction loans is the same as for
residential mortgage loans, except that the appraiser evaluates the building
plans, construction specifications, and estimates of construction costs. The
Bank also evaluates the feasibility of the proposed construction project and the
experience and track record of the developer. In addition, all construction
loans generally require a commitment from a third-party lender or from the Bank
for a permanent long-term loan to replace the construction loan upon completion
of construction.
Consumer loans are underwritten on the basis of the borrower's credit
history and an analysis of the borrower's income and expenses, ability to repay
the loan, and the value of the collateral, if any.
Currently, it is the Bank's policy to originate both fixed-rate and
adjustable-rate loans. The Bank is currently active in the secondary market and
sells the majority of its fixed rate loan products.
Interest Rates, Points and Fees
The Bank realizes interest, point, and fee income from their lending
activities. The Bank also realizes income from commitment fees for making
commitments to originate loans, from prepayment and late charges, loan fees,
application fees, and fees for other miscellaneous services.
The Bank accounts for loan origination fees in accordance with the
Statement of Financial Accounting Standards on Accounting for Nonrefundable Fees
and Costs Associated with Originating or Acquiring Loans ("SFAS No. 91") issued
by the Financial Accounting Standards Board (the "FASB"). SFAS No. 91 prohibits
the immediate recognition of loan origination fees as revenues and requires that
such income (net of certain direct loan origination costs) for each loan be
amortized, generally by the interest method, over the estimated life of the loan
as an adjustment of yield. The Bank also realizes income from gains on sales of
loans, and servicing released fees for loans sold with servicing released.
Delinquency and Classified Assets
Delinquencies
The Board of Directors reviews delinquencies on all loans monthly. The
Bank's collection procedures include sending a past due notice to the borrower
on the 17th day of nonpayment, making telephone contact with the borrower
between 20 and 30 days after nonpayment, and sending a letter after the 30th day
of nonpayment. A notice of intent to foreclose is sent between 60 and 90 days
after delinquency. When the borrower is contacted, the Bank attempts to obtain
full payment of the amount past due. However, the Bank generally will seek to
reach agreement with the borrower on a payment plan to avoid foreclosure.
The Bank categorizes its classified assets within four categories: A)
Special Mention, B) Substandard, C) Doubtful and D) Loss. Special Mention loans
are 60 days or more in arrears and include all borrowers who are in bankruptcy
that have not missed any post-petition payments. The Bank reserves 5% on all
Special Mention loans. Substandard loans are loans that are 90 days or more
delinquent and are loans that have borrowers in bankruptcy that have missed a
post-petition payment. The Bank reserves 15% of substandard loans. The Doubtful
category consists of loans where the Bank expects a loss, but not a total loss.
Various subjective factors are considered with the most important consideration
being the estimated underlying value of the collateral. The Bank reserves 50% of
the amount of Doubtful loans. Loans that are classified as "Loss" are fully
reserved.
All loans are individually evaluated if they are deemed classified. The
Bank also evaluates all delinquent loans, individually. The rest of the
portfolio is evaluated as a group and a determination is made, periodically,
concerning the inherent risks associated with particular types of loans and an
allowance is assigned to those particular groups.
The Bank allocates reserves to its allowance for loan losses in two
ways. Where the bank has classified an asset it generally allocates the
percentage of that asset under its classification system to a specific reserve
if the asset is classified as Doubtful or Loss. In cases where loans are
classified as Special Mention or Substandard the bank usually does not allocate
its allowance for loan loss reserves to a specific reserve. The bank does not
allocate its allowance for loan losses based upon the unclassified portion of
its loan portfolio to specific loan reserves.
It is the policy of the Bank to discontinue the accrual of interest on
any loan that is 90 days or more past due. The Bank historically has not
incurred any significant losses on delinquent mortgage loans.
The following table sets forth information as to non-accrual loans. The
Bank discontinues the accrual of interest on loans 90 days or more past due, at
which time all previously accrued but uncollected interest is deducted from
income. As of the most recent reported period, $156,042 would have been recorded
for the year ended December 31, 2002 if the loans had been current in accordance
with their original terms and had been outstanding throughout the year ended
December 31, 2002 or since their origination (if held for only part of the
fiscal year). For the year ended December 31, 2002, $80,487 in interest income
on such loans was actually included in net income.
At December 31,
------------------------------------------------
2002 2001 2000 1999 1998
---- ---- ---- ---- ----
(dollars in thousands)
Loans accounted for on a non-accrual basis:
Mortgage loans:
One-to-four family real estate $1,366 $ 1,801 $ 872 $ 909 $1,591
Home equity lines of credit - - - 16 14
Commercial 253 300 292 - 1,136
Land 139
Non-mortgage loans:
Consumer - - 14 - -
Commercial loans - - - - -
------------------------------------------------
Total non-accrual loans 1,758 2,101 1,178 925 2,741
Accruing loans which are contractually
past due 90 days or more:
Mortgage loans:
Permanent loans secured by one-to-four
family real estate - - - - -
Commercial - - - - -
Non-mortgage loans
Consumer - - - - -
------------------------------------------------
Total accruing loans greater than 90 days past due - - - - -
------------------------------------------------
Total non-performing loans $1,758 $2,101 $1,178 $ 925 $2,741
================================================
Foreclosed real-estate
224 312 312 672 104
================================================
Total nonperforming assets $1,982 $2,413 $1,490 $1,597 $2,845
================================================
Total non-accrual and accrual loans to net loans 0.42% 0.61% 0.43% 0.43% 1.42%
Allowance for loan losses to total non-performing loans,
including loans contractually past due 90 days or more 227.02% 159.59% 231.58% 232.11% 72.38%
================================================
Total non-accrual and accruing loans greater than
90 days past due to total assets 0.38% 0.57% 0.40% 0.40% 1.24%
================================================
Total non-performing assets to total assets 0.43% 0.66% 0.51% 0.68% 1.29%
================================================
Classified Assets
Federal regulations provide for the classification of loans and other
assets, such as debt and equity securities, considered by the Office of Thrift
Supervision (OTS) to be of lesser quality as "substandard," "doubtful" or "loss
assets." An asset is considered substandard if it is inadequately protected by
the paying capacity and net worth of the obligor or the collateral pledged, if
any. Substandard assets include those characterized by the distinct possibility
that the insured institution will sustain some loss if the deficiencies are not
corrected. Assets classified as doubtful have all of the weaknesses inherent in
those classified substandard with the added characteristic that the weaknesses
present make collection or liquidation in full highly questionable and
improbable, on the basis of currently existing facts, conditions, and values.
Assets classified as loss assets are those considered uncollectible and of such
little value that their continuance as assets without the establishment of a
specific loss reserve is not warranted. Assets which do not currently expose the
insured institution to a sufficient degree of risk to warrant classification in
one of these categories but possess credit deficiencies or potential weakness
are required to be designated special mention by management.
When an insured institution classifies problem assets as either
substandard or doubtful, it is required to establish general allowance for
losses in an amount deemed prudent by management. General allowances represent
loss allowances which have been established to recognize the inherent risk
associated with lending activities, but which, unlike specific allowances, have
not been allocated to particular problem assets. When an insured institution
classifies problem assets as loss assets, it is required either to establish a
specific allowances for losses equal to the full amount of the asset so
classified or to charge-off such amount. An institution's determination as to
the classification of its assets is subject to scrutiny by the OTS, which can
require the establishment of additional general or specific loss allowances. The
Bank reviews monthly the assets in its portfolio to determine whether any assets
require classification in accordance with applicable regulations.
Total classified loans as of December 31, 2002 were $3,214,472.
Allowance for loan losses as of December 31, 2002 was $3,990,600, which is 0.95%
of net loans receivable and 227% of total non-performing loans.
[see table on following page]
The following table summarizes the allocation of the allowance for loan losses
by loan type and the percent of loans in each category compared to total loans
at the dates indicted:
2002 2001 2000 1999 1998
--------------------------------------------------------------------------------------------------------------
Percentage Percentage Percentage Percentage Percentage
of Loans of Loans of Loans of Loans of Loans
in each in each in each in each in each
Allowance Category to Allowance Category to Allowance Category to Allowance Category to Allowance Category to
Amount Total Loans Amount Total Loans Amount Total Loans Amount Total Loan Amount Total Loans
--------------------- --------------------- --------------------- --------------------------------------------
(dollars in thousands)
Residential, one
to four family 1,542 36.58% 1,081 36.90% 995 41.95% 776 39.89% 826 43.58%
Multifamily 21 0.27% 24 0.26% 18 0.31% 10 0.39% 9 0.33%
Commercial and
industrial real
estate 881 19.33% 850 17.46% 658 16.48% 567 19.32% 560 17.84%
Construction and
land acquisition
and development
loans 1,202 38.77% 917 39.98% 662 35.80% 428 35.45% 323 34.51%
Land 300 4.08% 413 4.12% 308 3.48% 292 2.76% 241 2.81%
Business, commercial 33 0.79% 52 0.97% 75 1.71% 4 0.07% 8 0.26%
Other 12 0.18% 16 0.31% 12 0.27% 70 2.12% 17 0.67%
--------------------------------- -------- ------- -- --------------------------- -----------
Total 3,991 100.00% 3,353 100.00% 2,728 100.00% 2,147 100.00% 1,984 100.00%
================================= ======== ======= == ============================ ==========
The following table contains information with respect to Severn Bancorp's
allowance for loan losses for the periods indicated:
At or for the Year Ended
December 31,
2002 2001 2000 1999 1998
---- ---- ---- ---- ----
(dollars in thousands)
Average loans outstanding, net $ 384,537 $ 313,798 $ 246,631 $ 203,237 $ 176,223
=========================================================================
Total gross loans outstanding at end of period $ 493,083 $ 409,844 $ 327,740 $ 254,780 $ 227,317
=========================================================================
Allowance balance at beginning of period $ 3,353 $ 2,728 $ 2,147 $ 1,984 $ 1,519
Provision for loan losses 670 709 591 504 552
Actual charge-offs
1-4 family residential real estate - 74 30 89 62
Other 32 10 - 263 35
------------------------------------------------------------------------
Total charge-offs 32 84 30 352 97
-------------------------------------------------------------------------
Recoveries
Total recoveries - - 20 11 10
-------------------------------------------------------------------------
Net chargeoffs 32 84 10 341 87
-------------------------------------------------------------------------
Allowance balance at end of period $ 3,991 $ 3,353 $ 2,728 $ 2,147 $ 1,984
=========================================================================
Net chargeoffs as a percent of average loans 0.01% 0.03% 0.00% 0.17% 0.05%
Allowance for loan losses to total gross loans at end of
period 0.81% 0.82% 0.83% 0.84% 0.87%
=========================================================================
Investment Activities
Federal thrift institutions, such as the Bank, have authority to invest
in various types of liquid assets, including United States Treasury obligations
and securities of various federal agencies, certificates of deposit at insured
banks, bankers' acceptances and federal funds. As a member of the FHLB System,
the Bank must maintain minimum levels of liquid assets specified by the Office
of Thrift Supervision ("OTS"), which vary from time to time. Subject to various
regulatory restrictions, federal thrift institutions may also invest a portion
of their assets in certain commercial paper, corporate debt securities and
mutual funds whose assets conform to the investments that a federal thrift
institution is authorized to make directly.
The carrying values of the Bank's investment securities, including its
liquid assets, as of the dates indicated are presented in the following table:
at December 31,
2002 2001 2000
---- ---- ----
(dollars in thousands)
Investment Securities Available for Sale
GNMA Trust $ - $ - $ 858
-------------------------------
Total Investment Securities Available for Sale - - 858
-------------------------------
Investment Securities Held to Maturity
U.S. Treasury Notes $ - $ 2,001 $ 2,502
FHLB Notes 4,000 5,000 2,997
FNMA Notes - - 3,000
FFCB Note - - 1,000
-------------------------------
Total Investment Securities Held to Maturity 4,000 7,001 9,499
-------------------------------
Interest-bearing deposits in other banks $ 4,191 $ 1,059 $ 290
Federal funds sold 10,713 3,949 -
Mortgage-backed securities held to maturity 5,661 212 279
FHLB stock 1,900 2,500 1,800
-------------------------------
22,465 7,720 2,369
-------------------------------
$ 26,465 $ 14,721 $ 12,726
===============================
Investment Scheduled Maturity Table
As of December 31, 2002
More than One to More than Five to
One Year or Less Five Years Ten Years More than Ten Years Total Investment Securities
-----------------------------------------------------------------------------------------------------------
Carrying Average Carrying Average Carrying Average Carrying Average Carrying Average Market
Value Yield Value Yield Value Yield Value Yield Value Yield Value
----- ----- ----- ----- ----- ----- ----- ----- ----- ----- -----
(dollars in thousands)
Investment Securities
Held to Maturity
FHLB Notes - $ 4,000 4.36% - $4,000 4.36% $4,048
Interest-bearing
deposits in other banks $4,191 1.00% - - - 4,191 1.00% 4,191
Federal funds sold 10,713 1.25% - - - 10,713 1.25% 10,713
Mortgage-backed
securities held to
maturity - - - 5,661 4.63% 5,661 4.63% 5,670
FHLB stock - - - 1,900 5.04% 1,900 5.04% 1,900
-----------------------------------------------------------------------------------------------------------
Total $ 14,904 1.18% $ 4,000 4.36% $ - - $ 7,561 4.73% $ 26,465 2.68% $ 26,522
===========================================================================================================
Real Estate Owned
As of December 31, 2002, Bancorp owned real estate in the amount of
$224,000 as a result of default under a loan to the Bank. The real estate is
being held by a subsidiary of SBI and is under pending contract of sale for
$450,000, scheduled to settle in March 2003.
Deposits
Deposits are attracted principally from within the Bank's primary
market areas through the offering of a variety of deposit instruments, including
passbook and statement accounts and certificates of deposit ranging in terms
from three months to five years. Deposit account terms vary, principally on the
basis of the minimum balance required, the time periods the funds must remain on
deposit and the interest rate. The Bank also offers individual retirement
accounts ("IRA's").
The Bank's policies are designed primarily to attract deposits from
local residents rather than to solicit deposits from areas outside their primary
markets. Interest rates paid, maturity terms, service fees and withdrawal
penalties are established by the Bank on a periodic basis. Determination of
rates and terms are predicated upon funds acquisition and liquidity
requirements, rates paid by competitors, growth goals and federal regulations.
Deposits in the Bank as of December 31, 2002 and 2001 consisted of
savings programs described below:
2002 2001
Amount Percent Amount Percent
Category
NOW accounts $ 15,980,589 4.23% $ 13,457,798 4.68%
Money market accounts 132,767,052 35.13 61,759,483 21.53
Passbooks 18,189,610 4.81 21,024,223 7.33
Certificates 210,913,461 55.81 190,593,583 66.43
----------- ----- ----------- ------
377,850,712 99.98 286,835,087 99.97
Accrued interest 74,329 .02 82,481 .03
--------------- ------- --------------- --------
Total savings $377,925,041 100.00% $286,917,568 100.00%
========== ===== ========== =====
The bank held certificates of deposit totaling $210,913,461 and
$190,593,583 at December 31, 2002 and 2001 respectively, maturing as follows:
2002 2001
-------------------------------- -------------------------------
Amount Percent Amount Percent
One year or less $136,944,574 64.93 $139,073,988 72.97
More than 1 year to 2 years 27,531,898 13.05 23,138,385 12.14
More than 2 years to 3 years 11,058,263 5.24 9,361,585 4.91
More than 3 years to 4 years 16,060,941 7.62 9,344,464 4.91
More than 4 years to 5 years 19,268,496 9.14 9,630,221 5.05
More than 5 years 49,289 .02 44,940 .02
------------- ------- ------------- -------
$210,913,461 100.00 $190,593,583 100.00
========== ===== ========== =====
The following table contains information pertaining to the certificates
of deposit held by the Bank in excess of $100,000 ("Jumbo CD's") as of December
31, 2002.
Jumbo Certificate
of Deposits
(dollars in
Time Remaining Until Maturity thousands)
- ---------------------------------- ---------------------
Less than three months $ 9,918
3 months to 6 months 5,686
6 months to 12 months 13,742
Greater than 12 months 21,491
---------------------
Total $ 50,837
=====================
Liquidity and Asset/Liability Management
Two major objectives of asset and liability management are to maintain
adequate liquidity and to control the interest sensitivity of the balance sheet.
Liquidity is the measure of a company's ability to maintain sufficient
cash flow to fund operations and to meet financial obligations to depositors and
borrowers. Liquidity is provided by the ability to attract and retain deposits
and by principal and interest payments on loans and maturing securities in the
investment portfolio. A strong core deposit base, supplemented by other deposits
of varying maturities and rates, contributes to the Bank's liquidity.
Funds available through short-term borrowings and asset maturities are
considered adequate to meet all current needs, and Management is continually
monitoring the Bank's liquidity position to meet projected needs.
Interest rate sensitivity is maintaining the ability to reprice
interest earning assets and interest bearing liabilities in relationship to
changes in the general level of interest rates. Management contributes interest
rate sensitivity to a steady net interest margin through all phases of interest
rate cycles. Management attempts to make the necessary adjustments to constrain
adverse savings in net interest income resulting from interest rate movements
through GAP analysis and income simulation modeling techniques.
Short Term Borrowings
The Bank has an available line of credit, secured by its residential
mortgage portfolio, in the amount of Twenty-Five Percent (25%) of its total
assets, with the Federal Home Loan Bank of Atlanta. As of year-end the available
line of credit with the Federal Home Loan Bank of Atlanta was $113,884,235. The
Bank, from time to time, utilizes the line of credit when interest rates are
more favorable then obtaining deposits from the public. The following table sets
forth short-term borrowings with the Federal Home Loan Bank of Atlanta, with
original maturities of one year or less.
Year ended December 31,
------------------------------------------
2002 2001 2000
---- ---- ----
(dollars in thousands)
Short term borrowings and notes payable
Average balance outstanding during the period $ 4,917 $ 21,917 $ 13,167
Maximum amount outstanding at any month-end
during
the period 14,000 27,000 18,000
Weighted Average interest rate during the period 3.16% 5.38% 6.34%
Total short term borrowings at period end - 17,000 18,000
Weighted average interest rate at period end 0.00% 4.40% 6.83%
Employees
As of December 31, 2002, the Bank employed 69 persons on a full-time basis
and 10 persons on a part-time basis. The Bank's employees are not represented by
any collective bargaining group, and management considers its relations with its
employees to be excellent. The holding company has no employees.
Severn Capital
The Bank formed Severn Capital in 1997. Severn Capital was created for
the purpose of acquiring, holding and managing mortgage loans. Severn Capital
has elected to be subject to tax as a real estate investment trust under the
Internal Revenue Code and regulations promulgated thereunder. The Bank owns all
of the Common Stock of Severn Capital and administers the day-to-day operations
of Severn Capital for a fee. There are 200,002 shares of preferred stock of
Severn Capital outstanding. Dividends on the preferred stock are payable
quarterly, in an amount equal to $1.80 per annum per preferred share. The
preferred stock is redeemable, at $20 per share any time after June 30, 2001, at
the option of the Bank.
Hyatt Real Estate
Bancorp acquired Hyatt Real Estate, a real estate brokerage and
property management company, in June 2001. Hyatt Real Estate is a real estate
brokerage company specializing in commercial real estate sales, leasing and
property management. It owns the facility within which it is located, at 1919
West Street, and is also the owner of the property known as 1919A West Street,
which is leased to the Bank for its administrative offices. As of December 31,
2002 Hyatt Real Estate had 22 licensed real estate agents and 11 employees.
SBI Mortgage Company
SBI is a subsidiary of Bancorp that engages in the origination of
mortgages not suitable for the Bank. It owns subsidiary companies that have real
estate holdings. As of December 31, 2002, SBI had $676,696 in outstanding
mortgage loans and its subsidiary companies had $224,000 invested in the
ownership of land, which it acquired as a result of foreclosures initiated by
the Bank.
HS West, LLC
HS West, LLC ("HS") is a subsidiary of the Bank. It owns certain land,
being approximately one acre in size, which is located in the City of Annapolis,
Maryland fronting on Westgate Circle. HS has obtained a special exception
approval from the City of Annapolis to construct an 82,000+/- square foot office
building with parking garage on the site. Currently, studies are on going
concerning the cost of the proposed building and site development. If cost
estimates are determined to be reasonable, it is the intention of HS West to
construct the 82,000+/- square foot building on that site for the use of Bancorp
and its subsidiaries. It is estimated that if the building is built, Bancorp and
its subsidiaries will occupy approximately 35 to 40% of the space, with the
balance of the space being offered for rent to third parties.
Regulation
General
Savings and loan holding companies and savings associations are
extensively regulated under both federal and state law. This regulation is
intended primarily for the protection of depositors and the Savings Association
Insurance Fund ("SAIF") and not for the benefit of stockholders of Bancorp. The
following information describes certain aspects of that regulation applicable to
Bancorp and the Bank, and does not purport to be complete. The discussion is
qualified in its entirety by reference to all particular statutory or regulatory
provisions.
Regulation of Bancorp
General. Bancorp is a unitary savings and loan holding company subject
to regulatory oversight by the Office of Thrift Supervision ("OTS"). As such,
Bancorp is required to register and file reports with the OTS and is subject to
regulation and examination by the OTS. In addition, the OTS has enforcement
authority over Bancorp and its subsidiaries, which also permits the OTS to
restrict or prohibit activities that are determined to be a serious risk to the
subsidiary savings association.
Activities Restriction Test. As a unitary savings and loan holding
company, Bancorp generally is not subject to activity restrictions, provided the
Bank satisfies the Qualified Thrift Lender ("QTL") test or meets the definition
of domestic building and loan association pursuant to the Internal Revenue Code
of 1986, as amended (the "Code"). Bancorp presently intends to continue to
operate as a unitary savings and loan holding company. Recent legislation
terminated the "unitary thrift holding company exemption" for all companies that
apply to acquire savings associations after May 4, 1999. Since Bancorp is
grandfathered, its unitary holding company powers and authorities were not
affected. See "Financial Modernization Legislation." However, if Bancorp
acquires control of another savings association as a separate subsidiary, it
would become a multiple savings and loan holding company, and the activities of
Bancorp and any of its subsidiaries (other than the Bank or any other
SAIF-insured savings association) would become subject to restrictions
applicable to bank holding companies unless such other associations each also
qualify as a QTL or domestic building and loan association and were acquired in
a supervisory acquisition. Furthermore, if Bancorp were in the future to sell
control of the Bank to any other company, such company would not succeed to
Bancorp grandfathered status under and would be subject to the same business
activity restrictions. See "- Regulation of the Bank - Qualified Thrift Lender
Test."
Restrictions on Acquisitions. Bancorp must obtain approval from the OTS
before acquiring control of any other SAIF-insured association. Such
acquisitions are generally prohibited if they result in a multiple savings and
loan holding company controlling savings associations in more than one state.
However, such interstate acquisitions are permitted based on specific state
authorization or in a supervisory acquisition of a failing savings association.
Federal law generally provides that no "person," acting directly or
indirectly or through or in concert with one or more other persons, may acquire
"control," as that term is defined in OTS regulations, of a federally insured
savings association without giving at least 60 days written notice to the OTS
and providing the OTS an opportunity to disapprove the proposed acquisition. In
addition, no company may acquire control of such an institution without prior
OTS approval. These provisions also prohibit, among other things, any director
or officer of a savings and loan holding company, or any individual who owns or
controls more than 25% of the voting shares of a savings and loan holding
company, from acquiring control of any savings association not a subsidiary of
the savings and loan holding company, unless the acquisition is approved by the
OTS. For additional restrictions on the acquisition of a unitary thrift holding
company, see "Financial Services Modernization Legislation." Certain
individuals, including Alan J. Hyatt, Louis Hyatt, and Melvin Hyatt, and their
respective spouses ("Applicants"), filed an Application for Notice of Change In
Control ("Notice") in April 2001 pursuant to 12CFR Section 574.3(b). The Notice
called for the Applicants to acquire up to 32.32% of the Company's issued and
outstanding shares of stock. The OTS approved the request and required that the
proposed acquisition be consummated by April 16, 2002. By letter dated January
27, 2003, the Applicants requested an extension of time to acquire up to 32.32%
of the Company's issued and outstanding shares which request was granted by the
OTS. The Applicants have until February 12, 2004 to acquire up to 32.32%
ownership of the Company's shares. The Applicants own 28.7% of the total
outstanding shares of the Company, at this time.
USA Patriot Act of 2001
On October 26, 2001, President Bush signed the USA Patriot Act of 2001.
The Patriot Act is intended is to strengthen U.S. law enforcement's and the
intelligence communities' abilities to work cohesively to combat terrorism on a
variety of fronts. The potential impact of the Act on financial institutions of
all kinds is significant and wide ranging. The Act contains sweeping anti-money
laundering and financial transparency laws and requires various regulations,
including:
o due diligence requirements for financial institutions that administer,
maintain, or manage private banks accounts or correspondent accounts for
non-US persons
o standards for verifying customer identification at account opening
o rules to promote cooperation among financial institutions, regulators, and
law enforcement entities in identifying parties that may be involved in
terrorism or money laundering
o reports by nonfinancial trades and businesses filed with the Treasury
Department's Financial Crimes Enforcement Network for transactions
exceeding $10,000, and
o filing of suspicious activities reports securities by brokers and dealers
if they believe a customer may be violating U.S. laws and regulations.
On July 23, 2002, the Treasury proposed regulations requiring
institutions to incorporate into their written money laundering plans, a board
approved customer identification program implementing reasonable procedures for:
o verifying the identity of any person seeking to open an account, to the
extent reasonable and practicable;
o maintaining records of the information used to verify the person's
identity; and
o determining whether the person appears on any list of known or suspected
terrorists or terrorist organizations.
Account is defined as a formal banking or business relationship
established to provide ongoing services, dealings, or other financial
transactions.
Financial Services Modernization Legislation
General. On November 12, 1999, President Clinton signed into law the
Gramm-Leach-Bliley Act of 1999 (the "GLB"). The general effect of the law is to
establish a comprehensive framework to permit affiliations among commercial
banks, insurance companies, securities firms, and other financial service
providers by revising and expanding the Bank Holding Company Act framework to
permit a holding company system to engage in a full range of financial
activities through a new entity known as a "Financial Holding Company."
"Financial activities" is broadly defined to include not only banking,
insurance, and securities activities, but also merchant banking and additional
activities that the Federal Reserve Board, in consultation with the Secretary of
the Treasury, determines to be financial in nature, incidental to such financial
activities, or complementary activities that do not pose a substantial risk to
the safety and soundness of depository institutions or the financial system
generally.
The GLB provides that no company may acquire control of an insured
savings association unless that company engages, and continues to engage, only
in the financial activities permissible for a Financial Holding Company, unless
grandfathered as a unitary savings and loan holding company. The GLB
grandfathers any company that was a unitary savings and loan holding company on
May 4, 1999 or became a unitary savings and loan holding company pursuant to an
application pending on that date. Such a company may continue to operate under
present law as long as the company continues to meet the two tests: it can
control only one savings institution, excluding supervisory acquisitions, and
each such institution must meet the QTL test. Such a grandfathered unitary
savings and loan holding company also must continue to control at least one
savings association, or a successor institution, that it controlled on May 4,
1999.
The GLB also permits national banks to engage in expanded activities
through the formation of financial subsidiaries. A national bank may have a
subsidiary engaged in any activity authorized for national banks directly or any
financial activity, except for insurance underwriting, insurance investments,
real estate investment or development, or merchant banking, which may only be
conducted through a subsidiary of a Financial Holding Company. Financial
activities include all activities permitted under new sections of the Bank
Holding Company Act or permitted by regulation.
While the GLB has not had a material adverse effect on the operations
of Bancorp and the Bank in the near-term, to the extent that the act permits
banks, securities firms, and insurance companies to affiliate, the financial
services industry may experience further consolidation. The GLB is intended to
grant to community banks certain powers as a matter of right that larger
institutions have accumulated on an ad hoc basis and which unitary savings and
loan holding companies already possess. Nevertheless, this act may have the
result of increasing the amount of competition that Bancorp and the Bank face
from larger institutions and other types of companies offering financial
products, many of which may have substantially more financial resources than
Bancorp and the Bank. In addition, because Bancorp may only be acquired by other
unitary savings and loan holding companies or Financial Holding Companies, the
legislation may have an anti-takeover effect by limiting the number of potential
acquirors or by increasing the costs of an acquisition transaction by a bank
holding company that has not made the election to be a Financial Holding Company
under the new legislation.
Privacy. Under the GLB, federal banking regulators adopted rules that
limit the ability of banks and other financial institutions to disclose
non-public information about consumers to nonaffiliated third parties. Pursuant
to these rules, financial institutions must provide:
o initial notices to customers about their privacy policies, describing the
conditions under which they may disclose nonpublic personal information to
nonaffiliated third parties and affiliates;
o annual notices of their privacy policies to current customers; and
o a reasonable method for customers to "opt out" of disclosures to
nonaffiliated third parties.
These privacy provisions affect how consumer information is transmitted
through diversified financial companies and conveyed to outside vendors. Since
FSMA's enactment, a number of states have implemented their own versions of
privacy laws. The Bank has implemented its privacy policies in accordance with
the law.
Regulation of the Bank
General. As a federally chartered, SAIF-insured savings association,
the Bank is subject to extensive regulation by the OTS and the Federal Deposit
Insurance Corporation ("FDIC"). Lending activities and other investments of the
Bank must comply with various statutory and regulatory requirements. The Bank is
also subject to certain reserve requirements promulgated by the Board of
Governors of the Federal Reserve System ("Federal Reserve Board").
The OTS, in conjunction with the FDIC, regularly examines the Bank and
prepares reports for the consideration of the Bank's Board of Directors on any
deficiencies found in the operations of the Bank. The relationship between the
Bank and depositors and borrowers is also regulated by federal and state laws,
especially in such matters as the ownership of savings accounts and the form and
content of mortgage documents utilized by the Bank.
The Bank must file reports with the OTS and the FDIC concerning its
activities and financial condition, in addition to obtaining regulatory
approvals prior to entering into certain transactions such as mergers with or
acquisitions of other financial institutions. This regulation and supervision
establishes a comprehensive framework of activities in which an institution can
engage and is intended primarily for the protection of the SAIF and depositors.
The regulatory structure also gives the regulatory authorities extensive
discretion in connection with their supervisory and enforcement activities and
examination policies, including policies with respect to the classification of
assets and the establishment of adequate loan loss reserves for regulatory
purposes. Any change in such regulations, whether by the OTS, the FDIC, or the
Congress could have a material adverse impact on Bancorp, the Bank, and their
operations.
Insurance of Deposit Accounts. The SAIF, as administered by the FDIC, insures
the Bank's deposit accounts up to the maximum amount permitted by law. The FDIC
may terminate insurance of deposits upon a finding that the institution: o has
engaged in unsafe or unsound practices; o is in an unsafe or unsound condition
to continue operations; or o has violated any applicable law, regulation, rule,
order or condition imposed by the FDIC or the institution's primary
regulator.
The FDIC charges an annual assessment for the insurance of deposits based
on the risk a particular institution poses to its deposit insurance fund. Under
this system as of June 30, 2002, SAIF members pay within a range of 0 cents to
27 cents per $100 of domestic deposits, depending upon the institution's risk
classification. This risk classification is based on an institution's capital
group and supervisory subgroup assignment. In addition, all FDIC-insured
institutions were required to pay assessments to the FDIC at an annual rate for
the fourth quarter of 2002 at approximately $0.0170 per $100 of assessable
deposits to fund interest payments on bonds issued by the Financing Corporation
("FICO"), an agency of the Federal government established to recapitalize the
predecessor to the SAIF. These assessments will continue until the FICO bonds
mature in 2017.
Regulatory Capital Requirements. OTS capital regulations require
savings associations to meet three capital standards:
o tangible capital equal to 1.5% of total adjusted assets,
o leverage capital (core capital) equal to 3% of total adjusted assets, and
o risk-based capital equal to 8.0% of total risk-based assets.
The Bank must meet each of these standards in order to be deemed in
compliance with OTS capital requirements. In addition, the OTS may require a
savings association to maintain capital above the minimum capital levels.
These capital requirements are viewed as minimum standards by the OTS,
and most institutions are expected to maintain capital levels well above the
minimum. In addition, the OTS regulations provide that minimum capital levels
higher than those provided in the regulations may be established by the OTS for
individual savings associations, upon a determination that the savings
association's capital is or may become inadequate in view of its circumstances.
The OTS regulations provide that higher individual minimum regulatory capital
requirements may be appropriate in circumstances where, among others:
o a savings association has a high degree of exposure to interest rate
risk, prepayment risk, credit risk, concentration of credit risk,
certain risks arising from nontraditional activities, or similar risks
or a high proportion of off-balance sheet risk;
o a savings association is growing, either internally or through
acquisitions, at such a rate that supervisory problems are presented
that are not dealt with adequately by OTS regulations; and
o a savings association may be adversely affected by activities or
condition of its holding company, affiliates, subsidiaries, or other
persons, or savings associations with which it has significant business
relationships.
The Bank is not subject to any such individual minimum regulatory
capital requirement.
As shown below, the Bank's regulatory capital exceeded all minimum
regulatory capital requirements applicable to it as of December 31, 2002.
To Be Well
Capitalized Under
For Capital Prompt Corrective
Actual Adequacy Purposes Action Provisions
Amount % Amount % Amount %
December 31, 2002
Tangible (1) $39,898,384 8.8% $ 6,837,788 1.50% N/A N/A
Tier I capital (2) 39,893,384 12.1% N/A N/A $19,768,800 6.00%
Core (1) 39,893,384 8.8% 18,234,100 4.00% 22,792,625 5.00%
Risk-weighted (2) 43,781,865 13.3% 26,358,400 8.00% 32,948,000 10.00%
December 31, 2001
Tangible (1) $31,675,573 8.7% $ 5,468,226 1.50% N/A N/A
Tier I capital (2) 31,675,573 11.8% N/A N/A $16,066,080 6.00%
Core (1) 31,675,573 8.7% 14,581,936 4.00% 18,227,420 5.00%
Risk-weighted (2) 34,926,828 13.0% 21,421,440 8.00% 26,776,800 10.00%
- ------------
(1) To adjusted total assets.
(2) To risk-weighted assets.
The Home Owners' Loan Act ("HOLA") permits savings associations not in
compliance with the OTS capital standards to seek an exemption from certain
penalties or sanctions for noncompliance. Such an exemption will be granted only
if certain strict requirements are met, and must be denied under certain
circumstances. If an exemption is granted by the OTS, the savings association
still may be subject to enforcement actions for other violations of law or
unsafe or unsound practices or conditions.
Predatory Lending. The term "predatory lending," much like the terms
"safety and soundness" and "unfair and deceptive practices," is far-reaching and
covers a potentially broad range of behavior. As such, it does not lend itself
to a concise or a comprehensive definition. But typically predatory lending
involves at least one, and perhaps all three, of the following elements:
o making unaffordable loans based on the assets of the borrower rather than
on the borrower's ability to repay an obligation ("asset-based lending")
o inducing a borrower to refinance a loan repeatedly in order to charge high
points and fees each time the loan is refinanced ("loan flipping")
o engaging in fraud or deception to conceal the true nature of the loan
obligation from an unsuspecting or unsophisticated borrower.
On October 1, 2002, FRB regulations aimed at curbing such lending
became effective. The rule significantly widens the pool of high-cost
home-secured loans covered by the Home Ownership and Equity Protection Act of
1994, a federal law that requires extra disclosures and consumer protections to
borrowers. The following triggers coverage under the act:
o interest rates for first lien mortgage loans in excess of 8 percentage
points above comparable Treasury securities,
o subordinate-lien loans of 10 percentage points above Treasury securities.
and
o fees such as optional insurance and similar debt protection costs paid in
connection with the credit transaction, when combined with points and fees
if deemed excessive.
In addition, the regulation bars loan flipping by the same lender or
loan servicer within a year. Lenders also will be presumed to have violated the
law -- which says loans shouldn't be made to people unable to repay them --
unless they document that the borrower has the ability to repay. Lenders that
violate the rules face cancellation of loans and penalties equal to the finance
charges paid.
The Bank is unable at this time to determine the impact of these rule
changes and potential state action in this area on its financial condition or
results of operation.
Prompt Corrective Action. The prompt corrective action regulation of
the OTS, requires certain mandatory actions and authorizes certain other
discretionary actions to be taken by the OTS against a savings association that
falls within certain undercapitalized capital categories specified in the
regulation.
The regulation establishes five categories of capital classification:
o "well capitalized;"
o "adequately capitalized;"
o "undercapitalized;"
o "significantly undercapitalized;" and
o "critically undercapitalized."
Under the regulation, the risk-based capital, leverage capital, and
tangible capital ratios are used to determine an institution's capital
classification. At December 31, 2002, the Bank met the capital requirements of a
"well capitalized" institution under applicable OTS regulations.
In general, the prompt corrective action regulation prohibits an
insured depository institution from declaring any dividends, making any other
capital distribution, or paying a management fee to a controlling person if,
following the distribution or payment, the institution would be within any of
the three undercapitalized categories. In addition, adequately capitalized
institutions may accept Brokered Deposits only with a waiver from the FDIC and
are subject to restrictions on the interest rates that can be paid on such
deposits. Undercapitalized institutions may not accept, renew, or roll-over
Brokered Deposits.
If the OTS determines that an institution is in an unsafe or unsound
condition, or if the institution is deemed to be engaging in an unsafe and
unsound practice, the OTS may, if the institution is well capitalized,
reclassify it as adequately capitalized; if the institution is adequately
capitalized but not well capitalized, require it to comply with restrictions
applicable to undercapitalized institutions; and, if the institution is
undercapitalized, require it to comply with certain restrictions applicable to
significantly undercapitalized institutions. Finally, pursuant to an interagency
agreement, the FDIC can examine any institution that has a substandard
regulatory examination score or is considered undercapitalized - without the
express permission of the institution's primary regulator.
Loans-to-One Borrower Limitations. Savings associations generally are
subject to the lending limits applicable to national banks. With certain limited
exceptions, the maximum amount that a savings association or a national bank may
lend to any borrower (including certain related entities of the borrower) at one
time may not exceed 15% of the unimpaired capital and surplus of the
institution, plus an additional 10% of unimpaired capital and surplus for loans
fully secured by readily marketable collateral. Savings associations are
additionally authorized to make loans to one borrower, for any purpose, in an
amount not to exceed $500,000 or, by order of the Director of OTS, in an amount
not to exceed the lesser of $30,000,000 or 30% of unimpaired capital and surplus
to develop residential housing, provided:
o the purchase price of each single-family dwelling in the development does
not exceed $500,000;
o the savings association is in compliance with its fully phased-in capital
requirements;
o the loans comply with applicable loan-to-value requirements; and
o the aggregate amount of loans made under this authority does not exceed
150% of unimpaired capital and surplus.
At December 31, 2002, the Bank's loans-to-one-borrower limit was
$6,567,000 based upon the 15% of unimpaired capital and surplus measurement. At
December 31, 2002, the Bank's largest single lending relationship had an
outstanding balance of $5,200,000, and consisted of a loan secured by two office
buildings in Reston, Virginia, and was performing in accordance with its terms.
Qualified Thrift Lender Test. Savings associations must meet a QTL
test, which test may be met either by maintaining a specified level of assets in
qualified thrift investments as specified in HOLA or by meeting the definition
of a "domestic building and loan association" the Code. Qualified thrift
investments are primarily residential mortgages and related investments,
including certain mortgage-related securities. The required percentage of
investments under HOLA is 65% of assets while the Code requires investments of
60% of assets. An association must be in compliance with the QTL test or the
definition of domestic building and loan association on a monthly basis in nine
out of every 12 months. Associations that fail to meet the QTL test will
generally be prohibited from engaging in any activity not permitted for both a
national bank and a savings association. As of December 31, 2002, the Bank was
in compliance with its QTL requirement and met the definition of a domestic
building and loan association.
Affiliate Transactions. Transactions between a savings association and
its "affiliates" are quantitatively and qualitatively restricted under the
Federal Reserve Act and regulations adopted by the Federal Reserve. Affiliates
of a savings association include, among other entities, the savings
association's holding company and companies that are under common control with
the savings association. In general, a savings association or its subsidiaries
are limited in their ability to engage in "covered transactions" with
affiliates:
o to an amount equal to 10% of the association's capital and surplus, in the
case of covered transactions with any one affiliate; and
o to an amount equal to 20% of the association's capital and surplus, in the
case of covered transactions with all affiliates.
In addition, a savings association and its subsidiaries may engage in
covered transactions and other specified transactions only on terms and under
circumstances that are substantially the same, or at least as favorable to the
savings association or its subsidiary, as those prevailing at the time for
comparable transactions with nonaffiliated companies. A "covered transaction"
includes: o a loan or extension of credit to an affiliate; o a purchase of
investment securities issued by an affiliate; o a purchase of assets from an
affiliate, with some exceptions; o the acceptance of securities issued by an
affiliate as collateral for a loan or extension of credit to any party; or o the
issuance of a guarantee, acceptance or letter of credit on behalf of an
affiliate.
In addition, under the OTS regulations:
o a savings association may not make a loan or extension of credit to an
affiliate unless the affiliate is engaged only in activities permissible
for bank holding companies;
o a savings association may not purchase or invest in securities of an
affiliate other than shares of a subsidiary;
o a savings association and its subsidiaries may not purchase a low-quality
asset from an affiliate;
o covered transactions and other specified transactions between a savings
association or its subsidiaries and an affiliate must be on terms and
conditions that are consistent with safe and sound banking practices; and
o with some exceptions, each loan or extension of credit by a savings
association to an affiliate must be secured by collateral with a market
value ranging from 100% to 130%, depending on the type of collateral, of
the amount of the loan or extension of credit.
Regulations generally exclude all non-bank and non-savings association
subsidiaries of savings associations from treatment as affiliates, except for:
o a financial subsidiary,
o a subsidiary controlled by one or more affiliates,
o an ESOP, or
o a subsidiary determined by the OTS or the Federal Reserve to be an
affiliate.
The regulations also require savings associations to make and retain
records that reflect affiliate transactions in reasonable detail and provides
that specified classes of savings associations may be required to give the OTS
prior notice of affiliate transactions.
Capital Distribution Limitations. OTS regulations impose limitations
upon all capital distributions by savings associations, like cash dividends,
payments to repurchase or otherwise acquire its shares, payments to shareholders
of another institution in a cash-out merger and other distributions charged
against capital. The OTS recently adopted an amendment to these capital
distribution limitations. Under the new rule, a savings association in some
circumstances may:
o be required to file an application and await approval from the OTS before
it makes a capital distribution;
o be required to file a notice 30 days before the capital distribution; or
o be permitted to make the capital distribution without notice or application
to the OTS.
The OTS regulations require a savings association to file an
application if:
o it is not eligible for expedited treatment of its other applications under
OTS regulations;
o the total amount of all of capital distributions, including the proposed
capital distribution, for the applicable calendar year exceeds its net
income for that year to date plus retained net income for the preceding two
years;
o it would not be at least adequately capitalized, under the prompt
corrective action regulations of the OTS following the distribution; or
o the association's proposed capital distribution would violate a prohibition
contained in any applicable statute, regulation, or agreement between the
savings association and the OTS, or the FDIC, or violate a condition
imposed on the savings association in an OTS-approved application or
notice.
In addition, a savings association must give the OTS notice of a
capital distribution if the savings association is not required to file an
application, but:
o would not be well capitalized under the prompt corrective action
regulations of the OTS following the distribution;
o the proposed capital distribution would reduce the amount of or retire any
part of the savings association's common or preferred stock or retire any
part of debt instruments like notes or debentures included in capital,
other than regular payments required under a debt instrument approved by
the OTS; or
o the savings association is a subsidiary of a savings and loan holding
company.
If neither the savings association nor the proposed capital
distribution meets any of the above listed criteria, the OTS does not require
the savings association to submit an application or give notice when making the
proposed capital distribution. The OTS may prohibit a proposed capital
distribution that would otherwise be permitted if the OTS determines that the
distribution would constitute an unsafe or unsound practice.
Community Reinvestment Act and the Fair Lending Laws. Savings
associations have a responsibility under the Community Reinvestment Act and
related regulations of the OTS to help meet the credit needs of their
communities, including low- and moderate-income neighborhoods. In addition, the
Equal Credit Opportunity Act and the Fair Housing Act prohibit lenders from
discriminating in their lending practices on the basis of characteristics
specified in those statutes. An institution's failure to comply with the
provisions of the Community Reinvestment Act could, at a minimum, result in
regulatory restrictions on its activities and the denial of applications. In
addition, an institution's failure to comply with the Equal Credit Opportunity
Act and the Fair Housing Act could result in the OTS, other federal regulatory
agencies as well as the Department of Justice taking enforcement actions. Based
on an examination conducted November 24, 1997, the Bank received an outstanding
rating.
Effective January 1, 2002, the OTS raised the dollar amount limit in
the definition of small business loans from $500,000 to $2.0 million, if used
for commercial, corporate, business or agricultural purposes. Furthermore, the
rule raises the aggregate level that a thrift can invest directly in community
development funds, community centers and economic development initiatives in its
communities from the greater of a quarter of one percent of total capital or
$100,000 to one percent of total capital or $250,000.
Federal Home Loan Bank System. The Bank is a member of the FHLB system.
Among other benefits, each FHLB serves as a reserve or central bank for its
members within its assigned region. Each FHLB is financed primarily from the
sale of consolidated obligations of the FHLB system. Each FHLB makes available
loans or advances to its members in compliance with the policies and procedures
established by the Board of Directors of the individual FHLB. As an FHLB member,
the Bank is required to own capital stock in an FHLB in an amount equal to the
greater of:
o 1% of its aggregate outstanding principal amount of its residential
mortgage loans, home purchase contracts and similar obligations at the
beginning of each calendar year; or
o 5% of its FHLB advances or borrowings.
At December 31, 2002, the Bank was in compliance with this requirement.
The GLB Act made significant reforms to the FHLB system, including:
o Expanded Membership - (i) expands the uses for, and types of, collateral
for advances; (ii) eliminates bias toward QTL lenders; and (iii) removes
capital limits on advances using real estate related collateral (e.g.,
commercial real estate and home equity loans).
o New Capital Structure - each FHLB is allowed to establish two classes of
stock: Class A is redeemable within six months of notice; and Class B is
redeemable within five years notice. Class B is valued at 1.5 times the
value of Class A stock. Each FHLB will be required to maintain minimum
capital equal to 5% of equity. As of July 17, 2002, each FHLB, including
our FHLB of Atlanta, received Federal Housing Finance Board approval of its
capital plan. These plans must be implemented by July 1, 2004.
o Voluntary Membership - federally chartered savings associations, such as
the Bank, are no longer required to be members of the system.
o REFCorp Payments - changes the amount paid by the system on debt incurred
in connection with the thrift crisis in the late 1980s from a fixed amount
to 20% of net earnings after deducting certain expenses.
Federal Reserve System. The Federal Reserve Board requires all
depository institutions to maintain non-interest bearing reserves at specified
levels against their transaction accounts (primarily checking, NOW, and Super
NOW checking accounts) and non-personal time deposits. At December 31, 2002, the
Bank was in compliance with these requirements.
Activities of Subsidiaries. A savings association seeking to establish
a new subsidiary, acquire control of an existing company or conduct a new
activity through a subsidiary must provide 30 days prior notice to the FDIC and
the OTS and conduct any activities of the subsidiary in compliance with
regulations and orders of the OTS. The OTS has the power to require a savings
association to divest any subsidiary or terminate any activity conducted by a
subsidiary that the OTS determines to pose a serious threat to the financial
safety, soundness or stability of the savings association or to be otherwise
inconsistent with sound banking practices.
Item 2. Properties
Bancorp owns its retail branch locations at 1917 West Street,
Annapolis, Maryland 21401 and 413 Crain Highway, South-East, Glen Burnie,
Maryland 21061. The Bank's executive office at 1919A West Street, Annapolis,
Maryland 21401 (which also serves as a loan production office) is leased from
HRE, a wholly owned subsidiary of Bancorp. HRE owns its office building at 1919
West Street, Annapolis, Maryland 21401.
The Bank leases space for its accounting and loan servicing offices
from a third party at 1927 West Street, Annapolis, Maryland 21401. Homeowner's
Title, a subsidiary of the Bank, leases space at 1923 West Street, Annapolis,
Maryland 21401 from a corporation of which Alan J. Hyatt, Bancorp's Chairman and
Chief Executive Officer, is a principal, on a month-to-month basis. Current
monthly rental paid by Homeowner's Title is $2,254.60.
Item 3. Legal Proceedings
There are no material pending legal proceedings to which Bancorp, the
Bank or any subsidiary is a party or to which any of their property is subject.
Item 4. Submission of Matters to a Vote of Security Holders
None.
PART II
Item 5. Market for Registrant's Common Equity and Related Stockholder Matters
Quarterly Stock Information*
2002 2001
--------------------------- --------------------------
Quarter Stock Price Per Share Quarter Stock Price Per Share
Range Dividend Range Dividend
Low High Low High
1st $ 8.67 $ 11 $.06 1st $ 6.5 $ 8 $.046
2nd 9.75 17 .06 2nd 7.33 8 .046
3rd 14.64 16.97 .06 3rd 6.16 7.83 .046
4th 14.75 16.15 .06 4th 7 9 .046
*Adjusted to give retroactive effect to a 3 for 1 stock split declared
February 19, 2002.
Common shares of Bancorp are traded on the National Association of
Security Dealers Small Cap Market under the symbol "SVBI".
Registrar and Transfer Company, 10 Commerce Drive, Cranford, New Jersey
07016-3572, serves as the Transfer Agent and Registrar for Bancorp.
Equity Compensation Plan Table. See Part III, Item 11.
Item 6. Selected Financial Data
The following financial information is presented from the audited financial
statements of Bancorp. The information is a summary and should be read in
conjunction with management's Discussions and Analysis of Financial Condition
and Results of Operations.
Summary Financial and Other Data
at December 31,
2002 2001 2000 1999 1998
---- ---- ---- ---- ----
(dollars in thousands, except per share information)
Balance Sheet Data
Total assets $ 458,415 $ 366,890 $ 293,230 $ 233,724 $ 220,417
Cash and cash equivalents 18,660 6,038 1,007 2,430 12,896
Total loans, net 418,825 342,641 274,652 214,066 192,572
Securities available for sale - - 858 812 891
Mortgage backed securities and securities
held to maturity 9,661 7,213 9,779 10,326 8,455
Nonperforming loans 1,758 2,101 1,178 925 2,741
Real estate acquired through
foreclosure 224 312 312 672 104
Total nonperforming assets 1,982 2,413 1,490 1,597 2,845
Deposits 377,925 286,918 229,312 186,204 175,341
Short-term borrowings - 17,000 18,000 2,000 6,000
Notes payable 34,000 25,000 16,000 22,000 18,000
Total liabilities 415,233 332,059 268,009 211,743 200,849
Stockholders equity 43,181 34,831 25,221 21,981 19,567
Common shares outstanding * 4,142,592 4,057,092 3,239,316 3,234,492 3,229,086
Book value per common shares * 9.46 7.60 6.58 5.59 4.85
Other Data:
Number of:
Full service retail banking
facilities 2 2 2 2 2
Full-time equivalent employees 69 67 66 63 63
* Retroactively adjusted to reflect three-for-one stock split declared February
19, 2002.
Summary of Operations
For the Year Ended December 31,
2002 2001 2000 1999 1998
---- ---- ---- ---- ----
(dollars in thousands, except per share data)
Interest and dividend income 33,402 29,489 24,271 20,047 17,927
Interest expense
13,799 16,094 13,387 10,523 9,399
----------------------------------------------------------------
Net interest income
19,603 13,395 10,884 9,524 8,528
Provision for loan losses
670 708 591 504 552
----------------------------------------------------------------
Net interest income after provision for loan
losses 18,933 12,687 10,293 9,020 7,976
Noninterest income
4,133 2,570 1,439 1,586 1,607
Noninterest expense
8,447 6,588 5,348 5,477 5,433
----------------------------------------------------------------
Earnings before income tax provision
14,619 8,669 6,384 5,129 4,150
Provision for income taxes
5,671 3,413 2,439 2,002 1,612
----------------------------------------------------------------
Net income
8,948 5,256 3,945 3,127 2,538
================================================================
Per Share Data:
Basic earnings per share *
2.13 1.38 1.15 0.90 0.72
Diluted earnings per share *
2.13 1.37 1.12 0.84 0.70
Weighted number of shares
outstanding basic * 4,092,188 3,647,451 3,237,888 3,230,940 3,226,545
Weighted number of shares
outstanding diluted* 4,103,223 3,683,346 3,330,915 3,450,831 3,316,992
* Retroactively adjusted to reflect three-for-one stock split declared February
19, 2002.
Key Operating Ratios
For the Year Ended December 31,
2002 2001 2000 1999 1998
---- ---- ---- ---- ----
(dollars in thousands)
Performance Ratios:
Return on average assets 2.14% 1.55% 1.47% 1.38% 1.30%
Return on average equity 22.96% 17.55% 16.73% 14.91% 13.69%
Net interest margin 4.86% 4.05% 4.17% 4.34% 4.50%
Interest rate spread 4.59% 3.65% 3.75% 3.94% 4.09%
Noninterest expense to average assets 2.02% 1.95% 2.00% 2.43% 2.78%
Efficiency ratio 35.59% 41.27% 43.40% 49.30% 53.61%
Asset Quality Ratios:
Equity to Assets 9.42% 9.49% 8.60% 9.40% 8.88%
Nonperforming assets to total assets
at end of period 0.43% 0.66% 0.51% 0.68% 1.29%
Nonperforming loans to total gross
loans at end of period 0.36% 0.51% 0.36% 0.36% 1.21%
Allowance for loan losses to total
gross loans at end of period 0.81% 0.82% 0.83% 0.84% 0.87%
Allowance for loan losses to
nonperforming loans at end of period 227.02% 159.59% 231.58% 232.11% 72.38%
Mortgage Origination and Servicing Data:
Mortgage loans originated or purchased 343,787 342,915 213,614 180,782 177,979
Mortgage loans sold 100,535 60,302 36,869 37,706 44,211
Mortgage loans serviced for others 23,935 17,376 21,648 23,186 23,425
Capitalized value of mortgage
servicing rights 19 26 33 39 49
Average Balance Sheet
Average Balance Sheet. The following table contains for the periods indicated
information regarding the total dollar amounts of interest income from
interest-earning assets and the resulting average yields, the total dollar
amount of interest expense on interest-bearing liabilities and the resulting
average costs, net interest income, and the net yield on interest-earning
assets.
Years Ended December 31,
------------------------------------------------------------------------------------------------------------
--------------------------------------------------------------------------------------------------------
2002 2001 2000
--------------------------------------------------------------------------------------------------------------
Average Average Average
Volume Interest Yield/Cost Volume Interest Yield/Cost Volume Interest Yield/Cost
------ -------- ---------- ------ -------- ---------- ------ -------- ----------
(dollars in thousands)
ASSETS
Loans (1) $ 384,537 $ 32,723 8.51% $ 313,798 $ 28,617 9.12% $ 246,631 $ 23,320 9.46%
Investments (2) 7,339 362 4.93% 7,671 450 5.86% 10,879 651 5.98%
Mortgage-backed
securities 1,346 54 4.00% 255 18 7.09% 299 21 7.06%
Other interest-
earning assets (3) 10,123 263 2.60% 8,773 404 4.60% 3,427 279 8.13%
-------------------------------------------------------------------------------------------------------------
Total interest-
earning assets 403,345 33,402 8.28% 330,497 29,489 8.92% 261,236 24,271 9.29%
Non-interest earning
assets 13,979 7,800 6,651
--------------- --------------- ---------------
Total Assets $ 417,324 $ 338,297 $ 267,887
=============== =============== ===============
LIABILITIES AND
STOCKHOLDERS' EQUITY
Savings and checking
deposits $ 138,961 3,485 2.51% 69,846 2,422 3.47% $ 49,694 $ 2,309 4.65%
Certificates of
deposits 198,613 8,815 4.44% 190,391 11,170 5.87% 159,482 9,158 5.74%
Borrowings 36,500 1,499 4.11% 45,250 2,502 5.53% 32,667 1,920 5.88%
-------------------------------------------------------------------------------------------------------------
Total interest-
bearing liabilities 374,074 13,799 3.69% 305,487 16,094 5.27% 241,843 13,387 5.54%
Non-interest bearing
liabilities 4,271 2,866 2,463
Stockholders' equity 38,979 29,944 23,581
--------------- --------------- ---------------
Total liabilities and
stockholders'
equity $ 417,324 $338,297 $ 267,887
=============== =============== ===============
Net interest income
and Interest
rate spread $ 19,603 4.59% $ 13,395 3.65% $10,884 3.75%
======== =========== =======
Net interest margin 4.86% 4.05% 4.17%
Average interest-
earning assets
to average
interest-bearing
liabilities 107.82% 108.19% 108.02%
(1) Non-accrual loans are included in the average balances and in the
computation of yields.
(2) The Company does not have any tax exempt securities.
(3) Other interest earning assets includes interest bearing deposits in other
banks, federal funds, and FHLB stock investments.
Rate Volume Table
Year ended December 31, 2002 Year ended December 31, 2001
vs. vs.
Year ended December 31, 2001 Year ended December 31, 2000
---------------------------------- -----------------------------------
Total Changes Due to Total Changes Due to
----------------------- -----------------------
Change Volume (1) Rate (1) Change Volume (1) Rate (1)
------ ---------- -------- ------ ---------- --------
(dollars in thousands)
Interest-earning assets
Loans $ 4,106 $ 6,128 $ (2,022) $ 5,297 $ 6,162 $ (865)
Investments (88) (18) (70) (201) (188) (13)
Mortgage-backed securities 36 46 (10) (3) (3) -
Other interest-earning assets (141) 55 (196) 125 287 (162)
---------------------------------- -----------------------------------
Total interest income $ 3,913 $ 6,211 $ (2,298) $ 5,218 $ 6,258 $ (1,040)
Interest-bearing liabilities
Savings and checking deposits $ 1,063 $ 1,867 $ (804) $ 113 $ 791 $ (678)
Certificates of deposits (2,355) 463 (2,818) 2,012 1,803 209
Borrowings (1,003) (434) (569) 582 701 (119)
---------------------------------- -----------------------------------
Total interest expense $ (2,295) $ 1,896 $ (4,191) $ 2,707 $ 3,295 $ (588)
---------------------------------- -----------------------------------
Net change in interest income $ 6,208 $ 4,315 $ 1,893 $ 2,511 $ 2,963 $ (452)
================================== ===================================
(1) Changes in interest income/expense not arising from volume or rate variances
are allocated proportionately to rate and volume.
Item 7. Management's Discussion and Analysis of Financial Condition and Results
of Operations
Financial Condition
At December 31, 2002 total assets were $458,415,000 compared to
$366,890,000 at December 31, 2001, which represents an increase of $91,525,000
or 24.9%. The following is a discussion of the significant fluctuations between
the December 31, 2002 and 2001 balance sheets.
Loans
Loans Held For Sale. At December 31, 2002 loans held for sale was
$17,481,000 compared to $7,499,000 at December 31, 2001. This increase of
$9,982,000 or 133% was caused by an a growth in the loan portfolio that was
intended to be sold to investors due to the high volume of mortgage loans the
Bank has been originating. Historically low interest rates have resulted in
significant loan production by the Bank.
Loans Receivable. Total net portfolio loans were $401,343,000 at
December 31, 2002, an increase of $66,201,000 or 19.8% from $335,142,000 at
December 31, 2001. The increase in portfolio loans resulted from increases in
loan demand, resulting from historically low interest rates, including permanent
residential mortgage loans, residential construction mortgages and commercial
mortgages.
Federal Home Loan Bank of Atlanta Stock. Total Federal Home Loan Bank
of Atlanta stock owned by Bancorp at December 31, 2002 was $1,900,000, which is
$600,000 less, or 24% less, than the $2,500,000 of Federal Home Loan Bank of
Atlanta stock owned as of December 31, 2001. This reduction in Federal Home Loan
Bank of Atlanta stock is a result of the reduction in the amount of Federal Home
Loan Bank advances that the Bank had outstanding as of December 31, 2002
compared to December 31, 2001, as the Bank is obligated to purchase Federal Home
Loan Bank stock based upon the amount outstanding in advances at any given time.
Premises and Equipment. Premises and equipment totaled $4,738,000 at
December 31, 2002 compared to $4,642,000 at December 31, 2001. Although there
was no material change in premises and equipment between December 31, 2002 and
December 31, 2001, it is anticipated that premises and equipment will continue
to increase beginning in 2003 as a result of the intention of HS West, LLC, a
subsidiary of the Bank, to undertake the commencement of construction of an
office building for use by Bancorp and its subsidiaries at West Gate Circle in
Annapolis, Maryland.
Liabilities
Deposits. Total deposits were $377,925,000 at December 31, 2002
compared to $286,918,000 at December 31, 2001. This represents an increase of
$91,007,000 or 31.7%. The increase in deposits was used to fund loan growth. The
Bank engaged in a strategy to increase its money market accounts, which
increased $71,008,000 to $132,767,000 at December 31, 2002, representing an
increase of 115%. The increase was a result of the continued implementation of a
plan by the Bank to offer attractive rates on its short-term deposits as a match
to its short-term assets, which are primarily in construction mortgage loans.
FHLB Advances. FHLB advances were $34,000,000 at December 31, 2002
compared to $42,000,000 at December 31, 2001. This decrease of $8,000,000, or
19%, was due to the emphasis on the Bank to rely upon retail deposits to support
the growth of its loan portfolio.
Stockholders' Equity. Total stockholders' equity was $43,181,000 as of
December 31, 2002, which compared to $34,831,000 as of December 31, 2001. This
is an increase of $8,350,000 or 24%. The increase in stockholders' equity
resulted primarily from net income.
Comparison of Results of Operation for the Years Ended December 31, 2002 and
2001.
General. Bancorp's net income for the year ended December 31, 2002 was
$8,948,000 or $2.13 per share, diluted, compared to $5,256,000 or $1.37 per
share, diluted, for the year ended December 31, 2001. This increase of
$3,692,000 or 70% was primarily the result of increases in loan origination
volume and the increase in interest income coupled with a reduction in the cost
of deposits and the maintenance of relatively low non-interest expenses.
Net Interest Income. Net interest income (interest earned net of
interest charges) totaled $19,603,000 for the year ended December 31, 2002, as
compared to $13,395,000 for the year ended December 31, 2001, or an increase of
$6,208,000 or 46.3%. The change was due to the growth in the loan portfolio and
the reduction on the interest on deposits. The net interest margin increased to
4.86% at December 31, 2002 from 4.05% at December 31, 2001. The Bank's net
interest margin increased over the past year because interest rates paid on the
Bank's deposits have fallen faster than the interest rates earned on the Bank's
assets. This is due to the historically low interest rate environment. The cost
of the Bank's liabilities have gone down as a result of the historically low
interest rates and because of the less expensive costs of money market deposits
which the Bank has continued to promote.
Provision for Loan Losses. Bancorp's loan portfolio is subject to
varying degrees of credit risk and an allowance for loan losses is maintained to
absorb losses inherent in its loan portfolio. Credit risk includes, but is not
limited to, the potential for borrower default and the failure of collateral to
be worth what Bancorp determined it was worth at the time of the granting of the
loan. The Bank monitors its loan portfolio at least as often as quarterly and
its loan delinquencies at least as often as monthly. All loans that are
delinquent and all loans within the various categories of the Bank's portfolio
as a group are tabulated. The Bank's Board, with the advice and recommendation
of the Bank's delinquency committee, estimates an allowance to be set aside for
loan losses. Included in determining the calculation are such factors as the
inherent risk contained within the portfolio after considering the state of the
general economy, economic trends, consideration of particular risks inherent in
different kinds of lending and consideration of known information that may
affect loan collectibility. An increase in the loan loss provision from the
beginning of the period to the end of a period would have come about after an
analysis of the aforementioned factors and applying that rationale to the total
portfolio.
The greater the construction, commercial and higher loan-to-value loans
that are contained in the portfolio, the greater will be the allowance for loan
losses. Changes in estimation methods may take place based upon the status of
the economy and the estimate of the value of collateral and, as a result, the
allowance may increase or decrease. The Bank believes that some portions of its
loan portfolio have greater actual risk and, in other areas, there is greater
inherent risk. The loan loss allowance has increased when the Board believes
trends are negative and contributions to the allowance have decreased when
trends are more positive. Management believes that the allowance for loan losses
is adequate.
As of December 31, 2002, the total allowance for loan losses was
$3,991,000 as compared to $3,353,000 as of December 31, 2001, which is an
increase of $638,000 or 19%, as a result of the current year's provision reduced
slightly by a minimal amount of charge offs incurred. During the year ended
December 31, 2002, the provision for loan losses was $670,000 compared to
$709,000 for the year ended December 31, 2001. This reduction of $39,000 or
5.5%, was a result of Management's determination that the provision for loan
losses was, more or less, appropriate for the level of inherent risk in its
portfolio as compared to the year ended December 31, 2001.
Other Income and Non Interest Expense. Gain on sale of loans was
$1,264,000 for the year ended December 31, 2002 compared to $983,000 for the
year ended December 31, 2001. This increase of $281,000, or 28.6%, was a result
of an increasing volume of loan originations due to the continued low interest
rate environment that resulted in the continuing refinance of residential
mortgages. If interest rates increase in the future, it is likely that loan
originations will decrease, which will further result in a reduction on the gain
of the sale of loans. There is the potential that loan originations may decrease
as a result of competition, increases in interest rates or a loss of the Bank's
experienced personnel in loan origination. If there is a reduction in loan
originations, that will also cause a reduction in mortgage processing fees.
Real estate commissions and real estate management fees for the year
ended December 31, 2002 were $1,237,000 and $383,000, respectively, as compared
to December 31, 2001 when real estate commissions and real estate management
fees were $499,000 and $213,000, respectively. These increases aggregating
$908,000 or 128%, resulted in the fact that Bancorp acquired Hyatt Real Estate
in June 2001, so only one half of the year's commissions and fees were earned as
a subsidiary of Bancorp in 2001. Hyatt Real Estate was a wholly owned subsidiary
of Bancorp for all of 2002. There is no assurance that such commissions and fees
will continue to be generated in the future.
Mortgage processing and servicing fees for the year ended December 31,
2002 were $724,000 compared to $607,000 for the year ended December 31, 2001.
This increase of $117,000 or 19.3% was a result of a growth in the loan
portfolio.
Compensation and related expenses totaled $6,065,000 for the year ended
December 31, 2002 compared to $4,572,000 for the year ended December 31, 2001,
or an increase of 32.7%. The increase during 2002 was primarily attributable to
the increase in operations in staffing as well as compensation levels at the
Bank generated by a growth in the loan portfolio, and increases in commissions
at Hyatt Real Estate.
Other non-interest expense totaled $1,883,000 for the year ended
December 31, 2002 compared to $1,520,000 for the year ended December 31, 2001 or
an increase of $363,000 or 23.9%. Other non-interest expense consists primarily
of office and computer supplies, mail expenses, telephone and other expenses.
The increase in these expenses during 2002 was also attributable to the increase
in operations caused by a growth in the loan portfolio and expenses related to
the registration of Bancorp's shares with the Securities and Exchange
Commission.
Income taxes for the year ended December 31, 2002 were $5,671,000
compared to $3,413,000 for the year ended December 31, 2001. This increase of
$2,258,000 or 66.2% was a result of an increase in income before income tax
provision to $14,619,000 for the year ended December 31, 2002 compared to
$8,669,000 for the year ended December 31, 2001, being an increase of $5,950,000
or 68.6%. The effective tax rate for the years ended December 31, 2002 and 2001
were 38.79% and 39.37% respectively.
Liquidity and Capital Resources. Bancorp's liquidity is determined by
its ability to raise funds through loan payments, maturing investments,
deposits, borrowed funds, capital, or the sale of loans. Based on the internal
and external sources available, Bancorp's liquidity position exceeded
anticipated short-term and long-term needs at December 31, 2002. Core deposits,
considered to be stable funding sources and defined to include all deposits
except time deposits of $100,000 or more, equaled 87% of total deposits at
December 31, 2002. The Bank's experience is that a substantial portion of
certificates of deposit will renew at time of maturity and will remain on
deposit with the bank. Additionally, loan payments, maturities, deposit growth
and earnings contribute a flow of funds available to meet liquidity
requirements.
In addition to its ability to generate deposits, Bancorp has external
sources of funds which may be drawn upon, when desired. The primary source of
external liquidity is an available line of credit equal to 25% of the Bank's
assets with the Federal Home Loan Bank of Atlanta. The available line of credit
with the Federal Home Loan Bank of Atlanta was $114,000,000 at December 31,
2002, of which $34,000,000 was outstanding at that time.
In assessing its liquidity the management of Bancorp considers
operating requirements, anticipated deposit flows, expected funding of loans,
deposit maturities and borrowing availability, so that sufficient funds may be
available on short notice to meet obligations as they arise so that Bancorp may
take advantage of business opportunities. As of December 31, 2002 Bancorp had
$24,771,785 outstanding in loan commitments, which Bancorp expects to fund from
the sources of liquidity described above. This amount does not include
undisbursed lines of credit, home equity loans and standby letters of credit, in
the aggregate amount of $37,076,245, which Bancorp anticipates it will be able
to fund, if required, from these liquidity sources in the regular course of
business.
In addition to the foregoing, the payment of dividends is a use of cash
and the proceeds from the exercise of stock options and warrants is a source of
cash. Neither of these is expected to have a material effect on liquidity.
Comparison of Operating Results for the Years Ended December 31, 2001
and 2000
General.
Bancorp's net income for the year ended December 31, 2001 was
$5,256,000 or $1.37 per share, diluted, compared to $3,945,000 or $1.12 per
share, diluted, for the year ended December 31, 2000. The increase of $1,311,000
or 33.2% was primarily the result of increases in loan origination volume and
the increase in interest income.
Net Interest Income
Net interest income (interest earned net of interest charges) totaled
$13,395,000 for the year ended December 31, 2001, as compared to $10,884,000 for
the year ended December 31, 2000, or an increase of $2,511,000 or 23%. The
change was primarily due to growth in the loan portfolio. The net interest
margin decreased to 4.05% at December 31, 2001 from 4.17% at December 31, 2000.
The Bank's net interest margin has decreased slightly over the last three years
because interest rates earned on the Bank's assets have fallen faster than its
cost of funds. This is due, in part, to the need for the Bank to offer
competitive rates on its loan products. The Bank's liabilities have re-priced
less quickly then its assets because during this period there have been large
amounts of refinancings while the Bank has relied upon fixed term certificates
of deposit to fund its lending activities. The net interest margin has increased
since the end of 2001.
Provision for Loan Losses
Bancorp's loan portfolio is subject to varying degrees of credit risk
and an allowance for loan losses is maintained to absorb losses inherent in its
loan portfolio. Credit risk includes, but is not limited to, the potential for
borrower default and the failure of collateral to be worth what Bancorp
determined it was worth at the time of the granting of the loan. The Bank
monitors its loan portfolio at least as often as quarterly and its loan
delinquencies at least as often as monthly. All loans that are delinquent and
all loans within the various categories of the Bank's portfolio as a group are
tabulated. The Bank's Board, with the advice and recommendation of the Bank's
delinquency committee, estimates an allowance to be set aside for loan losses.
Included in determining the calculation are such factors as the inherent risk
contained within the portfolio after considering the state of the general
economy, economic trends, consideration of particular risks inherent in
different kinds of lending and consideration of known information that may
affect loan collectibility. An increase in the loan loss provision from the
beginning of the period to the end of a period would have come about after an
analysis of the aforementioned factors and applying that rationale to the total
portfolio.
The greater the construction, commercial and higher loan-to-value loans
that are contained in the portfolio, the greater will be the allowance for loan
losses. Changes in estimation methods may take place based upon the status of
the economy and the estimate of the value of collateral and, as a result, the
allowance may increase or decrease. The Bank believes that some portions of its
loan portfolio have greater actual risk and, in other areas, there is greater
inherent risk. The loan loss allowance has increased when the Board believes
trends are negative and contributions to the allowance have decreased when
trends are more positive. Management believes that the allowance for loan losses
is adequate.
During the year ended December 31, 2001, the provision for loan losses
was $709,000 compared to $591,000 for the year ended December 31, 2000. This
increase of $118,000 or 19.9%, was a result of increases in loans contained in
the loan portfolio that Management determined contained a greater inherent risk
than in the prior year, and as a result of an increase in nonperforming loans as
of December 31, 2001 compared to December 31, 2000. As of December 31, 2001 the
allowance for loan losses was $3,353,000 compared to $2,728,000 as of December
31, 2000 which is an increase of $625,000 or 22.9%.
Other Income and Non Interest Expense
Gain on sale of loans was $983,000 for the year ended December 31, 2001
compared to $610,000 for the year ended December 31, 2000. The increase of
$373,000 or 61.1% was a result of increased loan originations primarily from a
lower interest rate environment which resulted in significant residential
mortgage loan refinancings. Should loan originations decrease in the future,
gain on sale of loans will also likely decrease. Loan originations may decrease
as a result of greater competition, increases in general interest rates or a
loss of personnel experienced in loan origination. A reduction in loan
originations will also cause a reduction in mortgage processing fees.
Real estate commissions and real estate management fees for the year
ended December 31, 2001 were $499,000 and $213,000, respectively. These were
earned as a result of the acquisition of Hyatt Real Estate in 2001.
Mortgage processing and servicing fees for the year ended December 31,
2001 were $607,000 compared to $384,000 for the year ended December 31, 2000.
This increase of $223,000 or 58.1% was a result of increase in loan
originations.
Compensation and related expenses totaled $4,572,000 for the year ended
December 31, 2001 compared to $3,552,000 for the year ended December 31, 2000,
or an increase of $1,020,000 or 28.7%. The increase during 2001 was primarily
attributable to the increase in operations and staffing and compensation levels
of the Bank caused by the increase in loan production.
Other non-interest expense totaled $1,520,000 for the year ended
December 31, 2001 compared to $1,337,000 for the year ended December 31, 2000 or
an increase of $183,000 or 13.7%. Other non-interest expense consists primarily
of office and computer supplies, mail expenses, telephone and other expenses.
The increase during 2001 was primarily attributable to the increase in
operations caused by an increase in loan production.
Income taxes for the year ended December 31, 2001 were $3,413,000
compared to $2,439,000 for the year ended December 31, 2000. This increase of
$974,000 or 39.9% was a result of an increase in income before income tax
provision to $8,669,000 for the year ended December 31, 2001 compared to
$6,384,000 for the year ended December 31, 2000, being an increase of $2,285,000
or 35.8%. The effective tax rate for the years ended December 31, 2001 and 2000
were 39.37% and 38.2%, respectively.
Item 7A. Quantitative and Qualitative Disclosures About Market Risk
Qualitative Information About Market Risk. The principal objective of
Bancorp's interest rate risk management is to evaluate the interest rate risk
included in balance sheet accounts, determine the level of risks appropriate
given Bancorp's business strategy, operating environment, capital and liquidity
requirements and performance objectives, and manage the risk consistent with
Bancorp's interest rate risk management policy. Through this management, Bancorp
seeks to reduce the vulnerability of its operations to changes in interest
rates. The Board of Directors of Bancorp is responsible for reviewing
assets/liability policies and interest rate risk position. The Board of
Directors reviews the interest rate risk position on a quarterly basis. In
connection with this review, the Board of Directors evaluates Bancorp's business
activities and strategies, the effect of those strategies on Bancorp's net
interest margin and the effect that changes in interest rates will have on
Bancorp's loan portfolio. Continuous movement of interest rates is certain,
however, the extent and timing of these movements is not always predictable. Any
movement in interest rates has an effect on Bancorp's profitability. Bancorp
faces the risk that rising interest rates could cause the cost of interest
bearing liabilities, such as deposits and borrowings, to rise faster than the
yield on interest earning assets, such as loans and investments. Bancorp's
interest rate spread and interest rate margin may be negatively impacted in a
declining interest rate environment even though Bancorp generally borrows at
short-term interest rates and lends at longer-term interest rates. This is
because loans and other interest earning assets may be prepaid and replaced with
lower yielding assets before the supporting interest bearing liabilities reprice
downward. Bancorp's interest rate margin may also be negatively impacted in a
flat or inverse-yield curve environment. Mortgage origination activity tends to
increase when interest rates trend lower and decrease when interest rates rise.
Bancorp's primary strategy to control interest rate risk is to sell
substantially all long term fixed rate loans in the secondary market. To further
control interest rate risk related to its loan servicing portfolio, Bancorp
originates a substantial amount of construction loans that typically have terms
of one year or less. The turnover in construction loan portfolio assists Bancorp
in maintaining a reasonable level of interest rate risk.
Quantitative Information About Market Risk. The primary market risk
facing Bancorp is interest rate risk. From an enterprise prospective, Bancorp
manages this risk by striving to balance its loan origination activities with
the interest rate market. Bancorp attempts to maintain a substantial portion of
its loan portfolio in short-term loans such as construction loans. This has
proven to be an effective hedge against rapid increases in interest rates as the
construction loan portfolio reprices rapidly.
The matching of maturity or repricing of interest earning assets and
interest bearing liabilities may be analyzed by examining the extent to which
these assets and liabilities are interest rate sensitive and by monitoring the
Bank's interest rate sensitivity gap. An interest earning asset or interest
bearing liability is interest rate sensitive within a specific time period if it
will mature or reprice within that time period. The difference between rate
sensitive assets and rate sensitive liabilities represents the Bank's interest
sensitivity gap.
Exposure to interest rate risk is actively monitored by Bancorp's
management. Its objective is to maintain a consistent level of profitability
within acceptable risk tolerances across a board range of potential interest
rate environments. Bancorp uses the OTS Net Portfolio Value (NPV) model to
monitor its exposure to interest rate risk, which calculates changes in NPV. The
following table represents Bancorp's NPV at December 31, 2002. The NPV was
calculated by the OTS, based upon information provided to the OTS.
INTEREST RATE SENSITIVITY OF NET PORTFOLIO VALUE (NPV)
Change Net Portfolio Value NPV as % of PV of Assets
In Rates $ Amount $ Change % Change NPV Ratio Change
- -------- -------- -------- -------- --------- ------
(dollars are in thousands)
+300 bp 55,207 - 6,433 -10% 11.78% - 90 bp
+200 bp 55,574 - 3,066 - 5% 12.33% - 36 bp
+100 bp 60,938 - 702 - 1% 12.67% - 2 bp
0 bp 61,640 12.68%
- -100 bp 61,498 - 142 0% 12.53% - 15 bp
- -200 bp --- 0 0% 0.00% 0 bp
- -300 bp --- 0 0% 0.00% 0 bp
12/31/2002 09/30/2002 12/31/2001
---------- ---------- ----------
RISK MEASURES: FOR GIVE RATE SHOCK
Pre-Shock NPV Ratio: NPV as % of PV of Assets . . . . 12.68% 12.77% 10.87%
Post-Shock NPV Ratio . . . . . . . . . . . . . . . . 12.33% 12.55% 9.39%
Sensitivity Measure: Decline in NPV Ratio . . . . . . 36 bp 23 bp 148 bp
TB 13a Level of Risk . . . . . . . . . . . . . . . . Minimal Minimal Minimal
Note: Calculations of 2/21/2003 using CMR data edited 02/11/2003. CMR Report
filing required. For this quarter, the Sensitivity Measure is defined as the
decline in the pre-shock NPV ratio caused by a 100 basis point decrease of a 200
basis point increase in interest rates, whichever produced the larger decline.
Due to the abnormally low prevailing interest rate environment, this report no
longer provides NPV estimates for changes in interest rates of -400 or +400
basis points (beginning with the March 1999 cycle), -300 basis points (beginning
with the September 2001 Cycle), and -200 basis points (beginning with the
December 2001 cycle).
Item 8. Financial Statements and Supplementary Data
Financial statements and supplementary data are included herein at pages F1
through F36.
Item 9. Changes in and Disagreements with Accountants on Accounting and
Financial Disclosures
None.
PART III
Item 10. Directors and Executive Officers of the Registrant
Reference is made to the section captioned "The Severn Bancorp, Inc. Annual
Meeting-Election of Directors" in Bancorp's Proxy Statement dated March 27, 2003
for the information required by this Item, which is hereby incorporated by
reference.
Item 11. Executive Compensation
Reference is made to the section captioned "The Severn Bancorp, Inc. Annual
Meeting-Executive Officer Compensation" in Bancorp's Proxy Statement dated March
27, 2003 for the information required by this Item, which is hereby incorporated
by reference.
The following table details information regarding Bancorp's existing equity
compensation plans as of December 31, 2002:
(c)
-------------------------- Number of securities
remaining available for
(b) future issuance under
(a) Weighted-average equity compensation
Number of securities to exercise price of plans (excluding
Plan Category be issued upon exercise outstanding options, securities reflected in
of outstanding options, warrants and rights column (a))
warrants and rights
- --------------------------------------
Equity compensation plans approved
by security holders................. 18,000 5.50 70,500
Equity compensation plans not
approved by security holders........ 0 0 0
Total............................... 18,000 5.50 70,500
Item 12. Security Ownership of Certain Beneficial Owners and Management
Reference is made to the section captioned "The Severn Bancorp, Inc. Annual
Meeting-Securities Ownership of Certain Beneficial Owners in Bancorp's Proxy
Statement dated March 27, 2003 for the information required by this Item which
is hereby incorporated by reference.
Item 13. Certain Relationships and Related Transactions
Reference is made to the section captioned "The Severn Bancorp, Inc. Annual
Meeting-Transactions with Certain Related Persons" in Bancorp's Proxy Statement
dated March 27, 2003 for the information required by this Item, which is hereby
incorporated by reference.
Item 14. Controls and Procedures
Quarterly evaluation of Bancorp's Disclosure Controls and Internal Controls.
Within the 90 days prior to the date of this Annual Report on Form 10-K, Bancorp
evaluated the effectiveness of the design and operation of its "disclosure
controls and procedures" ("Disclosure Controls"). This evaluation ("Controls
Evaluation") was done under the supervision and with the participation of
management, including the Chief Executive Officer ("CEO") and Chief Financial
Officer ("CFO").
Limitations on the Effectiveness of Controls. Bancorp's management, including
the CEO and CFO, does not expect that its Disclosure Controls or its "internal
controls and procedures for financial reporting" ("Internal Controls" ) will
prevent all error and all fraud. A control system, no matter how well conceived
and operated, can provide only reasonable, not absolute, assurance that the
objectives of the control system are met. Further, the design of a control
system must reflect the fact that there are resource constraints, and the
benefits of controls must be considered relative to their costs. Because of the
inherent limitations in all control systems, no evaluation of controls can
provide absolute assurance that all control issues and instances of fraud, if
any, within Bancorp have been detected. These inherent limitations include the
realities that judgments in decision-making can be faulty, and that breakdowns
can occur because of simple error or mistake. Additionally, controls can be
circumvented by the individual acts of some persons, by collusion of two or more
people, or by management override of the control. The design of any system of
controls also is based in part upon certain assumptions about the likelihood of
future events, and there can be no assurance that any design will succeed in
achieving its stated goals under all potential future conditions; over time,
control may become inadequate because of changes in conditions, or the degree of
compliance with the policies or procedures may deteriorate. Because of the
inherent limitations in a cost-effective control system, misstatements due to
error or fraud may occur and not be detected.
Conclusions. Based upon the Controls Evaluation, the CEO and CFO have concluded
that, subject to the limitations noted above, the Disclosure Controls are
effective to timely alert management to material information relating to Bancorp
during the period when its periodic reports are being prepared.
In accordance with SEC requirements, the CEO and CFO note that, since the date
of the Controls Evaluation to the date of this Annual Report, there have been no
significant changes in Internal Controls or in other factors that could
significantly affect Internal Controls, including any corrective actions with
regard to significant deficiencies and material weaknesses.
Item 15. Principal Accounting Fees and Services
New SEC rules require the following information be set forth in a company's
proxy statement (with such disclosure being incorporated by reference into Part
III of Bancorp's Form 10-K) or separately stated in the Form 10-K if the
definitive proxy statement containing the disclosure is not filed with the SEC
within 120 days of the end of Bancorp's latest fiscal year reported in the Form
10-K: (1) disclosure related to audit fees, audit-related fees, tax fees and all
other fees for the two most recent fiscal years (additionally, other than for
the audit category, a description in qualitative terms, of the types of services
provided under the remaining three categories); (2) disclosure related to audit
committee's pre-approval policies and procedures and the percentage of services
described in each of the audit-related fees, tax fees and all other fees
categories that were approved by the audit committee. (Additionally, to the
extent that the audit committee has applied the "de minimis" exception, the
issuer must disclose the percentage of total fees paid to the independent
accountant where the "de minimis" exception was used. This information should be
provided by category.); and (3) if greater than 50%, disclosure regarding the
percentage of hours expended on the principal accountant's engagement to audit
the registrant's financial statements for the most recent fiscal year that were
attributed to work performed by persons other than the principal accountant's
full-time, permanent employees. Reference is made to the section captioned
"Relationship with Independent Auditors, Audit Fees" in Bancorp's Proxy
Statement dated March 27, 2003 for the information required by this Item, which
is hereby incorporated by reference.
PART IV
Item 16. Exhibits, Financial Statements, Schedules, and Reports on Form 8-K
(a) The following financial statements of Bancorp and its wholly owned
subsidiaries are filed as part of this report:
1. Financial Statements
o CONSOLIDATED BALANCE SHEETS AT DECEMBER 31, 2002 AND DECEMBER 31, 2001
o CONSOLIDATED STATEMENTS OF INCOME FOR THE YEARS ENDED DECEMBER 31, 2002,
2001, AND 2000
o CONSOLIDATED STATEMENTS OF CASH FLOWS FOR THE YEARS ENDED DECEMBER 31,
2002, 2001 AND 2000
o CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS EQUITY FOR THE YEARS
ENDED DECEMBER 31, 2002, 2001 AND 2000.
o NOTES TO CONSOLIDATED FINANCIAL STATEMENTS PAGES F2 - F36
o REPORT OF ANDERSON ASSOCIATES, LLP, INDEPENDENT AUDITORS PAGE F1.
2. Financial Statement Schedules
All financial statement schedules have been omitted, as required
information is either inapplicable or included in the consolidated financial
statements or related notes.
3. Exhibits
The following exhibits are filed as part of this report:
Exhibit No. Description of Exhibit
- ----------- ----------------------
3.1 Articles of Incorporation of Severn Bancorp, Inc. (1)
3.2 Bylaws of Severn Bancorp, Inc.
10.5 Employee Stock Ownership Plan (1)
23 Consent of Auditors
- ---------------------------------
(1) Incorporated by reference to Exhibit bearing the same number in
Bancorp's Registration Statement of Form 10 filed with the Securities and
Exchange Commission on June 7, 2002
(b) There were no reports on Form 8-K filed for the period January 1, 2002
through December 31, 2002.
The Securities and Exchange Commission maintains a Web sit that contains
reports, proxy and information statements and other information regarding
registrants that file electronically with the Commission including Bancorp. That
address is http://www.sec.gov.
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.
SEVERN BANCORP, INC.
March 20, 2003 /s/ ALAN J. HYATT
Alan J. Hyatt
Chairman of the Board,
and Director
Pursuant to the requirements 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.
March 20, 2003 /s/ ALAN J. HYATT
Alan J. Hyatt
Chairman of the Board,
President, Chief Executive Officer
and Director
March 20, 2003 /s/ MELVIN HYATT
Melvin Hyatt, Director
March 20, 2003 /s/ S. SCOTT KIRKLEY
S. Scott Kirkley, Director
March 20, 2003 /s/ MELVIN E. MEEKINS, JR.,
Melvin E. Meekins, Jr., Director
March 20, 2003 /s/ RONALD P. PENNINGTON
Ronald P. Pennington, Director
March 20, 2003 /s/ T. THEODORE SCHULTZ
T. Theodore Schultz, Director
March 20, 2003 /s/ DIMITRI SFAKIYANUDIS
Dimitri Sfakiyanudis, Director
March 20, 2003 /s/ LOUIS DIPASQUALE
Louis DiPasquale, Jr., Director
Under the requirements of the Securities Exchange Act of 1934, the
Registrant has duly caused this Report to be signed on its behalf by the
undersigned thereunto duly authorized. Each of the undersigned signatures
certifies pursuant to 18 U.S.C. ss. 1350, as adopted pursuant to ss. 906 of the
Sarbanes-Oxley Act of 2002, that:
(1) This Report fully complies with the requirements of section 13(a)
or 15(d) of the Securities Exchange Act of 1934; and
(2) The information contained in this Report fairly presents, in all
material respects, the financial condition and result of operations of the
Registrant.
SEVERN BANCORP, INC.
Registrant
Date: March 20, 2003 /s/ ALAN J. HYATT
Alan J. Hyatt, President, Chief Executive
Officer and Chairman of the Board
(Principal Executive Officer)
Date: March 20, 2003 /s/ CECELIA LOWMAN
Cecelia Lowman, Chief Financial Officer
(Principal Financial and Accounting Officer)
CERTIFICATION
I, Alan J. Hyatt, President, CEO and Chairman of the Board, certify that:
1. I have reviewed this annual report on Form 10-K of Severn Bancorp, Inc.
(the "Company");
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;
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 officer 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 annual 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 annual
report (the "Evaluation Date"); and
c) presented in this annual 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 officer and I have disclosed, based on our
most recent evaluation, to the registrant's auditors and the audit committee of
registrant's board of directors (or persons performing 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
annual 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 20, 2003 /s/ ALAN J. HYATT
By: Alan J. Hyatt, Chief Executive Officer
and Chairman of the Board
(Principal Executive Officer)
CERTIFICATION
I, Cecelia Lowman, Chief Financial Officer of Severn Bancorp, Inc., certify
that:
1. I have reviewed this annual report on Form 10-K of Severn Bancorp, Inc.;
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;
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 officer 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 annual 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 annual
report (the "Evaluation Date"); and
c) presented in this annual 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
registrant's board of directors (or persons performing 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
annual 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 20, 2003 /s/ CELCELIA LOWMAN
Cecelia Lowman, Chief Financial Officer
(Principal Financial and Accounting Officer)
CERTIFICATION PURSUANT TO 18 U.S.C. SECTION 1350
AS ADOPTED PURSUANT TO
SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002
This certification is intended to accompany the Annual Report of Severn
Bancorp, Inc. (the "Company") on Form 10-K for the period ended December 31,
2002, as filed with the Securities and Exchange Commission on the date hereof
(the "Report"), and is given solely for the purpose of satisfying the
requirements of 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of
the Sarbanes-Oxley Act of 2002. The undersigned, in my capacity as set forth
below, hereby certifies that:
1. The Report fully complies with the requirements of section 13(a) or 15(d)
of the Securities Exchange Act of 1934; and
2. The information contained in the Report fairly presents, in all material
respects, the financial condition and results of operations of the Company.
/s/
Chief Financial Officer Date: March 20, 2003
CERTIFICATION PURSUANT TO 18 U.S.C. SECTION 1350
AS ADOPTED PURSUANT TO
SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002
This certification is intended to accompany the Annual Report of Severn
Bancorp, Inc. (the "Company") on Form 10-K for the period ended December 31,
2002, as filed with the Securities and Exchange Commission on the date hereof
(the "Report"), and is given solely for the purpose of satisfying the
requirements of 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of
the Sarbanes-Oxley Act of 2002. The undersigned, in my capacity as set forth
below, hereby certifies that:
1. The Report fully complies with the requirements of section 13(a) or 15(d)
of the Securities Exchange Act of 1934; and
2. The information contained in the Report fairly presents, in all material
respects, the financial condition and results of operations of the Company.
/s/
Chief Executive Officer Date: March 20, 2003
INDEPENDENT AUDITOR'S REPORT
To the Stockholders and Board of Directors
Severn Bancorp, Inc.
Annapolis, Maryland
We have audited the accompanying statements of consolidated financial
condition of Severn Bancorp, Inc. and Subsidiaries as of December 31, 2002 and
2001, and the related consolidated statements of operations, stockholders'
equity and cash flows for each of the years in the three year period ended
December 31, 2002. These consolidated financial statements are the
responsibility of the Corporation's management. Our responsibility is to express
an opinion on these consolidated 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 audits to obtain reasonable assurance about whether the
consolidated financial statements are free of material misstatement. An audit
includes examining, on a test basis, evidence supporting the amounts and
disclosures in the consolidated financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall consolidated financial statement
presentation. We believe that our audits provide a reasonable basis for our
opinion.
In our opinion, the consolidated financial statements referred to above
present fairly, in all material respects, the financial position of Severn
Bancorp, Inc. and Subsidiaries as of December 31, 2002 and 2001, and the
consolidated results of its operations and cash flows for each of the years in
the three year period ended December 31, 2002, in conformity with accounting
principles generally accepted in the United States of America.
February 28, 2003
Baltimore, Maryland
F-1
SEVERN BANCORP, INC. AND SUBSIDIARIES
Annapolis, Maryland
CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION
December 31,
2002 2001
---- ----
ASSETS
Cash $ 3,756,640 $ 1,030,867
Interest bearing deposits in other banks 4,190,768 1,058,692
Federal funds 10,712,827 3,948,900
Investment securities, held to maturity 4,000,000 7,000,958
Mortgage backed securities held to maturity 5,661,304 212,021
Loans held for sale, net of unrealized loss of
$ -0- in 2002 and 2001 17,481,301 7,498,934
Loans receivable, net 401,343,360 335,142,276
Accrued interest receivable - loans 2,465,187 2,094,588
- mortgage backed
securities 22,327 1,330
- investments 61,911 100,895
Foreclosed real estate, net 223,911 312,118
Premises and equipment, at cost, less
accumulated depreciation 4,737,936 4,642,481
Mortgage servicing rights 19,340 25,940
Federal Home Loan Bank of Atlanta stock
at cost 1,900,000 2,500,000
Deferred income taxes 1,090,356 813,486
Income taxes receivable 164,255 950
Prepaid expenses and other assets 249,517 172,082
Goodwill 333,569 333,569
--------------- --------------
Total assets $458,414,509 $366,890,087
========== ==========
The accompanying notes to consolidated financial statements are an integral part
of these statements.
F-2a
December 31,
2002 2001
---- ----
LIABILITIES AND STOCKHOLDERS' EQUITY
Liabilities
Deposits $377,925,041 $286,917,568
Outstanding checks in excess of bank balance - 798,088
Federal Home Loan Bank of Atlanta advances 34,000,000 42,000,000
Advance payments by borrowers for expenses 1,049,408 1,007,068
Income taxes payable 464,937 174,529
Accounts payable and accrued expenses 1,793,746 1,161,952
------------- -------------
Total liabilities 415,233,132 332,059,205
Commitments - (Notes 4 and 5)
Stockholders' Equity
Non-cumulative preferred stock $1.00 par value, Series A 500,000 shares
authorized; 200,002 issued
and outstanding in 2002 and 2001 200,002 200,002
Additional paid-in capital 3,800,038 3,800,038
Common stock, $.01 par value, 20,000,000 shares
authorized; 4,142,592 and 1,352,364 issued and
outstanding in 2002 and 2001, respectively 41,426 13,524
Additional paid-in capital 11,425,910 10,816,887
Retained earnings (substantially restricted) 27,714,001 20,000,431
------------ ------------
Total stockholders' equity 43,181,377 34,830,882
------------ ------------
Total liabilities and stockholders' equity $458,414,509 $366,890,087
========== ==========
F-2b
SEVERN BANCORP, INC.
AND SUBSIDIARIES
Annapolis, Maryland
CONSOLIDATED STATEMENTS OF OPERATIONS
For Years Ended December 31,
----------------------------------------------------
2002 2001 2000
---- ---- ----
Interest Income
Interest on loans $32,722,911 $28,617,342 $23,320,153
Interest on securities available for sale - 43,809 42,988
Interest on securities held to maturity 361,908 406,117 607,713
Interest on mortgage backed securities 53,808 18,042 21,107
Other interest income 263,372 403,914 278,703
------------ ------------ ------------
Total interest income 33,401,999 29,489,224 24,270,664
Interest Expense
Interest on deposits 12,300,081 13,591,440 11,466,359
Interest on short term borrowings 155,249 1,178,202 834,298
Interest on long term borrowings 1,343,947 1,324,368 1,085,767
----------- ----------- -----------
Total interest expense 13,799,277 16,094,010 13,386,424
---------- ---------- ----------
Net interest income 19,602,722 13,395,214 10,884,240
Provision for loan losses 670,000 708,669 591,000
------------ ------------ ------------
Net interest income after provision
for loan losses 18,932,722 12,686,545 10,293,240
Other Income
Loss on sale of investments - (145,529) -
Gain on sale of loans 1,263,736 982,778 609,644
Real estate commissions 1,236,973 499,256 -
Real estate management fees 383,117 213,102 -
Unrealized loss on loans held for sale - - (26,455)
Mortgage processing and servicing fees 723,702 606,587 384,288
All other income 525,157 414,089 471,133
------------ ------------ ------------
Net other income 4,132,685 2,570,283 1,438,610
Non-Interest Expenses
Compensation and related expenses 6,064,850 4,572,101 3,552,266
Occupancy 487,891 465,628 443,352
Net expense of foreclosed real estate 11,053 30,786 14,685
Other 1,882,839 1,519,537 1,337,417
----------- ----------- ------------
Total non-interest expenses 8,446,633 6,588,052 5,347,720
----------- ----------- ------------
Income before income tax provision 14,618,774 8,668,776 6,384,130
Income tax provision 5,670,554 3,413,206 2,438,989
----------- ----------- ------------
Net income $ 8,948,220 $ 5,255,570 $ 3,945,141
========= ========= =========
Basic earnings per common share $ 2.13 $ 1.38 $ 1.15
========= ========= =========
Diluted earnings per common share $ 2.13 $ 1.37 $ 1.12
========= ========= =========
The accompanying notes to consolidated financial statements are an integral part
of these statements.
F-3
SEVERN BANCORP, INC. AND SUBSIDIARIES
Annapolis, Maryland
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
Non-Cumulative Additional Additional Accumulated Total
Preferred Stock Paid-In Common Paid-In Retained Comprehensive Stockholders'
Series A Capital Stock Capital Earnings Income (Loss) Equity
Balance - January 1, 2000 $200,002 $3,691,787 $10,782 $5,693,546 $12,500,240 $(115,368) $21,980,989
Comprehensive Income
Net income 3,945,141
Unrealized holding gains on
available for sale securities
net of taxes to $17,909 28,465
Total comprehensive income 3,973,606
Exercise of 1,200 options - - 12 19,788 - - 19,800
Exercise of 410 warrants - - 4 6,966 - - 6,970
Dividends on preferred stock
($1.80 per share) - - - - (360,004) - (360,004)
Tax effect of preferred
stock dividends - - - - 139,033 - 139,033
Dividends on common stock
($.50 per share) - - - - (539,760) - (539,760)
--------------- ------------------------------------------ ---------------- ----------------
Balance - December 31, 2000 200,002 3,691,787 10,798 5,720,300 15,684,650 (86,903) 25,220,634
Comprehensive Income
Net income 5,255,570
Reclassification for gains
included in net income
net of taxes to $54,162 86,903
Total comprehensive income 5,342,473
Exercise of 13,000 options - - 130 214,370 - - 214,500
Exercise of 199,592 warrants - 108,251 1,996 3,282,817 - - 3,393,064
Issuance of 60,000 shares of
common stock - - 600 1,599,400 - - 1,600,000
Dividends on preferred stock
($1.80 per share) - - - - (360,004) - (360,004)
Tax effect of preferred
stock dividends - - - - 139,033 - 139,033
Dividends on common stock
($.56 per share) - - - - (718,818) - (718,818)
--------------- ------------------------------------------ ---------------- ---------------------
Balance - December 31, 2001 200,002 3,800,038 13,524 10,816,887 20,000,431 - 34,830,882
Net income - - - - 8,948,220 - 8,948,220
Three-for-one stock split - - 27,047 - (27,047) - -
Exercise of 85,500 options - - 855 479,295 - - 480,150
Tax benefit of exercised options - - - 129,728 - - 129,728
Dividends on preferred stock
($1.80 per share) - - - - (360,004) - (360,004)
Tax effect of preferred
stock dividends - - - - 139,032 - 139,032
Dividends on common stock
($.24 per share) - - - - (986,631) - (986,631)
--------------- ------------------------------------------ ---------------- ---------------------
Balance - December 31, 2002 $200,002 $3,800,038 $41,426 $11,425,910 $27,714,001 $ - $43,181,377
====== ======== ===== ========= ========= ====== =========
The accompanying notes to consolidated financial statements are an integral part
of these statements.
F-4
SEVERN BANCORP, INC. AND SUBSIDIARIES
Annapolis, Maryland
CONSOLIDATED STATEMENTS OF CASH FLOWS
For Years Ended December 31,
2002 2001 2000
---- ---- ----
Operating Activities
Net income $ 8,948,220 $ 5,255,570 $ 3,945,141
Adjustments to Reconcile Net Income to Net
Cash Provided by Operating Activities _
Amortization of deferred loan fees (2,122,685) (1,530,021) (1,019,118)
Loan fees deferred 2,640,109 1,554,151 1,322,452
Accretion of discount on mortgages (7,674) (8,736) (6,875)
Amortization of premium on investment
securities 1,276 2,187 7,612
Accretion of discount on investment securities (318) (1,358) (2,575)
Amortization of premium on mortgage backed
securities 2,895 - -
Accretion of discount on mortgage backed
securities (161) (161) (161)
Provision for loan losses 670,000 708,669 591,000
Provision for losses on foreclosed real estate - 20,000 -
Provision for depreciation 260,232 227,331 210,868
Loss (gain) on sale of foreclosed real estate - 2,769 (2,596)
Gain on sale of loans (1,263,736) (982,778) (609,644)
Gain on disposal of premises and equipment - (5,656) -
Loss on sale of available for sale securities - 145,529 -
Proceeds from loans sold to others 101,798,171 61,258,782 37,402,282
Unrealized loss on loans held for sale - - 26,455
Loans originated for sale (110,564,769) (63,564,893) (38,024,380)
Principal collected on loans originated
for sale 47,967 (40,961) 25,274
Tax effect of preferred stock dividends 139,032 139,033 139,033
Tax effect of exercised options 129,728 - -
Increase in accrued interest on loans (370,599) (19,243) (625,024)
Decrease in accrued interest on investments 38,984 88,437 4,688
(Increase) decrease in accrued interest on
mortgage backed securities (20,997) 359 245
Decrease in mortgage servicing rights 6,600 6,600 6,600
Increase in deferred taxes (276,870) (260,702) (225,678)
(Increase) decrease in income taxes
receivable (163,305) 21,477 94,023
(Increase) decrease in prepaid expenses
and other assets (77,435) 105,349 14,651
(Decrease) increase in accrued interest payable (8,152) (8,445) 33,591
Increase (decrease) in accounts payable
and accrued expenses 631,794 408,297 (38,512)
Increase in income taxes payable 290,408 79,717 57,960
-------------- --------------- --------------
Net cash provided by operating activities 728,715 3,601,303 3,327,312
F-5
SEVERN BANCORP, INC. AND SUBSIDIARIES
Annapolis, Maryland
CONSOLIDATED STATEMENTS OF CASH FLOWS
For Years Ended December 31,
2002 2001 2000
---- ---- ----
Cash Flows from Investing Activities
- ------------------------------------
Cash consideration Louis Hyatt, Inc.
acquisition, net $ - $ (31,340) $ -
Purchase of investment securities (4,000,000) (4,000,000) (1,497,250)
Proceeds from maturing investment securities 7,000,000 6,497,754 2,000,000
Proceeds from sale of available for sale
securities - 854,471 -
Purchase of mortgage backed securities (5,759,846) - -
Principal collected on mortgage backed
securities 307,829 67,507 39,315
Longer term loans originated (227,115,936) (275,799,110) (169,845,620)
Principal collected on longer term loans 159,544,817 214,211,144 115,422,795
Net decrease (increase) in short-term loans 387,286 (370,809) 50,722
Loans purchased (197,000) (3,551,316) (5,743,786)
Proceeds from sale of foreclosed real estate 88,207 103,941 185,317
Investment in premises and equipment (355,687) (2,097,708) (102,004)
Proceeds from disposal of premises
and equipment - 15,029 -
Purchase of Federal Home Loan Bank of
Atlanta stock - (700,000) (600,000)
Redemption of Federal Home Loan Bank of
Atlanta stock 600,000 - -
-------------- ----------------------------------------
Net cash used by investing activities (69,500,330) (64,800,437) (60,090,511)
Cash Flows from Financing Activities
- ------------------------------------
Net increase in demand deposits, money
market, passbook accounts and advances
by borrowers for taxes and insurance 70,812,416 44,777,862 2,046,569
Net increase in certificates of deposit 20,245,549 13,424,172 40,868,310
(Decrease) increase in checks outstanding
in excess of bank balance (798,088) (2,500,270) 3,298,358
Additional borrowed funds 37,000,000 47,000,000 45,000,000
Repayment of borrowed funds (45,000,000) (39,000,000) (35,000,000)
Cash dividends (1,346,636) (1,078,822) (899,764)
Proceeds from exercise of options 480,150 214,500 19,800
Proceeds from exercise of warrants - 3,393,064 6,970
-------------------- ------------- ----------------
Net cash provided by financing activities 81,393,391 66,230,506 55,340,243
------------ ------------ ------------
F-6
SEVERN BANCORP, INC. AND SUBSIDIARIES
Annapolis, Maryland
CONSOLIDATED STATEMENTS OF CASH FLOWS
For Years Ended December 31,
2002 2001 2000
---- ---- ----
Increase (decrease) in cash and cash
equivalents $ 12,621,776 $ 5,031,372 $ (1,422,956)
Cash and cash equivalents at beginning of year 6,038,459 1,007,087 2,430,043
------------- ------------- -------------
Cash and cash equivalents at end of year $ 18,660,235 $ 6,038,459 $ 1,007,087
========== ========== =========
The Following is a Summary of Cash and
Cash Equivalents
Cash $ 3,756,640 $ 1,030,867 $ 717,477
Interest bearing deposits in other banks 4,190,768 1,058,692 289,610
Federal funds 10,712,827 3,948,900 -
------------ ------------- ---------------
Cash and cash equivalents reflected on the
statement of cash flows $ 18,660,235 $ 6,038,459 $ 1,007,087
========== ========== =========
Supplemental Disclosure of Cash Flows Information:
Cash Paid During Year For:
Interest $ 13,804,867 $ 16,094,010 $ 13,386,424
========== ========== =========
Income taxes $ 5,556,478 $ 3,282,444 $ 2,330,440
========== ========== =========
Transfer from loans to foreclosed real estate $ - $ 485,210 $ -
========== ========== =========
Transfer from foreclosed real estate to loans $ - $ 358,500 $ 189,000
========== ========== =========
Common stock issued for acquired company $ - $ 1,600,000 $ -
========== ========== =========
The accompanying notes to consolidated financial statements are an integral part
of these statements.
F-7
SEVERN BANCORP, INC. AND SUBSIDIARIES
Annapolis, Maryland
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2002 AND 2001
Note 1 - Summary of Significant Accounting Policies
A. Principles of Consolidation - The consolidated financial
statements include the accounts of Severn Bancorp, Inc. ("the
Corporation"), and its wholly-owned subsidiaries, Louis Hyatt,
Inc., SBI Mortgage Company and SBI Mortgage Company's
subsidiary, Crownsville Development Corporation, and its
subsidiary, Crownsville Holdings I, LLC, and Severn Savings
Bank, FSB ("the Bank"), and the Bank's subsidiaries,
Homeowners Title and Escrow Corporation, Severn Financial
Services Corporation, Creekside Commons, LLC, SSB Realty
Holdings, LLC, SSB Realty Holdings II, LLC, HS West, LLC and
Severn Preferred Capital Corporation ("the Company"). All
intercompany accounts and transactions have been eliminated in
the accompanying financial statements.
Severn Preferred Capital Corporation was organized on April
29, 1997 and commenced operations of July 22, 1997. The
Company qualifies as a real estate investment trust ("REIT")
under the Internal Revenue Code of 1986, as amended.
B. Business - The Bank's primary business activity is the
acceptance of deposits from the general public and the use of
the proceeds for investments and loan originations. The Bank
is subject to competition from other financial institutions.
The Bank is subject to the regulations of certain federal
agencies and undergoes periodic examinations by those
regulatory authorities.
C. Basis of Financial Statement Presentation - The consolidated
financial statements have been prepared in conformity with
accounting principles generally accepted in the United States
of America. In preparing the financial statements, management
is required to make estimates and assumptions that affect the
reported amounts of assets and liabilities as of the date of
the statement of financial condition and revenues and expenses
for the period. Actual results could differ significantly 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. See Notes H and K below
for a discussion of the determination of that estimate.
D. Investments Available for Sale - Available for sale securities
consisted of an investment in the Putnam GNMA Trust.
Unrealized holding gains and losses, net of tax, on available
for sale securities are reported as a net amount in a separate
component of shareholders' equity until realized. Premiums and
discounts are recognized in interest income using the interest
method over the period to maturity. Gains and losses are
determined using the specific identification method.
F-8
SEVERN BANCORP, INC. AND SUBSIDIARIES
Annapolis, Maryland
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2002 AND 2001
Note 1 - Summary of Significant Accounting Policies - Continued
E. Investments and Mortgage Backed Securities - Investments and
mortgage backed securities for which the Bank has the positive
intent and ability to hold to maturity are reported at cost,
adjusted for premiums and discounts that are recognized in
interest income using the interest method over the period to
maturity. Gains and losses are determined using the specific
identification method.
F. Loans Held for Sale - Loans held for sale are carried at lower
of cost or market value in the aggregate. Net unrealized
losses are recognized through a valuation allowance by charges
to income.
G. Loans - Loans are carried at cost since management has the
ability and intention to hold them to maturity.
H. Allowance for Loan Losses - An allowance for loan losses is
provided through charges to income in an amount that
management believes will be adequate to absorb losses on
existing loans that may become uncollectible, based on
evaluations of the collectibility of loans and prior loan loss
experience. The evaluations take into consideration such
factors as changes in the nature and volume of the loan
portfolio, overall portfolio quality, review of specific
problem loans, and current economic conditions that may affect
the borrowers' ability to pay. Determining the amount of the
allowance for loan losses requires the use of estimates and
assumptions, which is permitted under generally accepted
accounting principles. Actual results could differ
significantly from those estimates. Management believes the
allowance for losses on loans is adequate. While management
uses available information to estimate losses on loans, future
additions to the allowances may be necessary based on changes
in economic conditions, particularly in the State of Maryland.
In addition, various regulatory agencies, as an integral part
of their examination process, periodically review the Bank's
allowances for losses on loans. Such agencies may require the
Bank to recognize additions to the allowances based on their
judgments about information available to them at the time of
their examination. Statement of Financial Accounting Standards
("SFAS") No. 114, as amended by SFAS No. 118, addresses the
accounting by creditors for impairment of certain loans. It is
generally applicable for all loans except large groups of
smaller balance homogeneous loans that are collectively
evaluated for impairment, including residential mortgage loans
and consumer installment loans. It also applies to all loans
that are restructured in a troubled debt restructuring
involving a modification
F-9
SEVERN BANCORP, INC. AND SUBSIDIARIES
Annapolis, Maryland
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2002 AND 2001
Note 1 - Summary of Significant Accounting Policies - Continued
H. Allowance for Loan Losses - Continued
of terms. SFAS No. 114 requires that impaired loans be
measured based on the present value of expected future cash
flows discounted at the loan's effective interest rate, or at
the loan's observable market price or the fair value of the
collateral if the loan is collateral dependent. A loan is
considered impaired when, based on current information and
events, it is probable that a creditor will be unable to
collect all amounts due according to the contractual terms of
the loan agreement.
Accrual of interest is discontinued on a loan when management
believes, after considering economic and business conditions
and collection efforts, that the borrower's financial
condition is such that collection of interest is doubtful.
When a payment is received on a loan on non-accrual status,
the amount received is allocated to principal and interest in
accordance with the contractual terms of the loan.
I. Loan Origination Fees - Loan origination fees and certain
direct loan origination costs are deferred and recognized over
the contractual life of the related loan as an adjustment of
yield using the level-yield method.
J. Discounts or Premiums - Discounts received or premiums paid in
connection with loans purchased, investment and mortgage
backed securities are amortized into income over an average
loan life using the interest method.
K. Foreclosed Real Estate - Real estate acquired through or in
the process of foreclosure is recorded at the lower of cost or
fair value. Management periodically evaluates the
recoverability of the carrying value of the real estate
acquired through foreclosure using estimates as described
under the caption "Allowance for Loan Losses". In the event of
a subsequent decline, management provides an additional
allowance, to reduce real estate acquired through foreclosure
to fair value less estimated disposal cost. Expenses incurred
on foreclosed real estate prior to disposition are charged to
expense. Gains on the sale of foreclosed real estate are
recognized upon disposition of the property. Sale of the real
estate acquired through foreclosure is expected to occur
within the next twelve months.
F-10
SEVERN BANCORP, INC. AND SUBSIDIARIES
Annapolis, Maryland
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2002 AND 2001
Note 1 - Summary of Significant Accounting Policies - Continued
L. Loan Servicing - The cost of mortgage servicing rights is
amortized in proportion to, and over the period of, estimated
net servicing revenues. Impairment of mortgage servicing
rights is assessed based on the fair value of those rights.
Fair values are estimated using pricing sheets from
correspondent purchasers. For purposes of measuring
impairment, the rights are stratified based on the following
predominant risk characteristics of the underlying loans:
fixed rate loans with similar terms (i.e.; fifteen years,
twenty years or thirty years amortization) all originated
within the same fiscal year. The amount of impairment
recognized, if any, is the amount by which the capitalized
mortgage servicing rights for a stratum exceed their fair
value.
M. Premises and Equipment - Premises and equipment are carried at
cost less accumulated depreciation. Depreciation and
amortization of premises and equipment is accumulated by the
use of the straight-line method over the estimated useful
lives of the assets. Additions and improvements are
capitalized, and charges for repairs and maintenance are
expensed when incurred. The related cost and accumulated
depreciation are eliminated from the accounts when an asset is
sold or retired and the resultant gain or loss is credited or
charged to income.
N. Income Taxes - Deferred income taxes are recognized for
temporary differences between the financial reporting basis
and income tax basis of assets and liabilities based on
enacted tax rates expected to be in effect when such amounts
are realized or settled. Deferred tax assets are recognized
only to the extent that is more likely than not that such
amounts will be realized based on consideration of available
evidence. The effect on deferred tax assets and liabilities of
a change in tax rates is recognized in income in the period
that includes the enactment date.
0. Statement of Cash Flows - In the statement of cash flows, cash
and equivalents include cash, Federal Home Loan Bank of
Atlanta overnight deposits, federal funds and certificates of
deposit with an original maturity date less than ninety days.
P. Goodwill - During the year ended December 31, 2001, the
Corporation recorded goodwill in the amount of $333,569 as the
result of the purchase of Louis Hyatt, Inc. There were no
other changes in the carrying amount of goodwill for the years
ended December 31, 2002, 2001 and 2000. The Corporation tests
the goodwill for impairment in accordance with SFAS 142.
F-11
SEVERN BANCORP, INC. AND SUBSIDIARIES
Annapolis, Maryland
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2002 AND 2001
Note 1 - Summary of Significant Accounting Policies - Continued
Q. Earnings Per Share - Basic earnings per share of common stock
for the years ended December 31, 2002, 2001 and 2000 is
computed by dividing net income less preferred stock dividend
net of tax by 4,092,188, 3,647,451 and 3,237,888,
respectively, the weighted average number of shares of common
stock outstanding for each year. Diluted earnings per share of
common stock for the years ended December 31, 2002, 2001 and
2000, is computed by dividing net income for each year by
4,103,223, 3,683,346 and 3,330,915, respectively, the weighted
average number of diluted shares of common stock. (See Note
12) The above amounts have been retroactively adjusted to give
effect to a 3-for-1 stock split in the form of a 200% stock
dividend. (See Note 11)
R. Employee Stock Ownership Plan - The Corporation accounts
for its Employee Stock Ownership Plan ("ESOP") in
accordance with Statement of Position 93-6 of the Accounting
Standards Division of the American Institute of
Certified Public Accountants. The Corporation records
compensation expense equal to the cash contribution called for
under the Plan. All ESOP shares are included in the weighted
average shares outstanding for earnings per share
computations. All dividends paid on ESOP shares are charged to
retained earnings. (See Note 10)
S. Advertising Cost - Advertising cost is expensed as incurred.
For the years ended December 31, 2002, 2001 and 2000
advertising expenses were $131,298, $112,214 and $140,273,
respectively.
T. Reclassification - Certain prior year's amounts have been
reclassified to conform to the current year's method of
presentation.
U. Cash Concentrations - The Bank has a demand deposit account
with another financial institution in the amount of
$13,709,768 and $3,150,811 at December 31, 2002 and 2001,
respectively. The balance exceeds the Federal Deposit
Insurance Corporation ("FDIC") insurance level of $100,000 and
constitutes a concentration of credit risk.
F-12
SEVERN BANCORP, INC. AND SUBSIDIARIES
Annapolis, Maryland
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2002 AND 2001
Note 2 - Investment Securities
The amortized cost and fair values of investment securities
are as follows:
Gross Gross
Amortized Unrealized Unrealized Fair
Cost Gains Losses Value
Held to Maturity
December 31, 2002:
Federal Home Loan Bank
("FHLB") Notes $4,000,000 $48,400 $ - $4,048,400
--------- ------ ----------- ---------
$4,000,000 $48,400 $ - $4,048,400
======== ===== ===== ========
December 31, 2001:
U.S. Treasury Notes $2,001,276 $49,412 $ - $2,050,688
Federal Home Loan Bank
("FHLB") Notes 4,999,682 46,870 19,300 5,027,252
--------- ------ ------ ---------
$7,000,958 $96,282 $19,300 $7,077,940
======== ===== ===== ========
FHLB Notes in the amount of $4,000,000 are pledged as
collateral for its standby letters of credit issued on behalf of
various borrowers and developers in favor of Anne Arundel County.
The scheduled maturities of investment securities are as
follows at December 31, 2002:
Held To
Maturity Securities
Amortized Fair
Cost Value
Due after one year through five years $4,000,000 $4,048,400
--------- ---------
$4,000,000 $4,048,400
======== ========
F-13
SEVERN BANCORP, INC. AND SUBSIDIARIES
Annapolis, Maryland
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2002 AND 2001
Note 2 - Investment Securities - Continued
Gross losses of $145,529 and no gross gains were realized on
proceeds of $854,471 during the year ended December 31, 2001. No
gains or losses were realized during the years ended December 31,
2002 and December 31, 2000.
Note 3 - Mortgage Backed Securities
The amortized cost and fair values of mortgage backed
securities consisting of FHLMC Gold Certificates are as follows as
of December 31:
Gross Gross Gross
Amortized Unrealized Unrealized Fair
Cost Gains Losses Value
2002
$5,661,304 $13,559 $5,223 $5,669,640
======== ===== ==== ========
2001
$ 212,021 $ 4,241 $ - $ 216,262
======== ===== ==== ========
No gains or losses were realized during the years ended
December 31, 2002, 2001 and 2000.
F-14
SEVERN BANCORP, INC. AND SUBSIDIARIES
Annapolis, Maryland
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2002 AND 2001
Note 4 - Loans Receivable
Loans receivable consist of the following:
December 31,
2002 2001
---- ----
Residential mortgage loans $142,341,868 $129,777,646
Construction, land acquisition and
development loans 191,196,444 163,848,657
Land loans 20,109,481 16,895,189
Line of credit 12,472,108 8,776,251
Commercial real estate loans 90,861,798 68,599,149
Commercial non-real estate loans 3,444,297 3,393,331
Second mortgage loans 3,108,961 1,963,026
Home equity loans 11,196,706 7,834,818
Consumer loans 425,001 507,815
Loans secured by deposits 444,597 749,069
-------------- -------------
475,601,261 402,344,951
Less
Loans in process (67,593,187) (61,684,935)
Allowance for loan losses (3,990,600) (3,353,375)
Unearned discount on loans purchased (29,287) (36,961)
Deferred loan origination fees (2,644,827) (2,127,404)
------------- -------------
(74,257,901) (67,202,675)
------------ ------------
$401,343,360 $335,142,276
========== ==========
Residential lending is generally considered to involve less
risk than other forms of lending, although payment experience on
these loans is dependent to some extent on economic and market
conditions in the Bank's lending area. Multifamily residential,
commercial, construction and other loan repayments are generally
dependent on the operations of the related properties or the
financial condition of its borrower or guarantor. Accordingly,
repayment of such loans can be more susceptible to adverse
conditions in the real estate market and the regional economy.
A substantial portion of the Bank's loans receivable are
mortgage loans secured by residential and commercial real estate
properties located in the State of Maryland. Loans are extended
only after evaluation by management of customers' creditworthiness
and other relevant factors on a case-by-case basis. The Bank
generally does not lend more than 90% of the appraised value
F-15
SEVERN BANCORP, INC. AND SUBSIDIARIES
Annapolis, Maryland
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2002 AND 2001
Note 4 - Loans Receivable - Continued
of a property and requires private mortgage insurance on
residential mortgages with loan-to-value ratios in excess of 80%.
In addition, the Bank generally obtains personal guarantees of
repayment from borrowers and/or others for construction,
commercial and multifamily residential loans and disburses the
proceeds of construction and similar loans only as work progresses
on the related projects.
The following is a summary of the allowance for loan losses
for the three years ended December 31:
2002 2001 2000
---- ---- ----
Balance at beginning of year $3,353,375 $2,728,004 $2,146,572
Provision for loan losses 670,000 708,669 591,000
Recoveries - - 20,000
Charge-offs (32,775) (83,298) (29,568)
------------ ----------- -----------
Balance at end of year $3,990,600 $3,353,375 $2,728,004
======== ======== ========
Impaired loans as defined by SFAS No. 114 are summarized as
follows for the years ended December 31:
2002 2001 2000
---- ---- ----
Recorded investment $ 252,780 $300,000 $292,975
Average balances 371,725 542,628 254,671
Allowance for loan losses - - 30,000
Impaired loans as defined by SFAS No. 114 for which interest
income has been reduced are as follows for the year ended December
31:
2002 2001 2000
---- ---- ----
Interest income that would have been
recorded $29,779 $32,909 $20,056
Interest income recognized 21,335 25,159 8,318
------- ------ --------
Interest income not recognized $ 8,444 $ 7,750 $11,738
====== ====== ======
F-16
SEVERN BANCORP, INC. AND SUBSIDIARIES
Annapolis, Maryland
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2002 AND 2001
Note 4 - Loans Receivable - Continued
Nonperforming loans not subject to SFAS No. 114 amounted to
approximately $1,504,706 and $1,801,072 at December 31, 2002 and
2001, respectively.
Interest income that would have been recorded under the
original terms of such loans and the interest income actually
recognized for the years ended December 31, are summarized below:
2002 2001 2000
---- ---- ----
Interest income that would have
been recorded $126,263 $190,279 $103,124
Interest income recognized 59,152 145,199 71,063
-------- ------- --------
Interest income not recognized $ 67,111 $ 45,080 $ 32,061
======= ======= ======
Mortgage loans serviced for others are not included in the
accompanying consolidated statements of financial condition. The
unpaid principal balances of these loans at December 31 are
summarized as follows:
2002 2001
---- ----
Mortgage Loan Portfolio Serviced For:
FHLMC $ 5,758,947 $ 7,802,731
Other investors 18,175,891 9,573,744
---------- -----------
$23,934,838 $17,376,475
========= =========
Custodial escrow balances maintained in connection with the
foregoing loan servicing were approximately $53,749 and $68,239 at
December 31, 2002 and 2001, respectively.
The Bank is a party to financial instruments with
off-balance-sheet risk in the normal course of business to meet
the financial needs of its customers. These financial instruments
include standby letters of credit, and home equity loans which
involve, to varying degrees, elements of credit risk in excess of
the amount recognized in the statement of financial position. The
contract amounts of these instruments express the extent of
involvement the Bank has in each class of financial instruments.
F-17
SEVERN BANCORP, INC. AND SUBSIDIARIES
Annapolis, Maryland
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2002 AND 2001
Note 4 - Loans Receivable - Continued
The Bank's exposure to credit loss from non-performance by
the other party to the above mentioned financial instruments is
represented by the contractual amount of those instruments. The
Bank uses the same credit policies in making commitments and
conditional obligations as it does for on-balance-sheet
instruments.
Unless otherwise noted, the Bank requires collateral or other
security to support financial instruments with off-balance-sheet
credit risk.
Financial Instruments Whose Contract Contract Amount
Amounts Represent Credit Risk At December 31,
---------------------------------------- -------------------------------
2002 2001
---- ----
Standby letters of credit $ 6,693,732 $ 2,007,857
Home equity loans $ 8,014,492 $ 4,145,749
Loan commitments $24,771,785 $ 787,738
Lines of credit $22,368,021 $13,790,425
Loans sold and serviced with limited
repurchase provisions $10,162,735 $ 4,722,848
Standby letters of credit are conditional commitments issued
by the Bank guaranteeing performance by a customer to various
municipalities. These guarantees are issued primarily to support
performance arrangements, limited to real estate transactions.
Home equity loans are loan commitments to individuals as long
as there is no violation of any condition established in the
contract. Commitments under home equity lines expire ten years
after the date the loan closes and are secured by real estate. The
Bank evaluates each customer's credit worthiness on a case-by-case
basis.
Mortgage loan commitments not reflected in the accompanying
statements at December 31, 2002 include $22,249,547 at fixed rates
ranging from 5.00% to 9.375% and $2,522,238 at rates ranging from
prime to prime plus 1.0%.
Lines of credit are loan commitments to individuals and
companies as long as there is no violation of any condition
established in the contract. Lines of credit have a fixed
expiration date. The Bank evaluates each customer's credit
worthiness on a case-by-case basis.
F-18
SEVERN BANCORP, INC. AND SUBSIDIARIES
Annapolis, Maryland
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2002 AND 2001
Note 4 - Loans Receivable - Continued
The Bank has entered into several agreements to sell mortgage
loans to third parties. These agreements contain provisions that
require the Bank to repurchase a loan if the loan becomes
delinquent within the terms specified by the agreement.
The credit risk involved in these financial instruments is
essentially the same as that involved in extending loan facilities
to customers. No amount has been recognized in the statement of
financial condition at December 31, 2002, as a liability for
credit loss.
Note 5 - Premises and Equipment
Premises and equipment at December 31, 2002 and 2001 are
summarized by major classification as follows:
Estimated
December 31, Useful
------------
2002 2001 Lives
---- ---- --------------------
Land $1,923,960 $1,923,960 -
Building 2,188,696 2,073,135 39 Years
Leasehold improvements 535,016 515,272 15-27.5 Years
Furniture, fixtures and equipment 1,756,898 1,559,512 3-10 Years
--------- ---------
Total at cost 6,404,570 6,071,879
Accumulated depreciation (1,666,634) (1,429,398)
--------- ---------
$4,737,936 $4,642,481
======== ========
Depreciation expense for the years ended December 31, 2002,
2001 and 2000 was $260,232, $227,331 and $210,868, respectively.
The Bank is obligated under a long term lease for its
administrative offices. The rents adjust with the Consumer Price
Index. The lease expires on January 31, 2005. The minimum annual
rental payments are as follows:
Years Ended December 31,
2003 $28,494
2004 28,559
2005 2,380
F-19
SEVERN BANCORP, INC. AND SUBSIDIARIES
Annapolis, Maryland
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2002 AND 2001
Note 5 - Premises and Equipment - Continued
Homeowners Title and Escrow Corporation and Louis Hyatt, Inc.
are also obligated under a month-to-month lease with
no obligation to renew, but they anticipate that they will
continue to do so.
Total rent expense was $64,853, $106,868 and $140,504 for the
years ended December 31, 2002, 2001 and 2000, respectively.
Note 6 - Investment in Federal Home Loan Bank of Atlanta Stock
The Bank is required to maintain an investment in the stock
of the Federal Home Loan Bank of Atlanta ("FHLB") in an amount
equal to at least 1% of the unpaid principal balances of the
Bank's residential mortgage loans or 1/20 of its outstanding
advances from the FHLB, whichever is greater. Purchases and sales
of stock are made directly with the FHLB at par value.
Note 7 - Deposits
Deposits in the Bank as of December 31, 2002 and 2001
consisted of the savings programs described below:
2002 2001
------------------------------------- ---------------------------------------
Amount Percent Amount Percent
Category
NOW accounts $ 15,980,589 4.23% $ 13,457,798 4.68%
Money market accounts 132,767,052 35.13 61,759,483 21.53
Passbooks 18,189,610 4.81 21,024,223 7.33
Certificates 210,913,461 55.81 190,593,583 66.43
----------- ------- ----------- -------
377,850,712 99.98 286,835,087 99.97
Accrued interest 74,329 .02 82,481 .03
--------------- ------- ----------------- --------
Total savings $377,925,041 100.00% $286,917,568 100.00%
========== ===== ========== =====
F-20
SEVERN BANCORP, INC. AND SUBSIDIARIES
Annapolis, Maryland
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2002 AND 2001
Note 7 - Deposits - Continued
At December 31, scheduled maturities of certificates of
deposit are as follows:
2002 2001
---------------------------------- -----------------------------------------
Amount % Amount %
------ - ------ -
One year or less $136,944,574 64.93 $139,073,988 72.97
More than 1 year to 2 years 27,531,898 13.05 23,138,385 12.14
More than 2 years to 3 years 11,058,263 5.24 9,361,585 4.91
More than 3 years to 4 years 16,060,941 7.62 9,344,464 4.91
More than 4 years to 5 years 19,268,496 9.14 9,630,221 5.05
More than 5 years 49,289 .02 44,940 .02
---------------------- --------------- ---------
$210,913,461 100.00 $190,593,583 100.00
========== ===== ========== =====
Interest expense on deposits is summarized as follows:
For Years Ended December 31,
-----------------------------------------------------------
2002 2001 2000
---- ---- ----
NOW accounts $ 74,814 $ 66,785 $ 69,254
Money market accounts 2,853,484 1,579,829 1,352,655
Passbooks 556,444 775,017 886,788
Certificates 8,815,339 11,169,809 9,157,662
----------- ---------- -----------
$12,300,081 $13,591,440 $11,466,359
========= ========= =========
The aggregate amount of jumbo certificates of deposit with a
minimum denomination of $100,000 was approximately $50,837,141 and
$45,009,000 at December 31, 2002 and 2001.
F-21
SEVERN BANCORP, INC. AND SUBSIDIARIES
Annapolis, Maryland
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2002 AND 2001
Note 8 - Federal Home Loan Bank Advances and Loan Payable
During 1994, the Federal Home Loan Bank of Atlanta
established a Credit Availability Program. The Bank's Credit
Availability under the program at December 31, 2002 and 2001 was
$113,884,235 and $91,721,750, respectively. The maturities of the
advances are as follows:
Description Rate Amount Maturity
----------- ---- ------ --------
FHLB advances 1.79% to 5.79% $10,000,000 2003
FHLB advances 3.64% 5,000,000 2004
FHLB advances 4.52% 2,000,000 2005
FHLB advances 4.01% 5,000,000 2007
FHLB advances 2.57% to 4.48% 12,000,000 Thereafter
----------
$34,000,000
=========
The Bank's stock in the Federal Home Loan Bank of Atlanta is
pledged as security for the loan and under a blanket floating lien
security agreement with the Federal Home Loan Bank of Atlanta, the
Bank is required to maintain as collateral for its advances,
qualified home mortgage loans in an amount equal to 175% of the
advances. The Bank is also required to maintain an average daily
balance with the Federal Reserve Bank in a non-interest bearing
account. The amount in such account at December 31, 2002 was
$300,000.
Note 9 - Pension Plan
The Bank has a Supplemental Executive Retirement Plan
covering selected officers which is funded by life insurance
policies. The Bank owns the policies and is the beneficiary. The
amount of cost recognized for the years ended December 31, 2002,
2001 and 2000 was $11,753 per year.
The Bank has a 401(k) Retirement Savings Plan. Employees may
contribute a percentage of their salary up to a maximum of $11,000
for 2002. The Bank is obligated to contribute 50% of the
employee's contribution, not to exceed 6% of the employee's annual
salary. All employees who have completed one year of service with
the Bank are eligible to participate. The Bank's contribution to
this plan was $93,415, $75,174 and $70,413 for the years ended
December 31, 2002, 2001 and 2000, respectively.
F-22
SEVERN BANCORP, INC. AND SUBSIDIARIES
Annapolis, Maryland
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2002 AND 2001
Note 10- Employee Stock Ownership Plan
The Bank has an Employee Stock Ownership Plan ("ESOP") for
the exclusive benefit of participating employees. During the years
ended December 31, 2002, 2001 and 2000, the Bank recognized ESOP
expense of $140,400, $120,000 and $120,000, respectively.
Note 11- Common and Preferred Stock
In 1984, the Bank converted from a state chartered mutual
savings and loan to a state chartered stock savings and loan
association. At the time of conversion, the Bank established a
liquidation account in an amount equal to the Bank's retained
earnings as of September 30, 1983. The liquidation account is
maintained for the benefit of eligible savings account holders who
maintained their savings account in the Bank after conversion. In
the event of a complete liquidation (and only in such event), each
eligible savings account holder would be entitled to receive a
liquidation distribution from the liquidation account in an amount
equal to the account holder's then interest in the liquidation
account before any liquidation distribution may be made with
respect to capital stock. At December 31, 2002 and 2001, the
balance of the liquidation account is included in retained
earnings.
Severn Preferred Capital Corporation issued 200,002 shares of
preferred stock at $20.00 per share, together with warrants to
purchase 200,002 shares of the Corporation's common stock at
$17.00 per share and 200,000 shares of its common stock for $20
per share, par value of $1 per share for gross proceeds of
$8,000,080 and net proceeds of $7,891,829. The Bank purchased all
of the outstanding common stock. All of the warrants have been
exercised as of December 31, 2001.
The shareholders of the Corporation voted to approve an
amendment to the corporate charter to increase the number of
Common shares authorized to 20,000,000 and increased the
authorized number Serial Preferred shares to 1,000,000.
On February 19, 2002, the Corporation's Board of Directors
declared a 3-for-1 stock split in the form of a 200% stock
dividend, which was effective for shares outstanding as of March
1, 2002 to be paid March 15, 2002. All per share data in the
accompanying financial statements and all share and per share data
in the footnotes have been adjusted to give retroactive effect to
this transaction.
F-23
SEVERN BANCORP, INC. AND SUBSIDIARIES
Annapolis, Maryland
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2002 AND 2001
Note 11- Common and Preferred Stock - Continued
The Bank's Stock Option Plan ("Plan") provides for the
granting of options to acquire common stock to directors and key
employees. Option prices are equal to or greater than fair market
value of the common stock at the date of the grant. The Bank
granted options to purchase 156,000 shares. The Plan provides for
options granted to directors (60,000 shares) to be immediately
exercisable for a period of five years from the effective date of
November 25, 1997. Additionally, the Plan provides for one-fifth
of the remaining options granted to be exercisable on each of the
first five anniversaries of the effective date. If the participant
in the Plan terminates employment for reasons other than death or
disability, he or she forfeits all rights to unvested shares.
The following table summarizes the status of and changes in
the Bank's stock option plan.
Weighted
Average
Exercise
Shares Price
------ ----------
Outstanding at January 1, 2000 147,600 $5.56
Exercised in 2000 3,600 5.50
-------- ----
Outstanding at December 31, 2000 144,000 5.57
Exercised in 2001 39,000 5.50
------- ----
Outstanding at December 31, 2001 105,000 5.59
Exercised in 2002 85,500 5.62
Forfeited in 2002 1,500 5.50
-------- ----
Outstanding at December 31, 2002 18,000 $5.50
====== ====
Exercisable at December 31, 2001 85,800
======
Exercisable at December 31, 2002 18,000
======
All share and per share amounts have been retroactively
adjusted for a 3-for-1 stock split in the form of a 200% stock
dividend.
F-24
SEVERN BANCORP, INC. AND SUBSIDIARIES
Annapolis, Maryland
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2002 AND 2001
Note 12- Earnings Per Share
Basic EPS is computed based upon income available to common
shareholders and the weighted average number of common shares
outstanding for the period. Diluted EPS is to reflect the
potential dilution that could occur if securities or other
contracts to issue common stock were exercised or converted into
common stock or resulted in the issuance of common stock that then
shared in the earnings of the Company.
For Years Ended December 31,
-------------------------------------------------
2002 2001 2000
---- ---- ----
Net income $8,948,220 $5,255,570 $3,945,141
Less - preferred stock dividends,
net of tax (220,972) (220,971) (220,971)
----------- ---------- ----------
Net income available to shareholders $8,727,248 $5,034,599 $3,724,170
======== ======== ========
Weighted average shares outstanding
basic EPS 4,092,188 3,647,451 3,237,888
Effect of Dilutive Shares
Stock warrants - - 73,233
Stock options 11,035 35,895 19,794
------------ ------------ -----------
Adjusted weighted average shares
used for dilutive EPS 4,103,223 3,683,346 3,330,915
======== ======== ========
All share and per share amounts have been retroactively
adjusted for a 3-for-1 stock split in the form of a 200%
stock dividend. (See Note 11)
Note 13- Retained Earnings
The Bank is subject to various regulatory capital
requirements administered by the federal banking agencies. Failure
to meet minimum capital requirements can initiate certain
mandatory, and possible additional discretionary, actions by the
regulators that, if undertaken, could have a direct material effect
on 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
classifications are also subject to qualitative judgments by the
regulators about components, risk weightings, and other factors.
F-25
SEVERN BANCORP, INC. AND SUBSIDIARIES
Annapolis, Maryland
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2002 AND 2001
Note 13- Retained Earnings - Continued
Quantitative measures established by regulation to ensure
capital adequacy require the Bank to maintain minimum amounts and
ratios (set forth in the table below) of total and Tier I capital
(as defined in the regulations) and risk-weighted assets (as
defined), and of Tier I capital (as defined) to average assets (as
defined). Management believes, as of December 31, 2002, that the
Bank meets all capital adequacy requirements to which it is
subject.
As of December 31, 2002, the most recent notification from
the Office of Thrift Supervision 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 I risk-based, and Tier I
leverage ratios as set forth in the table. There are no conditions
or events since that notification that management believes have
changed the Bank's category. The Bank's actual capital amounts and
ratios are also presented in the table.
The following table presents the Bank's capital position
based on the financial statements.
To Be Well
Capitalized Under
For Capital Prompt Corrective
Actual Adequacy Purposes Action Provisions
------------------------------ ------------------- -------------------
Amount % Amount % Amount %
------ - -------- - ------ -
December 31, 2002
Tangible (1) $39,898,384 8.8% $ 6,837,788 1.50% $ N/A N/A
Tier I capital (2) 39,893,384 12.1% N/A N/A 19,768,800 6.00%
Core (1) 39,893,384 8.8% 18,234,100 4.00% 22,792,625 5.00%
Risk-weighted (2) 43,781,865 13.3% 26,358,400 8.00% 32,948,000 10.00%
December 31, 2001
Tangible (1) $31,675,573 8.7% $ 5,468,226 1.50% $ N/A N/A
Tier I capital (2) 31,675,573 11.8% N/A N/A 16,066,080 6.00%
Core (1) 31,675,573 8.7% 14,581,936 4.00% 18,227,420 5.00%
Risk-weighted (2) 34,926,828 13.0% 21,421,440 8.00% 26,776,800 10.00%
(1) To adjusted total assets.
(2) To risk-weighted assets.
F-26
SEVERN BANCORP, INC. AND SUBSIDIARIES
Annapolis, Maryland
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2002 AND 2001
Note 13- Retained Earnings - Continued
The Corporation has no significant source of income other
than dividends from the Bank. As a result, the Corporation's
dividends will depend primarily upon receipt of dividends from the
Bank.
OTS regulations limit the payment of dividends and other
capital distributions by the Bank. The Bank is able to pay
dividends during a calendar year without regulatory approval to
the extent of the greater of (i) an amount which will reduce by
one-half its surplus capital ratio at the beginning of the year
plus all its net income determined on the basis of generally
accepted accounting principles for that calendar year or (ii) 75%
of net income for the last four calendar quarters.
The Bank is restricted in paying dividends on its stock to
the greater of the restrictions described in the preceding
paragraph, or an amount that would reduce its retained earnings
below its regulatory capital requirement, the accumulated bad debt
deduction, or the liquidation account described in Note 11.
The Bank was allowed a special bad debt deduction at various
percentages of otherwise taxable income for various years
effectively through December 31, 1987. If the amounts which
qualified as deductions for federal income tax purposes prior to
December 31, 1987 are later used for purposes other than to absorb
loan losses, including distributions in liquidations, they will be
subject to federal income tax at the then current corporate rate.
Retained earnings at December 31, 2002 and 2001 include $482,000,
for which no provision for federal income tax has been provided.
The unrecorded deferred income tax liability on the above amount
was approximately $186,000.
F-27
SEVERN BANCORP, INC. AND SUBSIDIARIES
Annapolis, Maryland
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2002 AND 2001
Note 14- Income Taxes
The income tax provision consists of the following for the years
ended December 31:
For Years Ended December 31,
----------------------------------------
2002 2001 2000
---- ---- ----
Current
Federal $4,754,616 $2,891,156 $2,062,586
State 1,053,776 643,719 463,048
--------- ---------- ----------
5,808,392 3,534,875 2,525,634
Deferred
Federal (226,686) (213,450) (184,774)
State (50,184) (47,252) (40,904)
----------- ---------- ----------
(276,870) (260,702) (225,678)
Other
Federal 113,832 113,833 113,833
State 25,200 25,200 25,200
----------- ----------- -----------
139,032 139,033 139,033
---------- ---------- ----------
$5,670,554 $3,413,206 $2,438,989
======== ======== ========
Other income tax provision consists of income tax from
preferred stock dividends.
The amount computed by applying the statutory federal income
tax rate to income before federal taxes is greater than the taxes
provided for the following reasons:
2002 2001 2000
---- ---- ----
Percent Percent Percent
of Pretax of Pretax of Pretax
Amount Income Amount Income Amount Income_
------ --------- ------ --------- ------ ----------
Statutory federal
income tax rate $4,970,383 34.00% $2,947,384 34.00% $2,170,604 34.00%
State tax net of
federal income
tax benefit 689,291 4.72 410,300 4.73 295,247 4.62
Other adjustments 10,880 .07 55,522 .64 (26,862) (.42)
------------------- ------------------ ----------- --------
$5,670,554 38.79% $3,413,206 39.37% $2,438,989 38.20%
======== ===== ======== ==== ======== =====
F-28
SEVERN BANCORP, INC. AND SUBSIDIARIES
Annapolis, Maryland
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2002 AND 2001
Note 14- Income Taxes - Continued
The tax effects of temporary differences that give rise to
significant portions of the deferred tax assets and deferred tax
liabilities at December 31, 2002 and 2001 are presented below:
2002 2001
---- ----
Deferred Tax Assets:
Allowances for losses $1,541,170 $1,295,073
Reserve for uncollected interest 29,179 4,949
----------- --------------
Total gross deferred tax assets 1,570,349 1,300,022
Deferred Tax Liabilities:
Federal Home Loan Bank of Atlanta
stock dividends (79,976) (79,976)
Mortgage servicing rights (7,469) (10,018)
Accelerated depreciation (392,548) (396,542)
---------- ----------
Total gross deferred tax liabilities (479,993) (486,536)
---------- ----------
Net deferred tax assets $1,090,356 $ 813,486
======== ========
Note 15- Related Party Transactions
During the years ended December 31, 2002, 2001 and 2000, the
Bank engaged in the transactions described below with parties that
may be deemed affiliated.
The land and building for the office where the Bank's primary
operating activities are conducted were leased from a stockholder
of the Bank. Rent paid on this property was $ -0-, $32,012 and
$61,157 for 2002, 2001 and 2000, respectively. Additionally, two
subsidiaries rent property from a director of the Bank. Rent paid
on these properties was $38,562, $32,010 and $25,170 for 2002,
2001 and 2000, respectively.
A director of the Bank is a member of a law firm that
represents the Bank in certain legal matters. The fees for
services rendered by that firm were $161,890, $80,866 and $68,852
for the years ended December 31, 2002, 2001 and 2000,
respectively.
F-29
SEVERN BANCORP, INC. AND SUBSIDIARIES
Annapolis, Maryland
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2002 AND 2001
Note 15- Related Party Transactions - Continued
A subsidiary uses a related party to perform maintenance work
on managed properties. The fees for services rendered by that firm
were $12,300 and $9,137 for the years ended December 31, 2002 and
December 31, 2001, respectively. The subsidiary was not part of
the Corporation during the year ended December 31, 2000.
The Bank has participation and loan servicing agreements
outstanding, totaling $218,871, $263,823 and $276,856 at December
31, 2002, 2001 and 2000, respectively, with various stockholders
and related parties.
In June, 2001 the Corporation purchased Louis Hyatt, Inc.
(see Note 17) from Louis Hyatt who is a stockholder of
the Corporation and a relative of the Chairman of the Board.
The Corporation purchased HS West, LLC from Louis Hyatt who
is a stockholder of the Corporation and a relative of the Chairman
of the Board. HS West, LLC had no income or expenses and consisted
only of land.
Management believes that the terms in the above mentioned
transactions were no less favorable to the Bank than the terms
that would have been obtained in transactions with non-affiliated
persons or entities.
Note 16- Disclosure About Fair Value of Financial Instruments
The estimated fair values of the Bank's financial instruments
are summarized below. The fair values of a significant portion of
these financial instruments are estimates derived using present
value techniques prescribed by the FASB and may not be indicative
of the net realizable or liquidation values. Also, the calculation
of estimated fair values is based on market conditions at a
specific point in time and may not reflect current or future fair
values.
The carrying amount is a reasonable estimate of fair value
for cash, federal funds and interest-bearing deposits in other
banks due to the short-term nature of these investments. Fair
value is based upon market prices quoted by dealers for investment
securities and estimates using bid prices published in financial
newspapers for mortgage backed securities. The carrying amount of
Federal Home Loan Bank of Atlanta stock is a reasonable estimate
of fair value. Loans receivable were discounted using a single
discount rate, comparing the current rates at which similar loans
would be made to borrowers with similar credit ratings and for the
same remaining maturities.
F-30
SEVERN BANCORP, INC. AND SUBSIDIARIES
Annapolis, Maryland
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2002 AND 2001
Note 16- Disclosure About Fair Value of Financial Instruments - Continued
These rates were used for each aggregated category of loans as
reported on the Office of Thrift Supervision Quarterly Report. The
fair value of demand deposits, savings accounts and money market
deposits is the amount payable on demand at the reporting date.
The fair value of fixed-maturity certificates of deposit is
estimated using the rates currently offered on deposits of similar
remaining maturities.
The Bank is a party to financial instruments with off-balance
sheet risk in the normal course of business, including loan
commitments. The loan commitments were a blended rate based on the
relative risk of the properties involved and the lines of credit
are at adjustable rates.
The estimated fair values of the Bank's financial instruments
are as follows:
December 31, 2002 December 31, 2001
------------------------------- -------------------------------
Carrying Fair Carrying Fair
Value Value Value Value
----------- ----- ---------- -----
Financial Assets
Cash, interest bearing
deposits in other
banks and federal
funds $ 18,660,235 $ 18,660,235 $ 6,038,459 $ 6,038,459
Investment securities 4,000,000 4,048,400 7,000,958 7,077,940
Mortgage backed
securities 5,661,304 5,669,640 212,021 216,262
FHLB of Atlanta stock 1,900,000 1,900,000 2,500,000 2,500,000
Loans held for sale 17,481,301 17,481,301 7,498,934 7,498,934
Loans receivable, net 401,343,360 373,532,000 335,142,276 343,399,000
Financial Liabilities
Deposits $377,925,041 $380,038,000 $286,917,568 $289,285,000
FHLB advances 34,000,000 33,783,262 42,000,000 41,466,634
Commitments - 24,771,785 - 796,857
F-31
SEVERN BANCORP, INC. AND SUBSIDIARIES
Annapolis, Maryland
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2002 AND 2001
Note 17- Merger
On July 1, 2001, the Corporation acquired Louis Hyatt, Inc.
("LHI") a real estate sales and management company (see Note 15).
"LHI" was 100% owned by Louis Hyatt. The Corporation issued 60,000
shares new shares and transferred 20,000 shares that were
previously owned by "LHI" for all the outstanding stock of "LHI".
The combination was accounted for under the purchase method of
accounting, and accordingly, the net assets were recorded at their
estimated fair values at the date of acquisition. "LHI's" assets
consisted primarily of fixed assets and, accordingly, the fair
market value adjustment of $1,415,829 will be depreciated over the
estimated lives of the assets. The excess of the purchase price
over the estimated fair value of the underlying net assets of
$333,569 was allocated to goodwill.
Unaudited proforma condensed financial statements are not
presented because the amounts are not material to the consolidated
financial statements.
Note 18- Condensed Financial Information (Parent Company Only)
Information as to the financial position of Severn Bancorp,
Inc. as of December 31, 2002 and 2001 and results of operations
and cash flows for each of the years ended December 31, 2002, 2001
and 2000 is summarized below. During the years ended December 31,
2002, 2001 and 2000, respectively, the parent received dividends
in the amount of $986,631, $718,818 and $539,760 from its
subsidiary, the Bank.
December 31,
2002 2001
---- ----
Statement of Financial Condition
Cash $ 363,279 $ 366,379
Equity in net assets of subsidiaries 39,061,475 30,651,583
Taxes receivable 11,064 -
Prepaid expenses and other assets - 9,550
--------------- --------------
$39,435,818 $31,027,512
========= =========
F-32
SEVERN BANCORP, INC. AND SUBSIDIARIES
Annapolis, Maryland
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2002 AND 2001
Note 18- Condensed Financial Information (Parent Company Only) - Continued
December 31,
2002 2001
---- ----
Taxes payable $ 5,925 $ 5,414
Accounts payable and accrued expenses 248,556 191,256
------------ ------------
254,481 196,670
Common stock 41,426 13,524
Common stock paid-in surplus 11,425,910 10,816,887
Retained earnings 27,714,001 20,000,431
---------- ----------
39,181,337 30,830,842
---------- ----------
$39,435,818 $31,027,512
========= =========
For the Years Ended December 31,
-----------------------------------
2002 2001 2000
---- ---- ----
Statement of Operations
Equity in net income of subsidiaries $9,029,617 $5,273,766 $3,950,623
General and administrative expenses 137,961 27,569 8,306
---------- ----------- ------------
Net income before income taxes 8,891,656 5,246,197 3,942,317
Provision for income taxes (benefit) (56,564) (9,373) (2,824)
----------- ------------ ------------
Net income $8,948,220 $5,255,570 $3,945,141
======== ======== ========
December 31,
--------------------------------------------------------
2002 2001 2000
---- ---- ----
Statement of Cash Flows
Cash Flows from Operating Activities:
Net income $8,948,220 $5,255,570 $3,945,141
Adjustments to Reconcile Net Income Net
Cash Provided by Operating Activities
Equity in net income of subsidiaries (9,029,617) (5,273,766) (3,950,623)
Increase in taxes receivable (11,064) - -
Decrease (increase) in other assets 9,550 14,824 (22,749)
Increase (decrease) in taxes payable 511 (9,298) 13,251
Increase in accounts payable and
accrued expenses 57,300 53,684 18,976
Tax benefit of exercised options 129,728 - -
----------- --------------- ---------------
Net cash provided by operating activities 104,628 41,014 3,996
F-33
SEVERN BANCORP, INC. AND SUBSIDIARIES
Annapolis, Maryland
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2002 AND 2001
Note 18- Condensed Financial Information (Parent Company Only) - Continued
December 31,
------------------------------------------------------------
2002 2001 2000
---- ---- ----
Cash Flows From Investing Activities
Dividends received from subsidiary $ 986,631 718,818 539,760
Investment in subsidiaries (587,878) (3,299,313) (26,772)
Cash consideration Louis Hyatt, Inc.
acquisition - net - (31,340) -
---------------- ----------- ----------------
Cash provided by (used) investing
activities 398,753 (2,611,835) 512,988
Cash Flows from Financing Activities
Dividends paid on capital stock (986,631) (718,818) (539,760)
Proceeds from exercise of options 480,150 214,500 19,800
Proceeds from exercise of warrants - 3,284,813 6,970
---------------- --------- ------------
Net cash (used) provided by financing
activities (506,481) 2,780,495 (512,990)
---------- --------- ----------
(Decrease) increase in cash and
cash equivalents $ (3,100) $ 209,674 $ 3,994
Cash and cash equivalents at beginning
of year 366,379 156,705 152,711
---------- ---------- ----------
Cash and cash equivalents at end of year $ 363,279 $ 366,379 $ 156,705
======== ======== ========
Supplemental Disclosures of Cash Flows Information:
Common stock issued for
acquired Company $ - $1,600,000$ -
There was no cash paid during the years ended December 31,
2002, 2001 and 2000 for income taxes or interest.
F-34
SEVERN BANCORP, INC. AND SUBSIDIARIES
Annapolis, Maryland
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2002 AND 2001
Note 19- Recent Accounting Pronouncements
In April 2002, FASB issued SFAS 145, "Rescission of FASB
Statements No. 4, 44, and 64, Amendment of FASB Statement No. 13,
and Technical Corrections". This Statement requires, among other
things, that gains and losses on the early extinguishment of debt
be classified as extraordinary only if they meet the criteria for
extraordinary treatment set forth in Accounting Principles Board
Opinion No. 30. The provisions of this Statement related to
classification of gains and losses on the early extinguishment of
debt are effective for fiscal years beginning after May 15, 2002.
In June 2002, FASB issued SFAS No. 146, "Accounting for Costs
Associated with Exit or Disposal Activities". This Statement
requires recording costs associated with exit or disposal
activities at their fair values when a liability has been
incurred. Under previous guidance, certain exit costs were accrued
upon management's commitment to an exit plan, which is generally
before an actual liability has been incurred. The provisions of
this Statement are effective for exit or disposal activities that
are initiated after December 31, 2002.
In October 2002, FASB issued SFAS No. 147, "Acquisitions of
Certain Financial Institutions" an amendment of FASB Statements
No. 72 and 144 and FASB Interpretation No. 9. The provision of
this Statement requires long-term customer-relationship intangible
assets of financial institutions such as depositor - and borrower
- relationship intangible assets and credit cardholder intangible
assets to be subject to the same undiscounted cash flow
recoverability test and impairment loss recognition and
measurement provisions that Statement 144 requires for other
long-lived assets that are held and used.
In November, 2002, FASB issued Interpretation No. 45
"Guarantor's Accounting and Disclosure Requirements for
Guarantees, Including Indirect Guarantees of Indebtedness of
Others" an Interpretation of FASB Statements No. 5, 57, and 107
and rescission of FASB Interpretation No. 34. This Interpretation
elaborates on the disclosures to be made by a guarantor in its
financial statements about its obligations under certain
guarantees that it has issued. The Interpretation also clarifies
that a guarantor is required to recognize, at the inception of a
guarantee, a liability for the fair value of the obligation
undertaken in issuing the guarantee. The provisions for this
Interpretation are applicable on a prospective basis to guarantees
issued or modified after December 31, 2002.
F-35
SEVERN BANCORP, INC. AND SUBSIDIARIES
Annapolis, Maryland
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2002 AND 2001
Note 19- Recent Accounting Pronouncements - Continued
In December 2002, FASB issued SFAS No. 148 "Accounting for
Stock-Based Compensation - Transition and Disclosure."
This Statement amends SFAS No. 123 "Accounting for Stock-
Based Compensation" to provide alternative methods of
transition for an entity that voluntarily changes to the fair
value based method of accounting for stock-based employee
compensation. In addition, SFAS No. 148 amends the disclosure
provisions of SFAS No. 123 to require prominent disclosure
about the effects on reported net income of an entity's accounting
policy decisions with respect to stock-based employee
compensation. Finally, SFAS No. 148 amends APB Opinion No. 28,
"Interim Financial Reporting" to require disclosure about
those effects in interim financial information.
These statements will not have a material impact on the
consolidated financial statements.
F-36