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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, DC 20549
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FORM 10-KSB
ANNUAL REPORT UNDER SECTION 13 OR 15(D) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the fiscal year ended DECEMBER 31, 1997
Commission File No.: 0-22961
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ANNAPOLIS NATIONAL BANCORP, INC.
(Name of small business issuer in its charter)
MARYLAND 52-1648903
(State or other jurisdiction of (I.R.S. Employer I.D. No.)
incorporation or organization)
108 ADMIRAL COCHRANE DRIVE, SUITE 300, ANNAPOLIS, MARYLAND 21401
(Address of principal executive offices) (Zip Code)
Issuer's telephone number: (410) 224-4455
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 $0.01 PER SHARE
(Title of class)
THE NASDAQ STOCK MARKET(SM)
(Name of exchange on which registered)
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Check whether the issuer (1) filed all reports required to be filed by
Section 13 or 15(d) of the Securities Exchange Act of 1934 during the past 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 past 90
days. Yes [X] No [ ]
Check if there is no disclosure of delinquent filers pursuant to Item 405
of Regulation S-B contained in this form and no disclosure will be contained, to
the best of the registrant's knowledge, in definitive proxy or information
statements incorporated by reference in Part III of this Form 10-KSB or any
amendment to this Form 10-KSB. [X]
Issuer's revenues for its fiscal year ended December 31, 1997 were
$1,084,197.
The aggregate market value of the voting stock held by non-affiliates of
the registrant, I.E., persons other than directors and executive officers of the
registrant is $12,820,658 and is based upon the last sales price as quoted on
The Nasdaq Stock Market for March 20, 1998.
The Registrant had 2,312,306 shares of Common Stock outstanding as of March
20, 1998.
Transitional Small Business Disclosure Format. Yes [ ] NO [X]
DOCUMENTS INCORPORATED BY REFERENCE
PORTIONS OF THE ANNUAL REPORT TO STOCKHOLDERS FOR THE YEAR ENDED DECEMBER
31, 1997, ARE INCORPORATED BY REFERENCE INTO PART II OF THIS FORM 10-KSB.
PORTIONS OF THE PROXY STATEMENT FOR THE 1998 ANNUAL MEETING OF SHAREHOLDERS
ARE INCORPORATED BY REFERENCE INTO PART III OF THIS FORM 10-KSB.
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INDEX
PAGE
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PART I
Item 1. Description of Business.............................................................................3
Item 2. Properties.........................................................................................10
Item 3. Legal Proceedings..................................................................................10
Item 4. Submission of Matters to a Vote of Security Holders................................................10
Item 5. Executive Officers of the registrant...............................................................11
PART II
Item 6. Market for Common Equity and Related Stockholder Matters...........................................11
Item 7. Management's Discussion and Analysis or Plan of Operation..........................................11
Item 8. Financial Statements...............................................................................11
Item 9. Changes In and Disagreements With Accountants on Accounting and Financial Disclosure...............12
PART III
Item 10. Executive Compensation.............................................................................12
Item 11. Security Ownership of Certain Beneficial Owners and Management.....................................12
Item 12. Certain Relationships and Related Transactions.....................................................12
Item 13. Exhibits and Reports on Form 8-K...................................................................12
SIGNATURES
2
PART I
ITEM 1. DESCRIPTION OF BUSINESS
GENERAL
ANNAPOLIS NATIONAL BANCORP, INC.
Annapolis National Bancorp, Inc. (the "Company"), formerly Maryland Publick
Banks, Inc., was incorporated in May 1988 in Maryland for the purpose of
acquiring and holding all of the outstanding stock of Annapolis National Bank
(the "Bank"). The Company is a registered Bank Holding Company pursuant to the
Bank Holding Company Act (the "BHCA"). The Company was capitalized by an initial
offering of common stock which was sold at $10.00 per share in June 1989 and,
subsequent to January 1990, an offering at $12.50. The Company issued 833,334
shares of common stock at $6.00 per share for a total of $5 million in a public
offering that closed on September 30, 1997 (the "Public Offering"). The offering
expenses and commissions paid to underwriters and brokers in the Public Offering
totaled $491,000. In addition, the Company retired debt and related accrued
interest of $1.1 million. The net proceeds of $3.4 million is being used for
general corporate purposes. The Company's only significant activity is the
operation of the Bank. On a consolidated basis at December 31, 1997, the
Company's total assets were $120.8 million, total liabilities were $109.7
million and stockholders' equity was $11.1 million.
ANNAPOLIS NATIONAL BANK
The Bank is a commercial bank organized under the laws of the United
States. The Bank is a community oriented bank and the only independent
commercial bank headquartered in Annapolis, Maryland. As the Company's only
subsidiary, the Bank currently operates as a full service commercial bank
through its five branches located in Anne Arundel County, Maryland, and one
branch located on Kent Island in Queen Anne's County, Maryland. The Bank's
principal business consists of originating loans and attracting deposits. The
Bank originates commercial loans (including Small Business Administration
("SBA") loans), commercial real estate loans, construction loans, one- to
four-family real estate loans and, to a lesser extent, home equity and consumer
loans. The Bank also invests in U.S. Treasury and U.S. Government agency
securities and other securities issued by or guaranteed by the federal
government. At December 31, 1997, the Bank's loan portfolio totaled $72.2
million. Of this amount, $30.7 million or 42.61% were commercial loans, $20.4
million or 28.34% were commercial real estate loans, $10.0 million or 13.91%
were construction loans, $5.2 million or 7.25% were one- to four-family
residential mortgage loans, $3.4 million or 4.70% were home equity loans and
$2.3 million or 3.19% were consumer and other loans.
BACKGROUND
The Bank was formed as a de novo bank and commenced operations from a
single Annapolis location in January 1990. In June 1990, the Company acquired
most of the assets and liabilities of Gibraltar Savings and Loan, F.A.
("Gibraltar") from the Resolution Trust Corporation as receiver for Gibraltar,
expanding its branch network to five branches. This acquisition was funded, in
part, through a $3.2 million unsecured loan to the Company from a director who
is the principal stockholder of the Company (the "Principal Stockholder") which
bore interest at the Bank's prime rate less 2.0%. The acquisition was accounted
for as a purchase and resulted in a premium paid for the core deposits and other
intangible assets in the amount of $2.2 million to be amortized over a 15 year
period. At December 31, 1990, the fiscal year end following this acquisition,
the Company's assets totaled $43.6 million.
From June 1990 through December 31, 1996, management of the Company
concentrated its efforts on growing the Bank by developing loan and deposit
portfolios primarily in Anne Arundel County, Maryland and the surrounding
counties. The Bank experienced steady growth in assets and deposits while its
earnings consistently trailed its peers due to a high level of operating
expenses and loan losses.
In December 1994, the Company conducted a rights offering through which it
offered its stockholders, at the price of $3.50 per share, the right to purchase
2.5 shares of its Common Stock for each share of common stock owned. The primary
purpose of this offering was to convert the $3.2 million of debt accumulated in
the Gibraltar acquisition into capital to reduce the Company's interest expense
and increase its capitalization. A total of 937,672 shares were sold, of which
907,143 were sold to the Principal Stockholder in exchange for retirement of the
principal portion of the debt. A new note, which had a maturity date of December
31, 1997, was issued to the Principal Stockholder in the amount of $848,400 to
cover the portion of the loan that remained outstanding, and accrued interest at
the Wall Street Journal ("WSJ") prime rate plus 1.0%.The Company repayed the
debt owed to Mr. Lerner in full using a portion of the proceeds from its initial
public offering which closed on September 30, 1997.
3
REVISED BUSINESS STRATEGY
During the fourth quarter of 1996, the Board of Directors determined that
there was a need to implement a revised business strategy improve the Company's
financial performance. Several members of senior management were relieved of
their responsibilities late in 1996 and early in 1997 and certain other members
of senior management resigned during this same period. In February 1997, the
Board of Directors engaged John W. Marhefka, Jr. as President and Chief
Executive Officer of the Bank and as Vice President and Chief Executive Officer
of the Company. The Board of Directors believes that Mr. Marhefka's management
skills and local market experience will enable him to guide the Company and the
Bank through a reorganization process which will improve operating results
through implementation of a revised business plan. As President and Chief
Executive Officer of Annapolis Bancshares, Inc. and Bank of Annapolis, he
successfully guided those companies from their inception in 1988 through more
than eight years of steady growth and strong continually increasing earnings
performance before they merged with Sandy Springs Bancorp, Inc. In March 1997,
Mr. Marhefka hired Russell J. Grimes, who was appointed as Senior Vice
President, Chief Financial Officer and Treasurer of the Bank and Chief Financial
Officer and Treasurer of the Company. Mr. Grimes was formerly Vice President,
Chief Financial Officer and Treasurer of Annapolis Bancshares, Inc. and Bank of
Annapolis and was instrumental in implementing several successful financial
strategies with those firms. In April 1997, the Board appointed Stanley H.
Katsef as a Director and Vice Chairman of the Board. In addition to his role as
a Director, Mr. Katsef is an employee who assists the Board and Mr. Marhefka
with business development, public relations, and management strategy issues. Mr.
Katsef was formerly Chairman of the Board of Annapolis Bancshares, Inc. and Bank
of Annapolis. Additionally, the Board of Directors adopted a requirement that,
in order to assure a high level of commitment to the Company and the Bank, all
Directors must own at least $100,000 of the Company's common stock. Following
the imposition of this requirement, the composition of the Board of Directors
changed during April 1997. In addition to Messrs. Marhefka and Katsef, two
additional Directors were added who also have long-standing ties to Anne Arundel
County.
The reconstituted Board of Directors and senior management team are in the
process of implementing a revised business strategy designed to enhance
stockholder value. This strategy includes the following components:
CONSOLIDATING THE BANK'S BRANCH NETWORK TO INCLUDE FEWER BRANCH LOCATIONS
AND TO REDUCE OPERATING EXPENSES. The Bank currently operates seven facilities,
six branch offices and a separate 9,500 square foot administrative and
operations headquarters facility. As a result, the Bank's historical operating
expenses have been considerably higher than its peers that, at a comparable
asset size, operate from fewer locations. New management has undertaken a
strategy of reducing the number of locations from which the Bank operates.
Toward that end, the Bank entered into a lease at 900 Bestgate Road in Annapolis
to consolidate its two existing Annapolis branch office locations. Since the new
site is located between the Bank's existing Annapolis branches, management
anticipates that it will retain most of its current customers following the
consolidation. In addition, management believes that the new location is
superior in amenities to both of the Bank's current Annapolis locations and will
allow the Bank to better serve both current and new Annapolis customers. The new
Annapolis location is a "turn-key" existing banking location which required
minimal expense to be ready for occupancy. By reducing the number of branch
offices from six to five, management expects to reduce operating expenses
following the consolidation, which occured in October 1997. Management is
evaluating other branch network consolidation options. Also being evaluated is
the feasibility of relocating the Bank administrative and operations
headquarters to a lower cost and more highly visible location which may be
combined with a branch location to further reduce the total number of facilities
which the Bank operates.
REDUCING NON-PERFORMING ASSETS BY IMPLEMENTING MORE STRINGENT UNDERWRITING
CRITERIA AND MORE AGGRESSIVE COLLECTION PROCEDURES, AND BY INCREASING SECURED
REAL ESTATE LENDING. The Bank has historically had a high level of
non-performing assets and loan losses in relation to its peers. New management
has made a priority of emphasizing the resolution of problem assets by
aggressively pursuing the Bank's default remedies. In doing so, management
expects to reduce the amount of the Bank's existing non-performing assets.
During the first quarter of 1997, management conducted an evaluation of the loan
portfolio and provided for specific loan loss reserves for those assets for
which losses are expected. Additionally, new lending standards are being
implemented in an effort to improve asset quality. Such standards include an
increased emphasis on readily marketable collateral for new loans and a
de-emphasis on certain SBA loan programs.
REDUCING INTEREST EXPENSE BY RETIRING $1.1 MILLION OF COMPANY DEBT WITH A
PORTION OF THE PUBLIC OFFERING PROCEEDS. At December 31, 1997, the Company had
payed in full an unsecured loan from the Principal Stockholder with a principal
balance of $848,400, excluding accrued interest payable which accrued interest
at a rate of 1.0% above the WSJ prime rate. Accrued interest on this debt
totaled $59,574 in 1997, and $78,759 in 1996. The Company retired this debt and
accrued interest on September 30, 1997, following the completion of the Public
Offering.
4
FOSTERING SUPPORT FOR THE BANK BY INCREASING THE LOCAL OWNERSHIP OF THE
COMPANY BY MARKETING THE OFFERING TO A LARGE NUMBER OF BUYERS WITH THE BANK'S
LOCAL COMMUNITY. Management believes that those persons within the Bank's market
area who become stockholders of the Company are likely to become customers,
supporters and business referral sources of the Bank. Consequently, the Company
intends to market the Offering primarily within the Bank's market area to build
a backbone of community support. Also, the Company has strategically established
a low minimum subscription amount to encourage many small investors to become
owners of the Company and have a vested interest in the Bank.
RESTRUCTURING INTERNAL BANK OPERATIONS TO ATTAIN OPERATING EFFICIENCIES AND
COST REDUCTIONS. Certain of the Bank's systems of processing data and items are
inefficient and expensive. Management is evaluating alternative systems which
are expected to significantly reduce operating expenses. Additionally,
management is re-evaluating expenses bank-wide with a goal of making cost
conscious decisions about whether to continue purchasing certain goods and
services and, if they are to continue being purchased, soliciting competing bids
for such goods and services so as to assure optimum value for dollars spent.
Also, management has recently made an evaluation of its staffing, eliminating
several employment positions and reassigning those duties to other existing
personnel.
INCREASING NET INTEREST INCOME BY EXPANDING THE LOAN AND DEPOSIT
PORTFOLIOS; THE ADDITIONAL CAPITAL PROVIDED BY THE PUBLIC OFFERING WILL SUPPORT
SUCH GROWTH ENABLING THE BANK TO CONTINUE TO COMPLY WITH REGULATORY CAPITAL
REQUIREMENTS. The Bank intends to pursue growth in its loan and deposit
portfolios which it expects will add to net interest income. Growth in the loan
portfolio is intended to be accomplished by utilizing the substantial contacts
of new officers and directors of the Bank, adding additional loan personnel,
aggressively promoting competitively priced products, developing new customer
relationships based upon the Bank's position as the only independent commercial
bank headquartered in Annapolis, and by placing a greater emphasis on real
estate loans whose principal is expected to repay less quickly than commercial
loans. Growth in the deposit portfolio is intended to be accomplished by
aggressively promoting competitively priced products. The increased capital
realized from the Public Offering will allow the Bank to grow while continuing
to comply with regulatory capital requirements. Additionally, such new capital
will provide a low cost source of funds to enhance the Bank's net interest
income.
INCREASING NON-INTEREST INCOME THROUGH EXPANDING ONE- TO FOUR-FAMILY
RESIDENTIAL MORTGAGE SALES AND OTHER FEE INCOME OPPORTUNITIES. Management
expects to increase non-interest income in several areas. The Bank will add
additional home loan originators, expand its array of home loan products, and
seek to build relationships with builders which are intended to increase
opportunities to originate one- to four-family residential mortgage loans for
sale. In doing so, management expects that gains on sales of loans into the
secondary home loan market will increase. The Bank also expects to increase fee
income from operation of its automated teller machine ("ATM") network and from
other sources of fee income.
LENDING ACTIVITIES
The types of loans that the Bank may originate are subject to federal laws
and regulations. Interest rates charged by the Bank on loans are affected by the
demand for such loans and the supply of money available for lending purposes and
the rates offered by competitors. These factors are, in turn, affected by, among
other things, economic conditions, monetary policies of the federal government,
including the Federal Reserve Board, and legislative tax policies.
ANALYSIS OF LOANS
The following table presents the composition of the loan portfolio over the
previous five years.
YEARS ENDED DECEMBER 31,
(DOLLARS IN THOUSANDS)
1997 1996 1995 1994 1993
------------------ ------------------ ------------------ ------------------ ------------------
AMOUNT PERCENT AMOUNT PERCENT AMOUNT PERCENT AMOUNT PERCENT AMOUNT PERCENT
------- ------- ------- ------- ------- ------- ------- ------- ------- -------
Commercial loans..... $30,749 42.61% $30,469 43.80% $27,727 48.94% $27,025 47.14% $19,724 48.33%
Real estate:
Commercial......... 20,448 28.34 17,845 25.65% 13,553 23.92 5,601 9.77 12,806 31.38
Construction....... 10,035 13.91 10,173 14.62 7,937 14.01 8,672 15.12 345 0.85
One-to four-
family.......... 5,232 7.25 7,002 10.07 4,391 7.75 12,798 22.32 5,637 13.82
Home equity........ 3,393 4.70 1,744 2.51 1,197 2.11 1,016 1.77 615 1.51
Consumer loans....... 2,306 3.19 2,332 3.35% 1,848 3.27 2,226 3.88 1,676 4.11
------- ------- ------- ------- ------- ------- ------- ------- ------- -------
Total loans..... 72,162 100.00% 69,565 100.00% 56,653 100.00% 57,338 100.00% 40,803 100.00%
Less:
Allowance for loan
losses.......... (1,177) (765) (617) (687) (574)
------- ------- ------- ------- -------
Net loans
receivable......... $70,985 $68,800 $56,036 $56,651 $40,229
5
The Bank's loan portfolio consists of commercial, commercial real estate,
residential construction, one- to four-family residential mortgage, home equity
and consumer loans. At December 31, 1997, the Bank's loan portfolio totaled
$72.2 million, of which $30.7 million, or 42.61%, were commercial loans; $20.4
million, or 28.34%, were commercial real estate loans; $10.0 million, or 13.91%,
were construction loans; $5.2 million, or 7.25%, were one- to four-family
residential mortgage loans; $3.4 million, or 4.70% were home equity loans and
$2.3 million, or 3.19%, were consumer and other loans. All of the loans in the
Bank's portfolio are either adjustable-rate or short term fixed-rate loans with
terms to maturity of 30 days to 30 years.
LOAN MATURITY. The following table shows the remaining contractual maturity
of the Bank's loans at December 31, 1997. The table does not include the effect
of future principal prepayments
AT DECEMBER 31, 1997
------------------------------------------------------------
DUE AFTER ONE
DUE IN ONE YEAR BUT BEFORE DUE AFTER NON ACCRUAL
YEAR OR LESS FIVE YEARS FIVE YEARS LOANS
------------ --------------- ---------- -----------
Commercial loans............................................. $ 26,902 $ 2,784 $ 285 $ 778
Real Estate
Commercial................................................. 11,295 9,097 56 --
Construction............................................... 9,246 789 -- --
One-to four-family......................................... 2,817 858 1,557 --
Home equity loans.......................................... 3,393 -- -- --
Consumer loans............................................... 1,216 1,090 -- --
------------ --------------- ---------- -----------
Total Loans............................................. $ 54,869 $14,618 $1,898 $ 778
------------ --------------- ---------- -----------
------------ --------------- ---------- -----------
TOTAL
-------
Commercial loans............................................. $30,749
Real Estate
Commercial................................................. 20,448
Construction............................................... 10,035
One-to four-family......................................... 5,232
Home equity loans.......................................... 3,393
Consumer loans............................................... 2,306
-------
Total Loans............................................. $72,162
-------
-------
The following table sets forth at December 31, 1997, the dollar amount of
gross loans receivable contractually due after December 31, 1998, and whether
such loans have fixed interest rates or variable interest rates.
DUE AFTER DECEMBER 31, 1997
--------------------------------------
FIXED RATE VARIABLE RATE TOTAL
---------- ------------- -------
Commercial loans........................................................................ $1,475 $ 1,594 $ 3,069
Real Estate
Commercial............................................................................ 489 8,664 9,153
Construction.......................................................................... 789 -- 789
One-to four-family.................................................................... 1,274 1,141 2,415
Home equity loans..................................................................... -- -- --
Consumer loans.......................................................................... 490 600 1,090
---------- ------------- -------
Total Loans........................................................................ $4,517 $11,999 $16,516
---------- ------------- -------
---------- ------------- -------
The Bank does not engage in longer term fixed-rate portfolio lending. Any
long term fixed-rate loans made by the Bank are sold in the secondary market.
COMMERCIAL LENDING. The Bank offers commercial business loans to businesses
operating in the Bank's primary market area. These loans consist of lines of
credit which require an annual repayment, adjustable-rate loans with terms of
five to seven years, and short term fixed-rate loans with terms of up to three
years. Such loans are offered in amounts up to $750,000 and are generally
secured by receivable, inventories, equipment and other assets of the business.
The Bank generally requires personal guarantees on its commercial loans. The
Bank also offers unsecured commercial loans to businesses on a selective basis.
These types of loans are made to existing customers and are of a short duration,
generally one year or less, up to $500,000. The Bank also originates commercial
loans which are guaranteed by the Small Business Administration. The Bank has
been an active participant in a variety of SBA loan programs.
Commercial business loans are generally of higher risk and typically are
made on the basis of the borrower's ability to make repayment from the cash flow
of the borrower's business. As a result, the availability of funds for the
repayment of commercial business loans may be substantially dependent on the
success of the business itself. Further, the collateral securing the loans may
depreciate over time, may be difficult to appraise and may fluctuate in value
based on the success of the business. In order to reduce the overall risk and
cost of its loan portfolio, the Bank intends to reduce the ratio of commercial
loans to total loans and may reduce the level of its SBA loans.
6
COMMERCIAL REAL ESTATE LENDING. The Bank originates adjustable-rate
commercial real estate loans that are generally secured by properties used for
business purposes such as small office buildings or a combination of residential
and retail facilities located in the Bank's primary market area. The Bank's
underwriting procedures provide that commercial real estate loans may generally
be made in amounts up to 80% of the lower of the appraised value or sales price
of the property, subject to the Bank's current loans-to-one-borrower limit,
which at December 31, 1997, was $1.7 million. These loans may be made with terms
up to 25 years and are generally offered at interest rates which adjust annually
or annually after an initial three year period in accordance with the prime rate
as reported in the Wall Street Journal. In reaching a decision as to whether or
not to make a commercial real estate loan, the Bank considers the value of the
real estate to be financed and the credit strength of the borrower and/or the
lessee of the real estate project. The Bank has generally required that the
properties securing commercial real estate loans have debt service coverage
ratios of at least 1.2 times.
Loans secured by commercial real estate properties generally involve larger
principal amounts and a greater degree of risk than one- to four-family
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 such loans may be subject to adverse conditions
in the real estate market or the economy. The Bank seeks to minimize these risks
through its underwriting standards, which require such loans to be qualified on
the basis of the property's value, debt service ratio and, under certain
circumstances, additional collateral.
CONSTRUCTION LENDING. The Bank originates construction loans on both one-to
four-family residences and on commercial real estate properties. The Bank
originates two types of residential construction loans, consumer and builder.
The Bank originates consumer construction loans to build a primary residence, a
secondary residence, or an investment or rental property. The Bank will
originate builder construction loans to companies engaged in the business of
constructing homes for resale. These loans may be for homes currently under
contract for sale, model homes from which other homes will be marketed within a
subdivision or, on a very limited basis, homes built for speculative purposes to
be marketed for sale during construction. Although the Bank attempts to procure
permanent end financing, many of the Bank's construction loans, at the time
entered into with the Bank, have permanent end financing committed by other
financial institutions.
The Bank originates land acquisition and development loans with the source
of repayment being either the sale of finished lots or the sale of homes to be
constructed on the finished lots. The Bank will originate land acquisition,
development, and construction loans on a revolving line of credit basis for
subdivisions whereby the borrower may draw upon such line of credit as lots are
sold for the purpose of improving additional lots. Construction loans are
generally offered with terms up to six months for consumer loans, up to twelve
months for builder loans, and up to eighteen months for land development loans.
Construction loans are generally made in amounts up to 80% of the value of
the security property. During construction, loan proceeds are disbursed in draws
as construction progresses based upon inspections of work in place by
independent construction inspectors.
At December 31, 1997, the Bank had construction loans, including land
acquisition and development loans totaling $10.0 million, or 13.91% of the
Bank's total loan portfolio, of which $7.2 million consisted of one- to
four-family residential construction loans, $851,000 consisted of commercial
real estate construction loans and $2.0 million consisted of land acquisition
and development loans.
Construction loans are generally considered to involve a higher degree of
credit risk than long-term financing on improved, owner-occupied real estate.
Risk of loss on a construction loan is dependent largely upon the accuracy of
the initial estimate of the security property's value upon completion of
construction as compared to the estimated costs of construction, including
interest. Also, the Bank assumes certain risks associated with the borrowers'
ability to complete construction timely and in a workmanlike manner. If the
estimate of value proves to be inaccurate, or if construction is not performed
timely or accurately, the Bank may be confronted with a project which, when
completed, has a value which is insufficient to assure full repayment.
One- to Four-Family Residential Mortgage Lending. The Bank currently offers
both fixed-rate and adjustable-rate mortgage loans, first and second mortgage
loans secured by one- to four-family residences and lots for one- to four-family
residences located throughout Central Maryland. It is currently the general
policy of the Bank to originate for sale in the secondary market one-to
four-family fixed-rate residential mortgage loans which conform, except as to
size, to the underwriting standards of Fannie Mae, and Freddie Mac, and to
originate for investment adjustable rate one- to four-family residential
mortgage loans. The Bank generally does not retain the servicing rights of loans
it sells and sells such loans without recourse, with the exception of a recourse
in the event of breaches for any representations or warranties made by the Bank.
The Bank
7
recognizes, at the time of sale, the cash gain or loss on the sale of the loans
based on the difference between the net cash proceeds received and the carrying
value of the loans sold. One- to four-family mortgage loan originations are
generally obtained from the Bank's loan representatives and their contacts with
the local real estate industry, direct contacts made by the Bank's and the
Company's directors, existing or past customers, and members of the local
communities.
At December 31, 1997, one- to four-family residential mortgage loans
totaled $5.2 million, or 7.25%, of total loans. Of the one- to four-family
mortgage loans outstanding at that date, $1.6 million were fixed-rate loans with
terms of up to three years with a balloon payment at the end of the term and
$3.6 million were adjustable-rate mortgage loans. The Bank currently offers a
number of adjustable-rate mortgage loans with terms of up to 30 years and
interest rates which adjust annually from the outset of the loan or which adjust
annually after a 1 or 3 year initial period in which the loan has a fixed rate.
The interest rates for the majority of the Bank's adjustable-rate mortgage loans
are indexed to the one year Treasury Constant Maturity Index. Interest rate
adjustments on such loans are limited to a 2% annual adjustment cap with a
maximum adjustment of 6% over the life of the loan.
The origination of adjustable-rate residential mortgage loans, as opposed
to fixed-rate residential mortgage loans, helps to reduce the Bank's exposure to
increases in interest rates. However, adjustable-rate loans generally pose
credit risks not inherent in fixed-rate loans, primarily because as interest
rates rise, the underlying payments of the borrower rise, thereby increasing the
potential for default. Although the Bank offers adjustable-rate loans at below
market interest rates, all loans are underwritten to assure that the borrower is
qualified on a fully-indexed basis.
Periodic and lifetime caps on interest rate increases help to reduce the
risks associated with the Bank's adjustable-rate loans, but also limit the
interest rate sensitivity of its adjustable-rate mortgage loans.
The Bank currently originates one- to four-family residential mortgage
loans in amounts up to 80% of the lower of the appraised value or the selling
price of the property securing the loan. Mortgage loans originated by the Bank
generally include due-on-sale clauses which provide the Bank with the
contractual right to deem the loan immediately due and payable in the event the
borrower transfers ownership of the property without the Bank's consent.
Due-on-sale clauses are an important means of adjusting the yields on the Bank's
fixed-rate mortgage loan portfolio and the Bank has generally exercised its
rights under these clauses.
HOME EQUITY LENDING. As of December 31, 1997, home equity loans totaled
$3.4 million, or 4.70% of the Bank's total loan portfolio. Fixed-rate,
fixed-term home equity loans and adjustable rate home equity lines of credit are
offered in amounts up to 100% of the appraised value with a maximum loan amount
of $100,000. Fixed-rate, fixed-term home equity loans are offered with terms up
to five years and home equity lines of credit are offered with terms up to
twenty years. Substantially all of the Bank's home equity loans are adjustable
rate and reprice with changes in the WSJ prime rate.
CONSUMER LENDING. The Bank's portfolio of consumer loans primarily consists
of adjustable rate, personal lines of credit and installment loans secured by
new or used automobiles, new or used boats, and loans secured by deposit
accounts. Unsecured consumer loans are made with a maximum term of three years
and a maximum loan amount based on a borrower's financial condition. At December
31, 1997, consumer loans totaled $2.3 million or 3.19% to total loans
outstanding. Consumer loans are generally originated in the Bank's primary
market area.
CREDIT RISK MANAGEMENT
The Bank's allowance for loan losses is established through a provision for
loan losses based on management's evaluation of the risks inherent in its loan
portfolio and the general economy. The allowance for loan losses is maintained
at an amount management considers adequate to cover estimated losses in loans
receivable which are deemed probable and estimable based on information
currently known to management. The allowance is based upon a number of factors,
including current economic conditions, actual loss experience and industry
trends. In addition, various regulatory agencies, as an integral part of their
examination process, periodically review the Bank's allowance for loan losses.
Such agencies may require the Bank to make additional provisions for estimated
loan losses based upon judgments different from those of management. As of
December 31, 1997, the Bank's allowance for loan losses was $1.2 million or 1.6%
of total loans and 102.44% of non-performing loans as compared to $765,000, or
1.1% of total loans and 38.35% of non-performing loans as of December 31, 1996.
The Bank had total non-performing loans of $1.1 million and $2.0 million at
December 31, 1997 and December 31, 1996, respectively, and non-performing loans
to total loans of 1.59% and 2.87%, at December 31, 1997, and December 31, 1996,
respectively.
The Bank continues to monitor and modify its allowances for loan losses as
conditions dictate. While management believes that, based on information
currently available, the Bank's allowance for loan losses is sufficient to cover
losses
8
inherent in its loan portfolio at this time, no assurances can be given that the
Bank's level of allowance for loan losses will be sufficient to cover future
loan losses incurred by the Bank or that future adjustments to the allowance for
loan losses will not be necessary if economic and other conditions differ
substantially from the economic and other conditions at the time management
determined the current level of the allowance for loan losses. Management may in
the future increase its level of loan loss allowances as a percentage of total
loans and non-performing loans as its loan portfolio increases.
ANALYSIS OF CREDIT RISK
Activity in the allowance for loan losses for the preceding two years ended
December 31 is shown below:
AT DECEMBER 31,
(DOLLARS IN THOUSANDS)
1997 1996
------- -------
Total loans outstanding................................................................................. $72,162 $69,565
Average loans outstanding............................................................................... 72,385 62,144
Allowance for loan losses at beginning of period........................................................ 765 617
Provision charged to expense............................................................................ 748 452
------- -------
Chargeoffs:
Residential/commercial real estate.................................................................... 0 15
Commercial loans...................................................................................... 362 279
Consumer and other loans.............................................................................. 6 28
------- -------
Total.............................................................................................. 368 322
------- -------
Recoveries:
Residential/commercial real estate.................................................................... 9 8
Commercial loans...................................................................................... 21 10
Consumer and other loans.............................................................................. 2 --
------- -------
Total.............................................................................................. 32 18
------- -------
Net chargeoffs.......................................................................................... 336 304
------- -------
Allowance for loan losses at end of period.............................................................. $ 1,177 $ 765
------- -------
------- -------
Allowance for loan losses as a percent of total loans................................................... 1.63% 1.10%
Net chargeoffs as a percent of average loans............................................................ .46% .49%
------- -------
------- -------
PERSONNEL
As of December 31, 1997 the Bank had 50 authorized full-time positions and
13 authorized part-time employee positions.
FEDERAL TAXATION
The Company and the Bank file consolidated federal income tax returns and
separate Maryland income tax returns. The Company and the Bank use the accrual
method of accounting, and are subject to federal income taxation in the same
manner as other corporations with some exceptions, notably the Bank's reserve
for bad debts. This discussion of tax matters is intended only as a summary and
is not intended to be a comprehensive description of the tax rules applicable to
the Bank or the Company. The Bank has not been audited by the Internal Revenue
Service or State of Maryland in the last 5 years. For its 1997 taxable year, the
Bank is subject to a maximum federal income tax rate of 34%.
STATE AND LOCAL TAXATION
STATE OF MARYLAND. The Company files a Maryland income tax return.
"Maryland Taxable Income" generally means federal taxable income, subject to
certain adjustments (including the addition of interest income on state and
municipal obligations and the exclusion of interest income on United States
Treasury obligations). The exclusion of income on United States Treasury and
certain United States agency obligations has the effect of reducing Maryland
taxable income. For 1997, neither the Company nor the Bank accrued or payed
Maryland income tax due to these exclusions. The Bank is required to file an
annual report with and pay an annual franchise tax to the State of Maryland.
Taxable income reported on a franchise
9
tax return is similar to taxable income on a Maryland income tax return, except
that U.S. government and agency obligations are only 75% excluded.
IMPACT OF NEW ACCOUNTING STANDARDS
In 1997, the Company adopted Statement of Financial Accounting Standards
(SFAS) No. 128, Earnings per Share which changes the earnings per share
disclosed from primary and fully diluted per share amounts to basic and diluted
per share. Under SFAS No. 128, basic earnings per share are determined by
dividing net income by the weighted average number of shares of common stock
outstanding. Diluted earnings per share is calculated including the average
dilutive common stock equivalents outstanding during the period. Earnings per
share disclosures for prior periods have been restated to conform to these new
calculation methods. Dilutive common equivalent shares consist of stock options,
calculated using the treasury stock method. In loss periods, dilutive common
equivalent shares are excluded since the shares would be antidilutive.
Information relating to the regulation and supervision of the registrant
appears in the registrant's 1997 Annual Report to Stockholders on page 21, and
is incorporated herein by reference.
ITEM 2. PROPERTIES
The executive offices of the Company and the Bank are located at 180
Admiral Cochrane Drive, Suite 300, Annapolis, Maryland 21401.
The following table sets forth the location of and certain additional
information regarding the offices of the Company and the Bank at December 31,
1997.
ORIGINAL NET BOOK VALUE
YEAR OF PROPERTY OR
LEASED YEAR OF LEASEHOLD
LEASED/ OR LEASE IMPROVEMENTS AT
LOCATION OWNED ACQUIRED EXPIRATION DECEMBER 31, 1997
- ---------------- ------------ -------- ---------- -----------------
Administration Leased 1995 2005 $49,408
Bestagate Leased 1997 1999 22,275
Edgewater Land Leased 1996 2006(1) 418,262
Cape St. Claire Leased 1995 2000(1) 72,121
Kent Island Leased 1990 1998(1) -0-
Severna Park Leased 1996 2006(1) 18,718
- ---------------
(1) These leases may be extended at the option of the Company for periods
ranging from three to twenty years.
The Bank consolidated its West Street and Taylor Avenue branches located in
Annapolis to one new location at 900 Bestgate Road in Annapolis on October 14,
1997.
ITEM 3. LEGAL PROCEEDINGS
The Company is not involved in any pending legal proceedings other than
routine legal proceedings occurring in the ordinary course of business. Such
routine legal proceedings, in the aggregate, are believed by management to be
immaterial to the Company's financial condition or results of operations.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
None.
10
ITEM 5. EXECUTIVE OFFICERS OF THE REGISTRANT
The information relating to directors and named executive officers of the
Registrant is incorporated herein by reference to the Registrant's Proxy
Statement for the Annual Meeting of Shareholders to be held on April 23, 1998 at
pages 4 through 6. In addition, information concerning Executive Officers who
are not directors is set forth below:
AGE AT
NAME 12/31/97 POSITION WITH THE COMPANY AND BANK AND PAST FIVE YEARS EXPERIENCE
- ----------------------- -------- ---------------------------------------------------------------------
Jeffrey S. Armiger 41 Senior Vice President, Business Banking of the Bank. Mr. Armiger has
been an officer of the Bank since 1990 and is primarily responsible
for the Bank's Commercial loan activities including business
development and relationship management. Mr. Armiger has held similar
positions with First American Bank.
Kevin J. Barron 42 Senior Vice President, Real Estate Lending, of the Bank. Mr. Barron
has been an officer of the Bank since December 1997, and is primarily
responsible for the Bank's Commercial and Residential real estate
lending activities and the Bank's Mortgage banking division. His
prior thirteen years of related experience included ten years with
Signet Bank, culminating as Senior Vice President in charge of real
estate lending for the Baltimore and Washington regions. Prior to
joining Signet, Mr. Barron served as a real estate lender at a Mellon
Bank subsidiary for three years.
Russell J. Grimes, Jr. 41 Chief Financial Officer and Treasurer of the Company and Senior Vice
President, Chief Financial Officer and Treasurer of the Bank. Prior
to joining the Company in 1997, Mr. Grimes was Vice President,
Treasurer and Chief Financial Officer of Annapolis Bancshares, Inc.
and Bank of Annapolis from 1994 to 1996. Mr. Grimes held similar
positions with First Virginia Banks, Inc. and American National
Savings Bank, F.S.B. prior to 1994.
Michael L. Irwin 38 Senior Vice President, Credit Administration of the Bank. Mr. Irwin
has been an officer of the Bank since February 1997 and is primarily
responsible for the administration of credit standards for the Bank.
Mr. Irwin held similar positions with Taneytown Bank and Trust.
Lori J. Mueller 34 Secretary of the Company and Senior Vice President, Administration
and Marketing of the Bank. Ms. Mueller has been an officer of the
Bank since 1990 and is responsible for retail banking, deposit
account administration, marketing, employee benefits and general bank
administration.
PART II
ITEM 6. MARKET FOR COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
Information relating to the market for Registrant's common equity and
related stockholder matters appears in the Registrant's 1997 Annual Report to
Stockholders on page 22, and is incorporated herein by reference.
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OR PLAN OF OPERATION
The above-captioned information appears under Management's Discussion and
Analysis of Results of Operations and Financial Condition in the Registrant's
1997 Annual Report to Stockholders on pages 6 through 22 and is incorporated
herein by reference.
ITEM 8. FINANCIAL STATEMENTS
The Consolidated Financial Statements of Annapolis National Bancorp, Inc.
and its subsidiary, together with the report thereon by Rowles & Company, LLP
for the year ended December 31 1997 appears in the Registrant's 1997 Annual
Report to Stockholders on pages 23 through 42 and are incorporated herein by
reference.
11
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
None.
PART III
ITEM 10. EXECUTIVE COMPENSATION
The information relating to directors' and executive compensation is
incorporated herein by reference to the Registrant's Proxy Statement for the
Annual Meeting of Shareholders to be held on April 23, 1998 on pages 7 through
10.
ITEM 11. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
The information relating to security ownership of certain beneficial owners
and management is incorporated herein by reference to the Registrant's Proxy
Statement for the Annual Meeting of Shareholders to be held on April 23, 1998 on
pages 2 and 3.
ITEM 12. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
The information relating to certain relationships and related transactions
is incorporated herein by reference to the Registrant's Proxy Statement for the
Annual Meeting of Shareholders to be held on April 23, 1998 at page 10.
ITEM 13. EXHIBITS AND REPORTS ON FORM 8-K
(a) The following documents are filed as a part of this report:
(1) Financial Statements
Consolidated Financial Statements of the Company are incorporated by
reference to the following indicated pages of the 1997 Annual Report to
Stockholders
PAGE
------
Independent Auditors' Report............................................................................... 23
Consolidated Balance Sheet as of December 31, 1997......................................................... 24
Consolidated Statements of Income for the years ended December 31, 1997 and 1996........................... 25
Consolidated Statements of Changes in Stockholders' Equity for the years ended December 31, 1997 and 1996.. 26
Consolidated Statements of Cash Flows for the years ended December 31, 1997 and 1996....................... 27-28
Notes to Consolidated Financial Statements................................................................. 29-42
The remaining information appearing in the Annual Report to
Stockholders is not deemed to be filed as part of this report, except as
expressly provided herein.
(2) Exhibits
The following exhibits are filed as part of this report.
3.1 Articles of Incorporation of Annapolis National Bancorp, Inc.*
3.2 Bylaws of Annapolis National Bancorp, Inc.*
4.0 Stock Certificate of Annapolis National Bancorp, Inc.*
10.1 Employment Agreement between Annapolis National Bancorp, Inc. and John W. Marhefka, Jr.*
10.2 Promissory Note between Annapolis National Bancorp, Inc. and Lawrence E. Lerner dated January 31, 1995*
10.3 Annapolis National Bancorp, Inc. Employee Stock Option Plan*
10.4 Form of Escrow Agreement between Annapolis National Bancorp, Inc. and FMB Trust Company, National
Association*
11.0 Computation of earnings per share (filed herewith)
13.0 1997 Annual Report to Stockholders (filed herewith)
21.0 Subsidiary information is incorporated herein by reference to "Part I -- Subsidiaries"
27.0 Financial Data Schedule (filed herewith)
99.0 1997 Proxy Statement (filed herewith)
-----------------------
* Incorporated herein by reference to the Exhibits to Form SB-2,
Registration Statement, filed on June 23, 1997 and any amendments
thereto, Registration No. 333-29841.
(b) Reports on Form 8-K:
None.
12
CONFORMED
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, hereunto duly authorized.
ANNAPOLIS NATIONAL BANCORP, INC.
By: /s/ JOHN W. MARHEFKA, JR.
__________________________________
JOHN W. MARHEFKA, JR.
PRESIDENT, CHIEF EXECUTIVE OFFICER
AND DIRECTOR
Date: March 30, 1998
Pursuant to the requirements of the Securities Exchange Act of 1934, this
report has been signed by the following persons in the capacities and on the
dates stated.
NAME TITLE DATE
---- ----- ----
/s/ JOHN W. MARHEFKA, JR. President, Chief Executive Officer and Director March 30, 1998
____________________________________ (principal executive officer)
JOHN W. MARHEFKA, JR.
/s/ RUSSELL J. GRIMES, JR. Treasurer and Chief Financial Officer March 30, 1998
____________________________________ (principal accounting and financial officer)
RUSSELL J. GRIMES, JR.
/s/ ALBERT PHILLIPS Director-President March 30, 1998
____________________________________
ALBERT PHILLIPS
/s/ STANLEY H. KATSEF Director March 30, 1998
____________________________________
STANLEY H. KATSEF
/s/ RONALD E. GARDNER Director March 30, 1998
____________________________________
RONALD E. GARDNER
/s/ STANLEY J. KLOS, JR. Director March 30, 1998
____________________________________
STANLEY J. KLOS, JR.
/s/ LAWRENCE E. LERNER Director March 30, 1998
____________________________________
LAWRENCE E. LERNER
/s/ RICHARD M. LERNER Director March 30, 1998
____________________________________
RICHARD M. LERNER
/s/ DIMITRI P. MALLIOS Director March 30, 1998
____________________________________
DIMITRI P. MALLIOS
13