U.S. SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
[ x ] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the quarterly period ended June 30, 2003
-------------
[ ] 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 0-28635
VIRGINIA COMMERCE BANCORP, INC.
(Exact Name of Registrant as Specified in its Charter)
VIRGINIA 54-1964895
-------- ----------
(State or Other Jurisdiction (I.R.S. Employer Identification No.)
of Incorporation or Organization)
5350 LEE HIGHWAY, ARLINGTON, VIRGINIA 22207
-------------------------------------------
(Address of Principal Executive Offices)
703-534-0700
------------
(Registrant's Telephone Number, Including Area Code)
N/A
(Former Name, Former Address and Former Fiscal Year,
If Changed Since Last Report)
Indicate by check 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 whether the registrant is an accelerated filer as defined in
Rule12b-2 of the Securities Exchange Act of 1934. Yes . No X .
--- ---
As of August 14, 2003 the number of outstanding shares of registrant's common
stock, par value $1.00 per share was: 7,814,156
PART I. FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
VIRGINIA COMMERCE BANCORP, INC.
CONSOLIDATED BALANCE SHEETS
(In thousands of dollars, except per share data)
Unaudited Audited
June 30, December 31,
2003 2002
---- ----
ASSETS
Cash and due from banks $ 28,521 $ 19,907
Securities (fair value: 2003, $110,470; 2002, $71,766) 109,872 71,231
Federal funds sold 45,430 24,071
Loans held-for-sale 23,851 18,948
Loans, net of allowance for loan losses of $6,652 in 2003 and
$5,924 in 2002 573,973 516,900
Bank premises and equipment, net 6,405 6,517
Accrued interest receivable 2,538 2,489
Other assets 9,395 2,824
-------- --------
Total assets $799,985 $662,887
======== ========
LIABILITIES AND STOCKHOLDERS' EQUITY
DEPOSITS
Non-interest bearing demand deposits $119,795 $ 98,575
Savings and interest-bearing demand deposits 271,558 190,811
Time deposits 306,847 277,610
-------- --------
Total deposits $698,200 $566,996
Securities sold under agreement to repurchase and federal funds
purchased 32,539 32,081
Other borrowed funds 400 400
Trust preferred capital notes 18,000 18,000
Accrued interest payable 1,115 1,271
Other liabilities 712 2,289
Commitments and contingencies -- --
-------- --------
Total liabilities $750,966 $621,037
======== ========
STOCKHOLDERS' EQUITY
Preferred stock, $1.00 par, 1,000,000 shares authorized and
un-issued $ -- $ --
Common stock, $1.00 par, 20,000,000 shares authorized, issued and
outstanding 2003, 7,801,806; 2002, 3,739,330 7,802 3,739
Surplus 17,537 19,622
Retained earnings 23,063 17,808
Accumulated other comprehensive income 617 681
-------- --------
Total stockholders' equity $ 49,019 $ 41,850
-------- --------
Total liabilities and stockholders' equity $799,985 $662,887
======== ========
Notes to consolidated financial statements are an integral part of these
statements.
2
VIRGINIA COMMERCE BANCORP, INC.
CONSOLIDATED STATEMENTS OF INCOME
(In thousands of dollars, except per share data)
(Unaudited)
Three Months Ended Six Months Ended
June 30, June 30,
2003 2002 2003 2002
---- ---- ---- ----
INTEREST AND DIVIDEND INCOME:
Interest and fees on loans $ 10,168 $ 8,728 $ 19,860 $ 16,648
Interest and dividends on investment securities:
U.S. Treasury securities and agency obligations 848 739 1,522 1,387
Other securities 161 93 294 181
Interest on federal funds sold 116 74 205 166
-------- -------- -------- --------
Total interest and dividend income $ 11,293 $ 9,634 $ 21,881 $ 18,382
INTEREST EXPENSE:
Deposits $ 3,333 $ 3,345 $ 6,473 $ 6,513
Securities sold under agreement to repurchase
and federal funds purchased 32 67 60 141
Other borrowed funds 6 151 12 286
Trust preferred capital notes 213 -- 426 --
-------- -------- -------- --------
Total interest expense $ 3,584 $ 3,563 $ 6,971 $ 6,940
-------- -------- -------- --------
NET INTEREST INCOME: $ 7,709 $ 6,071 $ 14,910 $ 11,442
Provision for loan losses 408 322 764 843
-------- -------- -------- --------
Net interest income after provision for loan losses $ 7,301 $ 5,749 $ 14,146 $ 10,599
-------- -------- -------- --------
NON-INTEREST INCOME:
Service charges and other fees $ 394 $ 367 $ 814 $ 773
Fees and net gains on loans held-for-sale 1,555 818 2,854 1,672
Gain (loss) on sale of securities -- -- -- (1)
Other 40 9 64 17
-------- -------- -------- --------
Total non-interest income $ 1,989 $ 1,194 $ 3,732 $ 2,461
-------- -------- -------- --------
NON-INTEREST EXPENSE:
Salaries and employee benefits $ 3,078 $ 2,386 $ 6,076 $ 4,790
Occupancy expense 781 720 1,566 1,387
Data processing expense 307 258 591 506
Other operating expense 866 752 1,717 1,497
-------- -------- -------- --------
Total non-interest expense $ 5,032 $ 4,116 $ 9,950 $ 8,180
-------- -------- -------- --------
Income before taxes on income $ 4,258 $ 2,827 $ 7,928 $ 4,880
Provision for income taxes 1,421 952 2,673 1,642
-------- -------- -------- --------
NET INCOME $ 2,837 $ 1,875 $ 5,255 $ 3,238
-------- -------- -------- --------
Earnings per common share, basic (1) $ 0.36 $ 0.28 $ 0.68 $ 0.48
Earnings per common share, diluted (1) $ 0.33 $ 0.25 $ 0.62 $ 0.42
(1) Adjusted to give effect to a two-for-one split in the form of a 100% stock
dividend in May 2003.
Notes to consolidated financial statements are an integral part of these
statements.
3
VIRGINIA COMMERCE BANCORP, INC.
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
For the six months ended June 30, 2003 and 2002
(In Thousands of Dollars)
(Unaudited)
Accumulated
Other
Preferred Common Retained Comprehensive Comprehensive
Stock Stock Surplus Earnings Income (loss) Income Total
---------- ---------- ---------- ---------- --------------- -------------- ----------
Balance, January 1, 2002 $ -- $ 2,721 $ 13,190 $10,138 $171 $ 26,220
Comprehensive Income:
Net Income -- -- -- 3,238 $ 3,238 3,238
Other comprehensive income, net of tax
Unrealized holding gains on
securities available-for-sale arising
during the period (net of tax of $205) 398
-------
Other comprehensive income, net of tax -- -- -- -- 398 398 398
-------
Total comprehensive income -- -- -- -- -- $ 3,636 --
=======
Issuance of common stock-25% stock split -- 680 (680) -- -- --
Cash paid in lieu of fractional shares -- -- -- (7) -- (7)
---- ------- -------- ------- ----- --------
Balance, June 30, 2002 $ -- $ 3,401 $ 12,510 $13,369 $ 569 $ 29,849
==== ======= ======== ======= ===== ========
Balance, January 1, 2003 $ -- $ 3,739 $ 19,622 $ 17,808 $ 681 $ 41,850
Comprehensive Income:
Net Income -- -- -- 5,255 $5,255 5,255
Other comprehensive income (loss), net
of tax
Unrealized holding losses on securities
available-for-sale arising during the
period (net of tax of $33) (64)
------
Other comprehensive income (loss), net of tax -- -- -- -- (64) (64) (64)
------
Total comprehensive income -- -- -- -- -- $5,191 --
======
Issuance of common stock-
Stock options/warrants exercised -- 169 1,809 -- -- 1,978
100% stock split -- 3,894 (3,894) -- -- --
---- ------- -------- ------- ----- --------
Balance, June 30, 2003 $ -- $ 7,802 $ 17,537 $ 23,063 $ 617 $ 49,019
==== ======= ======== ======== ===== ========
Notes to consolidated financial statements are an integral part of these
statements.
4
VIRGINIA COMMERCE BANCORP, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(In Thousands of Dollars)
(Unaudited)
Six Months Ended
June 30,
---------------
2003 2002
---- ----
CASH FLOWS FROM OPERATING ACTIVITIES:
Net Income $ 5,255 $ 3,238
Adjustments to reconcile net income to net cash
provided by operating activities:
Depreciation and amortization 488 474
Provision for loan losses 764 843
Deferred tax benefit (284) (300)
Amortization of security premiums and (accretion) of discounts (9) 9
Loss on sale of securities available-for-sale -- 1
Origination of loans held-for-sale (152,993) (86,299)
Sales of loans 148,090 97,967
Changes in other assets and other liabilities:
Increase in accrued interest receivable (49) (275)
Increase in other assets (6,254) (183)
(Decrease) increase in other liabilities (1,729) 107
--------- ---------
Net Cash Provided by (Used In) Operating Activities $ (6,721) $ 15,582
CASH FLOWS FROM INVESTING ACTIVITIES:
Net increase in loans (57,838) (74,669)
Purchase of securities available-for-sale (82,915) (23,650)
Purchase of securities held-to-maturity (5,500) (4,371)
Proceeds from sales of securities available-for-sale -- 1,350
Proceeds from principal payments on securities available-for-sale 4,589 3,169
Proceeds from principal payments on securities held-to-maturity 2,569 1,160
Proceeds from calls and maturities of securities available-for-sale 37,525 12,000
Proceeds from calls and maturities of securities held-to-maturity 5,000 502
Purchase of bank premises and equipment (376) (1,082)
--------- ---------
Net Cash (Used In) Investing Activities $ (96,946) $ (85,591)
CASH FLOWS FROM FINANCING ACTIVITIES:
Net increase in deposits $ 131,204 $ 98,778
Net increase (decrease) in repurchase agreements 458 (11,184)
Net decrease in other borrowed funds -- (3,000)
Net proceeds from issuance of capital stock 1,978 --
Cash paid in lieu of fractional shares -- (7)
--------- ---------
Net Cash Provided by Financing Activities $ 133,640 $ 84,587
Net Increase In Cash and Cash Equivalents 29,973 14,578
CASH AND CASH EQUIVALENTS - BEGINNING OF PERIOD 43,978 15,155
--------- ---------
CASH AND CASH EQUIVALENTS - END OF PERIOD $ 73,951 $ 29,733
========= =========
Notes to consolidated financial statements are an integral part of these
statements.
5
VIRGINIA COMMERCE BANCORP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
1. GENERAL
The accompanying unaudited consolidated financial statements of Virginia
Commerce Bancorp, Inc. and its subsidiaries (the Company) have been
prepared in accordance with accounting principles generally accepted in
the United States of America for interim financial information. All
significant intercompany balances and transactions have been eliminated.
In the opinion of management, the accompanying unaudited consolidated
financial statements contain all adjustments and reclassifications
consisting of a normal and recurring nature considered necessary to
present fairly the financial positions as of June 30, 2003 and December
31, 2002, the results of operations for the three and six months ended
June 30, 2003 and 2002, and statements of cash flows and stockholders'
equity for the six months ended June 30, 2003 and 2002.
Operating results for the three and six month periods ended June 30, 2003
are not necessarily indicative of the results that may be expected for the
year ending December 31, 2003.
2. INVESTMENT SECURITIES
Amortized cost and fair value of securities available-for-sale and
held-to-maturity as of June 30, 2003 are as follows (dollars in
thousands):
--------------------------------------------
Gross Gross
Amortized Unrealized Unrealized Fair
Cost Gains (Losses) Value
--------------------------------------------
AVAILABLE-FOR-SALE:
U.S. Government Agency obligations $ 86,135 $ 799 $ -- $ 86,934
Domestic corporate debt obligations 6,000 -- (5) 5,995
Obligations of states and political subdivisions 1,199 141 -- 1,340
Restricted stock:
Federal Reserve Bank 722 -- -- 722
Federal Home Loan Bank 1,355 -- -- 1,355
Community Bankers' Bank 55 -- -- 55
-------- -------- -------- --------
$ 95,466 $ 940 $ (5) $ 96,401
HELD-TO-MATURITY:
U.S. Government Agency obligations $ 5,952 $ 233 $ -- $ 6,185
Obligations of states and political subdivisions 7,034 299 (6) 7,327
Domestic corporate debt obligations 485 72 -- 557
-------- -------- -------- --------
$ 13,471 $ 604 $ (6) $ 14,069
======== ======== ======== ========
6
VIRGINIA COMMERCE BANCORP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, Continued
(Unaudited)
Amortized cost and fair value of securities available-for-sale and
held-to-maturity as of December 31, 2002 are as follows (dollars in thousands):
Gross Gross
Amortized Unrealized Unrealized Fair
Cost Gains (Losses) Value
------------------------------------------------
AVAILABLE-FOR-SALE:
U.S. Government Agency obligations $51,679 $ 982 $ -- $52,661
Obligations of states and political subdivisions 1,179 50 -- 1,229
Restricted stock:
Federal Reserve Bank 542 -- -- 542
Federal Home Loan Bank 1,194 -- -- 1,194
Community Bankers' Bank 55 -- -- 55
------- ------- ------- -------
$54,649 $ 1,032 $ -- $55,681
HELD-TO-MATURITY:
U.S. Government Agency obligations $ 8,534 $ 341 $ -- $ 8,875
Obligations of states and political subdivisions 6,534 130 -- 6,664
Domestic corporate debt obligations 482 64 -- 546
------- ------- ------- -------
$15,550 $ 535 $ -- $16,085
======= ======= ======= =======
3. LOANS
Major classifications of loans are summarized as follows:
June 30, 2003 December 31, 2002
---------------------------------
(In Thousand of Dollars)
Commercial $ 57,025 $ 44,559
Real estate-one-to-four family residential 73,658 67,061
Real estate-multi-family residential 31,569 29,269
Real estate-non-farm, non-residential 290,217 265,694
Real estate-construction 124,654 111,333
Consumer 5,754 6,941
--------- ---------
Total Loans 582,877 524,857
Less unearned income (2,252) (2,033)
Less allowance for loan losses (6,652) (5,924)
--------- ---------
Loans, net $ 573,973 $ 516,900
========= =========
7
VIRGINIA COMMERCE BANCORP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, Continued
(Unaudited)
4. EARNINGS PER SHARE
The following shows the weighted average number of shares used in computing
earnings per share and the effect on weighted average number of shares of
diluted potential common stock. The weighted average number of shares for the
six months ended June 30, 2002, have been adjusted to give effect to a
two-for-one stock split in the form of a 100% stock dividend in May 2003.
Six Months Ended
--------------------------------------------
June 30, 2003 June 30, 2002
---------------------- ---------------------
Per Per
Share Share
Shares Amount Shares Amount
------ ------ ------ ------
Basic earnings per share 7,736,171 $0.68 6,801,542 $0.48
----- -----
Effect of dilutive securities:
Stock options 664,241 547,897
Warrants 32,643 336,922
--------- ---------
Diluted earnings per share 8,433,055 $0.62 7,686,361 $0.42
========= ===== ========= =====
5. STOCK COMPENSATION PLAN
At June 30, 2003, the Company had a stock-based compensation plan. The Company
accounts for the plan under the recognition and measurement principles of APB
Opinion 25, Accounting for Stock Issued to Employees, and related
interpretations. No stock-based employee compensation cost is reflected in net
income, as all options granted under the plan had an exercise price equal to the
market value of the underlying common stock on the date of the grant. The
following illustrates the effect on net income and earnings per share for the
six months ended June 30, 2003, and 2002 had the fair value recognition
provisions of FASB Statement No. 123, Accounting for Stock-Based Compensation,
been adopted.
SIX MONTHS ENDED
- ------------------------------------------------------------------------------
(Dollars in thousands except per share amounts) JUNE 30, 2003 JUNE 30, 2002
- ------------------------------------------------------------------------------
NET INCOME, AS REPORTED $5,255 $3,238
Deduct: total stock-based employee compensation (178) (209)
expense determined based on fair value
method of awards, net of tax
PRO FORMA NET INCOME $5,077 $3,029
BASIC EARNINGS PER SHARE:
$0.68 $0.48
As reported
Pro forma $0.66 $0.45
DILUTED EARNING PER SHARE:
As reported $0.62 $0.42
Pro Forma $0.60 $0.39
The fair value of each grant is estimated at the grant date using the
Black-Scholes option-pricing model with the following weighted average
assumptions for grants in 2003, and 2002, respectively: price volatility of
28.78% and 21.48%, risk-free interest rates of 4.02% and 5.43%, dividend rate of
..04% and expected lives of 10 years.
8
VIRGINIA COMMERCE BANCORP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, Continued
(Unaudited)
6. CAPITAL REQUIREMENTS
A comparison of the Company's and its wholly-owned subsidiary's, Virginia
Commerce Bank (the "Bank") capital as of June 30, 2003 with the minimum
regulatory guidelines is as follows:
Minimum Minimum to be
Actual Guidelines "Well-Capitalized"
------ ---------- ------------------
Total Risk-Based Capital:
Company 11.46% 8.00% --
Bank 11.28% 8.00% 10.00%
Tier 1 Risk-Based Capital:
Company 10.13% 4.00% --
Bank 7.40% 4.00% 6.00%
Leverage Ratio:
Company 8.59% 4.00% --
Bank 6.35% 4.00% 5.00%
7. TRUST PREFERRED SECURITIES
On November 13, 2002, the Company completed a private placement issuance of $3.0
million of trust preferred securities through a newly formed, wholly-owned,
subsidiary trust (VCBI Capital Trust I). The securities bear a floating rate of
interest, adjusted semi-annually, of 340 basis points over six month Libor,
currently 4.65%, with a maximum rate of 12.0% until November 15, 2007. The
securities have a thirty year term and are callable at par beginning November
15, 2007. On December 19, 2002, the Company completed a separate private
placement issuance of $15.0 million of trust preferred securities through
another newly formed, wholly-owned, subsidiary trust (VCBI Capital Trust II).
These securities bear a floating rate of interest, adjusted semi-annually, of
330 basis points over six month Libor, currently 4.40%, with a maximum rate of
11.9% until December 30, 2007. These securities also have a thirty year term and
are callable at par beginning December 30, 2007. The principal asset of each
trust is a similar amount of the Company's junior subordinated debt securities
with like maturities and interest rates to the trust preferred securities. The
obligations of the Company with respect to the issuance of the trust preferred
securities constitute a full and unconditional guarantee by the Company of each
Trust's obligations with respect to the trust preferred securities to the extent
set forth in the related guarantees. Subject to certain exceptions and
limitations, the Company may elect from time to time to defer interest payments
on the junior subordinated debt securities, resulting in a deferral of
distribution payments on the related trust preferred securities.
The Trust Preferred Securities may be included in Tier 1 capital for regulatory
capital adequacy purposes up to 25.0% of Tier 1 capital after its inclusion. The
portion of the trust preferred securities not qualifying as Tier 1 capital may
be included as part of total qualifying capital in Tier 2 capital.
9
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
Forward-Looking Statements
- --------------------------
This management's discussion and analysis and other portions of this report,
contain forward-looking statements within the meaning of the Securities and
Exchange Act of 1934, as amended, including statements of goals, intentions, and
expectations as to future trends, plans, events or results of Company operations
and policies and regarding general economic conditions. In some cases,
forward-looking statements can be identified by use of words such as "may,"
"will," "anticipates," "believes," "expects," "plans," "estimates," "potential,"
"continue," "should," and similar words or phrases. These statements are based
upon current and anticipated economic conditions, nationally and in the
Company's market, interest rates and interest rate policy, competitive factors,
and other conditions which by their nature, are not susceptible to accurate
forecast, and are subject to significant uncertainty. Because of these
uncertainties and the assumptions on which this discussion and the
forward-looking statements are based, actual future operations and results may
differ materially from those indicated herein. Readers are cautioned against
placing undue reliance on any such forward-looking statements. The Company's
past results are not necessarily indicative of future performance.
Non-GAAP Presentations
- ----------------------
This management's discussion and analysis refers to the efficiency ratio, which
is computed by dividing non-interest expense by the sum of net interest income
on a tax equivalent basis and non-interest income. This is a non-GAAP financial
measure which we believe provides investors with important information regarding
our operational efficiency. Comparison of our efficiency ratio with those of
other companies may not be possible because other companies may calculate the
efficiency ratio differently. The Company, in referring to its net income, is
referring to income under generally accepted accounting principals, or "GAAP".
General
- -------
The following presents management's discussion and analysis of the consolidated
financial condition and results of operations of Virginia Commerce Bancorp, Inc.
and subsidiaries (the "Company") as of the dates and for the periods indicated.
This discussion should be read in conjunction with the Company's Consolidated
Financial Statements and the Notes thereto, and other financial data appearing
elsewhere in this report. The Company is the parent bank holding company for
Virginia Commerce Bank (the "Bank"), a Virginia state chartered bank that offers
a full range of banking services through thirteen branch offices and two
residential mortgage offices, principally to individuals and small to
medium-size businesses in the Metropolitan Washington, D.C. area.
Critical Accounting Policies
- ----------------------------
During the quarter ended June 30, 2003 there were no changes in the Company's
critical accounting policies as reflected in the last report.
The Company's financial statements are prepared in accordance with accounting
principles generally accepted in the United States (GAAP). The financial
information contained within our statements is, to a significant extent,
financial information that is based on measures of the financial effects of
transactions and events that have already occurred. A variety of factors could
affect the ultimate value that is obtained either when earning income,
recognizing an expense, recovering an asset or eliminating a liability. We use
historical loss factors as one factor in determining the inherent loss that may
be present in our loan portfolio. Actual losses could differ significantly from
the historical factors that we use. In addition, GAAP itself may change from one
previously acceptable method to another method. Although the economics of our
transactions would be the same, the timing of events that would impact our
transactions could change.
The allowance for loan losses is an estimate of the losses that are inherent in
our loan portfolio. The allowance is based on two basic principles of
accounting: (i) SFAS 5, Accounting for Contingencies, which requires that losses
be accrued when they are probable of occurring and estimatable and (ii) SFAS
114, Accounting by Creditors for
10
Impairment of a Loan, which requires that losses be accrued based on the
differences between the value of collateral, present value of future cash flows
or values that are observable in the secondary market and the loan balance.
Our allowance for loan losses has three basic components: the specific
allowance, the formula allowance and the unallocated allowance. Each of these
components is determined based upon estimates that can and do change when the
actual events occur. The specific allowance is used to individually allocate an
allowance for loans identified as impaired. Impairment testing includes
consideration of the borrower's overall financial condition, resources and
payment record, support available from financial guarantors and the fair market
value of collateral. These factors are combined to estimate the probability and
severity of inherent losses. When impairment is identified, then a specific
reserve is established based on the Company's calculation of the loss embedded
in the individual loan. Large groups of smaller balance, homogeneous loans are
collectively evaluated for impairment. Accordingly, the Company does not
separately identify individual consumer and residential loans for impairment.
The formula allowance is used for estimating the loss on internally risk rated
loans exclusive of those identified as impaired. The loans meeting the criteria
for special mention, substandard, doubtful and loss, as well as impaired loans
are segregated from performing loans within the portfolio. Internally classified
loans are then grouped by loan type (commercial, commercial real estate,
commercial construction, residential real estate, residential construction or
installment). Each loan type is assigned an allowance factor based on
management's estimate of the associated risk, complexity and size of the
individual loans within the particular loan category. Classified loans are
assigned a higher allowance factor than non-rated loans due to management's
concerns regarding collectibility or management's knowledge of particular
elements surrounding the borrower. Allowance factors grow with the worsening of
the internal risk rating. The unallocated formula is used to estimate the loss
of non-classified loans and loans identified for impairment testing for which no
impairment was identified. These un-criticized loans are also segregated by loan
type and allowance factors are assigned by management based on delinquencies,
loss history, trends in volume and terms of loans, effects of changes in lending
policy, the experience and depth of management, national and local economic
trends, concentrations of credit, quality of the loan review system and the
effect of external factors (i.e. competition and regulatory requirements). The
factors assigned differ by loan type. The unallocated allowance captures losses
whose impact on the portfolio has occurred but has yet to be recognized in
either the formula or specific allowance. Allowance factors and the overall size
of the allowance may change from period to period based on management's
assessment of the above described factors and the relative weights given to each
factor. Further information regarding the allowance for loan losses is provided
under the caption: Allowance for Loan Losses/Provision for Loan Loss Expense,
later in this report.
Results of Operations
- ---------------------
Total assets increased $137.1 million, or 20.7%, from $662.9 million at December
31, 2002, to $800 million at June 30, 2003, as total deposits grew $131.2
million, or 23.1%, from $567.0 million at December 31, 2002, to $698.2 million.
Other funding sources were mostly unchanged during the six month period ended
June 30, 2003.
Loans, net of allowance for loan losses, increased $57.1 million, or 11.1%, from
$516.9 million at December 31, 2002, to $574.0 million at June 30, 2003, and
represented 82.2% of total deposits at June 30, 2003, compared to 91.2% at
December 31, 2002. The majority of loan growth occurred in non-farm,
non-residential real estate loans which increased $24.5 million, or 9.2%, from
$265.7 million at December 31, 2002, to $290.2 million at June 30, 2003. Real
estate construction loans represented the second largest dollar increase rising
$13.4 million, or 12.0%, from $111.3 million at December 31, 2002, to $124.7
million at June 30, 2003, while commercial loans rose $12.4 million, or 28.0%,
from $44.6 million at December 31, 2002, to $57.0 million at June 30, 2003.
One-to-four family residential real estate loans increased $6.6 million, or
9.8%, from $67.1 million at December 31, 2002, to $73.7 million at June 30,
2003, and consumer loans fell $1.2 million during the six month period.
Loans held-for-sale, which represent one-to-four family residential real estate
loans originated on a pre-sold basis to various investors, increased $4.9
million, or 25.9%, from $18.9 million at December 31, 2002, to $23.8 million at
June 30, 2003. Originations were up $66.7 million, or 77.3%, from $86.3 million
during the six months ended June 30, 2002, to $153.0 million during the current
six month period due to a higher level of refinancing activity. Of the $153.0
million in originations year-to-date, $122.5 million, or 80.1%, represented
loans for refinance purposes. This level of activity, and the resulting fees and
net gains thereon, would be expected to decline should long term interest rates
rise.
11
With the increase in loans trailing deposit growth during the six month period,
investment securities increased $38.7 million, or 54.3%, from $71.2 million at
December 31, 2002, to $109.9 million at June 30, 2003, and fed funds sold
increased $21.3 million, or 88.7%, from $24.1 million at December 31, 2002, to
$45.4 million. With long term interest rates at historically low levels growth
in investment securities was concentrated in short-term U.S. Government Agency
obligations and variable rate domestic corporate debt obligations in the
available-for-sale portfolio. This strategy, together with carrying higher
levels of fed funds sold, is expected to provide the Company with greater
flexibility and opportunities when interest rates rise, although it serves to
compress the net interest margin over the near term. The Bank also purchased $6
million in single premium life insurance policies late in the second quarter
through three highly rated insurance carriers. These policies were recorded on
the balance sheet under other assets and increases in their cash value are
accreted to other income on a tax-exempt basis.
Deposit growth occurred in all categories with non-interest bearing demand
deposits increasing $21.2 million, or 21.5%, from $98.6 million at December 31,
2002, to $119.8 million at June 30, 2003. Savings and interest-bearing demand
deposits increased $80.7 million, or 42.3%, and time deposits grew by $29.2
million, or 10.5%, from $277.6 million at December 31, 2002, to $306.8 million
at June 30, 2003. Although the majority of the Bank's deposits are attracted
from individuals and businesses in the Northern Virginia and the Metropolitan
Washington, D.C. area, $15.8 million of the $29.2 million in time deposit growth
was attracted from out-of-market financial institutions and growth in savings
accounts includes a $15.8 million escrow account for an un-related company's
stock offering. That account was closed in early August. All deposits from
out-of-market financial institutions bear the same interest rates paid by the
Bank on comparable deposits from local consumers and businesses. Those rates are
generally near the top of the local market.
Growth for the three months ended June 30, 2003 was similar to what the Company
experienced for the six month period with total assets rising $79.1 million, or
11.0%, from $720.9 million at March 31, 2003 to $800 million at June 30, 2003,
total deposits increasing $72.3 million, or 11.6%, from $625.9 million to $698.2
million , and loans, net of allowance for loans losses, growing $26.0 million,
or 4.7%, from $548.0 million to $574.0 million. As loans also trailed deposit
growth for the three-month period ended June 30, 2003, investment securities
increased $12.3 million, or 12.7%, and fed funds sold grew $18.4 million, or
67.8%. For both the three and six month periods ended June 30, 2003, loans as a
percentage of total deposits declined while investment securities and federal
funds sold increased. The result was higher levels of liquidity and downward
pressure on the net interest margin.
For the six months ended June 30, 2003, net income of $5.3 million reflected an
increase of 62.3% compared to $3.2 million for the six months ended June 30,
2002, as net interest income increased $3.5 million, or 30.3%, non-interest
income rose $1.3 million, or 51.6%, and non-interest expense was up $1.7
million, or 21.6%. Provisions for loan losses decreased $79 thousand from $843
thousand for the six months ended June 30, 2002, to $764 thousand for the six
months ended June 30, 2003, due to a decline in net charge-offs and in the level
of identified potential problem loans. Diluted earnings per share, adjusted
giving effect to a two-for-one stock split in the form of a 100% stock dividend
paid May 30, 2003, of $0.62 were up $0.20, or 47.6%, from $0.42 for the
comparable period in 2002. The Company's annualized return on average assets and
return on average equity were 1.47% and 23.22% for the current six month period
compared to 1.21% and 23.50% for the six months ended June 30, 2002.
For the three months ended June 30, 2003, net income of $2.8 million increased
$962 thousand, or 51.3%, compared to $1.9 million for the same period in 2002 as
net interest income rose $1.6 million, non-interest income increased by $795
thousand and non-interest expenses were up $916 thousand. Diluted earnings per
share increased $0.08, or 32.0%, from $0.25 for the three months ended June 30,
2002, to $0.33 for the three month period ended June 30, 2003. The return on
average assets and return on average equity were 1.51% and 23.96% for the three
months ended June 30, 2003, compared to 1.33% and 26.33% for the same period in
2002.
Overall, while the net interest margin declined for both the three and six month
periods ended June 30, 2003, due to lower interest rates and higher liquidity
levels, revenue sources continued to increase due to strong balance sheet growth
and higher fees and net gains from mortgage lending operations. As a result, the
Company's efficiency ratio improved from 58.8% for the six months ended June 30,
2002 to 53.1% for the current six-month period.
Stockholders' equity increased $19.2 million, or 64.2%, from $29.8 million at
June 30, 2002, to $49.0 million at June 30, 2003, on earnings over the last four
quarters of $9.7 million, $7.0 million in net proceeds from a rights
12
offering to existing stockholders in July 2002, and $2.5 million in proceeds and
tax benefits from the exercise of stock options and warrants by Company
directors and officers. For the six months ended June 30, 2003, stockholders'
equity increased $7.2 million, or 17.1%, with $5.3 million in earnings and $1.9
million in proceeds and tax benefits from the exercise of stock options and
warrants by Company directors and officers. On May 30, 2003, the Company
recorded a two for one stock split in the form of a 100% stock dividend
increasing the number of shares outstanding by 3,892,769.
Net Interest Income
- -------------------
Net interest income is the excess of interest earned on loans and investments
over the interest paid on deposits and borrowings. The Company's net interest
income increased $3.5 million, or 30.3%, from $11.4 million for the six months
ended June 30, 2002, to $14.9 million for the six month period ended June 30,
2003, and increased $1.6 million, or 27.0%, from $6.1 million for the three
months ended June 30, 2002, to $7.7 million for the three months ended June 30,
2003. Increases for both periods were due to significant growth in earning
assets as the Company's net interest margin declined from 4.42% in the second
quarter of 2002 to 4.23% for the current three-month period and from 4.39% for
the six months ended June 30, 2002, to 4.34% year-to-date.
The Company's yields on earning assets and costs of interest-bearing liabilities
have continued to fall along with market interest rates since early 2001. The
yield on earning assets dropped seventy-one basis points from 7.10% for the six
months ended June 30, 2002, to 6.39% for the six months ended June 30, 2003,
while the average rate paid on interest-bearing liabilities fell seventy-six
basis points from 3.25% to 2.49%. For the three month period ended June 30,
2003, the yield on earning assets fell eighty-five basis points to 6.22% and the
cost of interest-bearing liabilities fell seventy-five basis points to 2.44%, as
compared to the three month period ended June 30, 2002. As a result, the net
interest margin dropped from 4.42% in the second quarter of 2002 to 4.23% for
the current three-month period. The Company expects that due to another
twenty-five basis point reduction in rates by the Federal Reserve in late June
and a higher level of short-term investment securities and federal funds sold
being carried on the balance sheet, that its net interest margin could decline
further in the third quarter of 2003.
The following table shows the average balance sheets for each of the three and
six month periods ended June 30, 2003, and 2002. In addition, the amounts of
interest earned on earning assets, with related yields on a tax-equivalent
basis, and interest expense on interest-bearing liabilities, with related rates,
are shown. Loans placed on a non-accrual status are included in the average
balances. Net loan fees and late charges included in interest income on loans
totaled $570 thousand and $393 thousand for the three month period ended June
30, 2003 and 2002, respectively, and totaled $955 thousand and $756 thousand for
the six month periods.
13
-----------------------------------------------------------------------------------
Three months ended June 30,
-----------------------------------------------------------------------------------
2003 2002
--------------------------------------- ----------------------------------------
Average Average
Average Interest Yields Average Interest Yields
(Dollars in thousands) Balance Income-Expense /Rates Balance Income-Expense /Rates
--------------------------------------- ----------------------------------------
ASSETS
Securities (1) $ 98,504 $ 1,009 4.26% $ 63,431 $ 832 5.31%
Loans, net of unearned income (2) 582,957 10,168 6.90% 459,114 8,728 7.52%
Federal funds sold 39,648 116 1.16% 17,651 74 1.66%
--------- -------- ---- --------- ------- ----
TOTAL EARNING ASSETS $ 721,109 $ 11,293 6.22% $ 540,196 $ 9,634 7.07%
Non-earning assets 32,169 27,002
--------- ---------
TOTAL ASSETS $ 753,278 $ 567,198
========== ==========
LIABILITIES AND STOCKHOLDERS' EQUITY
Interest-bearing deposits:
NOW accounts $ 133,493 $ 589 1.77% $ 85,953 $ 461 2.15%
Money market accounts 81,368 370 1.82% 50,227 306 2.44%
Savings accounts 25,039 63 1.00% 14,964 51 1.36%
Time deposits 299,210 2,311 3.10% 248,670 2,527 4.08%
--------- -------- ---- --------- ------- ----
Total interest-bearing deposits $ 539,110 $ 3,333 2.48% $ 399,814 $ 3,345 3.36%
Securities sold under agreement to
repurchase and federal funds purchased 31,961 32 0.41% 35,075 67 0.76%
Other borrowed funds 400 6 5.93% 12,224 151 4.88%
Trust preferred capital notes 18,000 213 4.73% -- -- --
-------- -------- ---- --------- ------- ----
TOTAL INTEREST-BEARING LIABILITIES $ 589,471 $ 3,584 2.44% $ 447,113 $ 3,563 3.19%
Demand deposits and other non-interest
bearing liabilities 116,312 91,515
--------- ---------
TOTAL LIABILITIES $ 705,783 $ 538,628
Stockholders' equity 47,495 28,570
--------- ---------
TOTAL LIABILITIES AND STOCKHOLDERS'
EQUITY $ 753,278 $ 567,198
========= =========
Interest rate spread 3.78% 3.88%
Net interest income and margin $ 7,709 4.23% $ 6,071 4.42%
(1) Yields on securities available-for-sale have been calculated on the basis of
historical cost and do not give effect to changes in the fair value of those
securities, which are reflected as a component of stockholders' equity. Interest
income includes the effects of taxable-equivalent adjustments, using the
appropriate marginal federal income tax rate of 34.0%, to increase tax-exempt
interest income to a tax-equivalent basis.
14
-------------------------------------------------------------------------------------
Six Months Ended June 30,
-------------------------------------------------------------------------------------
2003 2002
--------------------------------------- ------------------------------------------
(Dollars in thousands) Interest Average Interest Average
Average Income- Yields Average Income- Yields
Balance Expense /Rates Balance Expense /Rates
------- ------- ------ ------- ------- ------
ASSETS
Securities(1) $ 87,240 $ 1,816 4.35% $ 58,756 $ 1,568 5.41%
Loans, net of unearned income 561,118 19,860 7.04% 437,012 16,648 7.58%
Federal funds sold 35,399 205 1.15% 19,936 166 1.66%
--------- -------- ----- --------- -------- -----
TOTAL EARNING ASSETS $ 683,757 $ 21,881 6.39% $ 515,704 $ 18,382 7.10%
Non-earning assets 34,950 25,740
--------- ---------
TOTAL ASSETS $ 718,707 $ 541,444
========= =========
LIABILITIES AND STOCKHOLDERS' EQUITY
Interest-bearing deposits:
NOW accounts $ 126,520 $ 1,084 1.73% $ 84,704 $ 893 2.13%
Money market accounts 76,080 692 1.83% 46,350 535 2.33%
Savings accounts 21,916 111 1.02% 14,714 103 1.40%
Time deposits 290,844 4,586 3.18% 238,155 4,982 4.22%
--------- -------- ----- --------- -------- -----
Total interest-bearing deposits $ 515,360 $ 6,473 2.53% $ 383,923 $ 6,513 3.42%
Securities sold under agreement to
repurchase and federal funds purchased 31,160 60 0.39% 34,897 141 0.82%
Other borrowed funds 400 12 5.93% 11,726 286 4.86%
Trust preferred capital notes 18,000 426 4.74% -- -- --
--------- -------- ----- --------- -------- -----
TOTAL INTEREST-BEARING LIABILITIES $ 564,920 $ 6,971 2.49% $ 430,546 $ 6,940 3.25%
Demand deposits and other non-interest
bearing liabilities 108,149 83,114
--------- ---------
TOTAL LIABILITIES $ 673,069 $ 513,660
Stockholders' equity 45,638 27,784
--------- ---------
TOTAL LIABILITIES AND STOCKHOLDERS' $ 718,707 $ 541,444
EQUITY ========= ==========
Interest rate spread 3.90% 3.85%
Net interest income and margin $ 14,910 4.34% $ 11,442 4.39%
(1) Yields on securities available-for-sale have been calculated on the basis of
historical cost and do not give effect to changes in the fair value of those
securities, which are reflected as a component of stockholders' equity. Interest
income includes the effects of taxable-equivalent adjustments, using the
appropriate marginal federal income tax rate of 34.0%, to increase tax-exempt
interest income to a tax-equivalent basis.
15
Allowance for Loan Losses / Provision for Loan Loss Expense
- -----------------------------------------------------------
The provision for loan losses is based upon management's estimate of the amount
required to maintain an adequate allowance for loan losses reflective of the
risks in the loan portfolio. For the six months ended June 30, 2003, net
charge-offs totaled $36 thousand, or 0.01% of average loans compared to $88
thousand, or 0.02% for the same period in 2002, while the provision for loan
loss expense for the first six months of 2003 was $764 thousand compared to $843
thousand in 2002. As a result, the total allowance for loan losses increased
$728 thousand, or 12.3%, from $5.9 million at December 31, 2002, to $6.7 million
at June 30, 2003. The decrease in the provision for loan loss expense is
reflective of the decline in net charge-offs, a decrease in identified other
potential problem loans from $2.2 million at June 30, 2002, to $1.1 million at
June 30, 2003, and a drop in non-performing assets and past due loans from $2.4
million at December 31, 2002 to $1.5 million at June 30, 2003. See "Risk
Elements and Non-Performing Assets" below for additional information regarding
changes in the level of non-performing assets.
Management feels that the allowance for loan losses is adequate. There can be no
assurance, however, that additional provisions for loan losses will not be
required in the future, including as a result of changes in the economic
assumptions underlying management's estimates and judgments, adverse
developments in the economy, on a national basis or in the Company's market
area, or changes in the circumstances of particular borrowers.
The Company generates a quarterly analysis of the allowance for loan losses,
with the objective of quantifying portfolio risk into a dollar figure of
inherent losses, thereby translating the subjective risk value into an objective
number. Emphasis is placed on semi-annual independent external loan reviews and
monthly internal reviews. The determination of the allowance for loan losses is
based on applying and summing the results of eight qualitative factors and one
quantitative factor to each category of loans along with any specific allowance
for impaired and adversely classified loans within the particular category. Each
factor is assigned a percentage weight and that total weight is applied to each
loan category. The resulting sum from each loan category is then combined to
arrive at a total allowance for all categories. Factors are different for each
loan category. Qualitative factors include: levels and trends in delinquencies
and non-accruals, trends in volumes and terms of loans, effects of any changes
in lending policies, the experience, ability and depth of management, national
and local economic trends and conditions, concentrations of credit, quality of
the Company's loan review system, and regulatory requirements. The total
allowance required thus changes as the percentage weight assigned to each factor
is increased or decreased due to its particular circumstance, as the various
types and categories of loans change as a percentage of total loans and as
specific allowances are required due to an increase in impaired and adversely
classified loans.
The following schedule summarizes the changes in the allowance for loan losses:
Six Months Six Months Twelve Months
Ended Ended Ended
June 30, 2003 June 30, 2002 December 31, 2002
-----------------------------------------------
(In Thousands of Dollars)
Allowance, at beginning of period $ 5,924 $ 4,356 $ 4,356
Provision charged against income 764 843 1,678
Recoveries:
Consumer loans 6 24 40
Commercial loans 1 1 5
Losses charged to reserve:
Consumer loans (21) (57) 68
Commercial loans (22) (56) 87
------- ------- -------
Net (charge-offs) recoveries (36) (88) (110)
Allowance, at end of period $ 6,652 $ 5,111 $ 5,924
======= ======= =======
Ratio of net charge-offs to average loans net of
unearned income: .01% .02% .02%
16
Risk Elements and Non-performing Assets
- ---------------------------------------
Non-performing assets consist of non-accrual loans, impaired loans, restructure
loans, and other real estate owned (foreclosed real properties). The total
non-performing assets and loans that are ninety days or more past due and still
accruing interest decreased 37.9% from $2.4 million at December 31, 2002 to $1.5
million at June 30, 2003, and increased $1.1 million, or 315.1%, from $357
thousand at June 30, 2002. The decrease during the six months ended June 30,
2003, was due to the payoff of a $1.0 million non-accrual loan on a
single-family residential property, while the increase of $1.1 million since
June 30, 2002 was due to a troubled debt restructuring of a loan for $875
thousand on a single-family residential property and a loan for $289 thousand on
a single-family residential property that was past due ninety-one days as of
June 30, 2003. The loan for $875 thousand is performing in accordance with its
modified terms while the loan for $289 thousand was brought current in July
2003.
Loans are placed in non-accrual status when in the opinion of management the
collection of additional interest is unlikely or a specific loan meets the
criteria for non-accrual status established by regulatory authorities. No
interest is taken into income on non-accrual loans. A loan remains on
non-accrual status until the loan is current as to both principal and interest
or the borrower demonstrates the ability to pay and remain current, or both.
The ratio of non-performing assets and loans past due ninety days and still
accruing to total loans decreased from 0.44% at December 31, 2002, to 0.25% at
June 30, 2003, and increased from 0.07% at June 30, 2002. As noted above, the
decrease in the ratio from December 31, 2002, to June 30, 2003, was due to the
payoff of a $1.0 million non-accrual loan on a single-family residential
property, while the increase in the ratio since June 30, 2002 was due mostly to
another loan on a single-family residential property for $875 which was
restructured to provide the debtor with relief through lower interest payments
and an extended term. The Company expects its ratio of non-performing assets to
total loans to improve as the loan for $289 thousand was subsequently brought
current and the loan for $875 thousand continues to perform in accordance with
its modified terms; however, there can be no assurance since there were another
$1.1 million of loans as of June 30, 2003 for which management has identified
risk factors that may result in them not being repaid in accordance with their
terms. These loans are primarily well secured and are currently performing.
Foreclosed real properties include properties that have been substantively
repossessed or acquired in complete or partial satisfaction of debt. Such
properties, which are held for resale, are carried at the lower of cost or fair
value, including a reduction for the estimated selling expenses, or principal
balance of the related loan. As of June 30, 2003, June 30, 2002, and December
31, 2002, the Company held no foreclosed real properties.
Total non-performing assets consist of the following:
June 30, 2003 June 30, 2002 December 31, 2002
---------------------------------------------------------
(In Thousands of Dollars)
Non-accrual loans $ 253 $ 70 $1,943
Impaired loans 65 287 444
Troubled debt restructurings 875 -- --
------ ------ ------
Total non-performing assets $1,193 $ 357 $2,387
Loans past due 90 days and still
Accruing 289 -- --
Total non-performing assets and
loans past due 90 days and
still accruing $1,482 $ 357 $2,387
====== ====== ======
As a percentage of total loans 0.25% 0.07% 0.44%
As a percentage of total assets 0.18% 0.06% 0.36%
17
Concentrations of Credit Risk
- -----------------------------
At June 30, 2003, the Company had $446.4 million, or 76.6%, of total loans
concentrated in commercial real estate. Commercial real estate for purposes of
this discussion includes all construction loans, loans secured by multi-family
residential properties and loans secured by non-farm, non-residential
properties. At December 31, 2002 commercial real estate loans were $406.3
million, or 77.4%, of total loans. Total construction loans of $124.7 million at
June 30, 2003, represented 21.4% of total loans, loans secured by multi-family
residential properties of $31.6 million represented 5.4% of total loans, and
loans secured by non-farm, non-residential properties of $290.2 million
represented 49.8%.
Construction loans at June 30, 2003, included $85.5 million in loans to
commercial builders on single family residential property and $13.0 million to
individuals on single family residential property in the Northern Virginia
market, representing 14.7% and 2.2% of total loans, respectively, and together
representing 16.9% of total loans. These loans are made to a number of unrelated
entities and generally have a term of twelve to eighteen months. In addition the
Company had $26.1 million of construction loans on non-residential commercial
property at June 30, 2003, representing 4.5% of total loans. Total construction
loans of $124.7 million include $43.3 million in land acquisition and or
development loans on residential property and $21.0 million in land acquisition
and or development loans on commercial property, together totaling $64.3
million, or 11.0% of total loans. Adverse developments in the Northern Virginia
real estate market or economy including substantial increases in mortgage
interest rates, slower housing sales, and increased commercial property vacancy
rates could have an adverse impact on these groups of loans and the Bank's
income and financial position. At June 30, 2003, the Company had no other
concentrations of loans in any one industry exceeding 10% of its total loan
portfolio. An industry for this purpose is defined as a group of counterparties
that are engaged in similar activities and have similar economic characteristics
that would cause their ability to meet contractual obligations to be similarly
affected by changes in economic or other conditions.
The ultimate collectibility of the Company's loan portfolio and the ability to
realize the value of any underlying collateral, if needed, are influenced by the
economic conditions of the market area. The Company's operating results are
therefore closely related to the economic conditions and trends in the
Metropolitan Washington, D.C. area.
Non-Interest Income
- -------------------
Non-interest income increased $1.3 million, or 51.6%, from $2.4 million for the
six months ended June 30, 2002, to $3.7 million for the same period ended June
30, 2003. Fees and net gains on loans held-for-sale were the contributing factor
increasing $1.2 million, or 70.7%, from $1.7 million in 2002, to $2.9 million
for the six months ended June 30, 2003, as originations increased $66.7 million,
or 77.3%, from $86.3 million during the first six months of 2002, to $153.0
million for the comparable period in 2003. Sales also increased rising $50.1
million from $98.0 million in 2002, to $148.1 million for the first six months
of 2003. These higher levels of originations and subsequent sales are
attributable to both low interest rates and a strong local housing market. For
the three months ended June 30, 2003 non-interest income increased $795
thousand, or 66.6%, with an increase in fees and net gains on loans
held-for-sale of $737 thousand.
Loans classified as held-for-sale represent loans on one-to-four family
residential real estate, originated on a pre-sold and servicing released basis
to various investors, and carried on the balance sheet at the lower of cost or
market. The Company expects that should long-term interest rates rise, and
consequently mortgage rates rise, the level of originations and sales and the
fees and gains thereon, would be adversely affected.
Non-Interest Expense
- --------------------
For the three months ended June 30, 2003, non-interest expense increased $916
thousand, or 22.3%, compared to the same period in 2002, and increased $1.7
million, or 21.6%, from $8.2 million for the six months ended June 30, 2002, to
$9.9 million for the six months ended June 30, 2003. Salaries and benefits
expense for the three and six month periods ended June 30 accounted for $692
thousand and $1.3 million, or greater than 70% of the total increases in
non-interest expenses. Incentive compensation associated with increases in total
loans, commissions on loans originated for sale, and staff increases due to
overall growth, were the main reason for the increase in salaries
18
and benefits expense. Commissions on loans originated for sale were $541
thousand and $618 thousand for the three and six months ended June 30, 2003, and
would also be expected to decline along with any decline in the amount of loans
originated for sale, and the fees and net gains thereon.
Occupancy expense, which includes rents, depreciation, and equipment/systems
costs, increased $61 thousand, or 8.5%, and $179 thousand, or 12.9%, for the
three and six month periods ended June 30, 2003, due mostly to the opening of
the Bank's thirteenth branch office in May 2002. Other operating expense
increases of $114 thousand and $220 thousand for the three and six months ended
June 30 were up 15.2% and 14.7% due to higher marketing, legal and professional
services expenses. As a percentage of total revenue sources (net interest income
on a tax-equivalent basis and non-interest income) non-interest expense fell
from 56.6% for the three months ended June 30, 2002, to 51.6% for same period in
2003, and fell from 58.8% during the first six months of 2002 to 53.1% for the
six months ended June 30, 2003. This reduction is a result of both increases in
total revenue and on-going cost containment efforts.
Provision for Income Taxes
- --------------------------
The Company's income tax provisions are adjusted for non-deductible expenses and
non-taxable interest after applying the U.S. federal income tax rate of 34%.
Provision for income taxes totaled $1.6 million and $2.7 million for the six
months ended June 30, 2002 and 2003, respectively.
Liquidity
- ---------
The Company's principal sources of liquidity and funding are its deposit base.
The level of deposits necessary to support the Company's lending and investment
activities is determined through monitoring loan demand. Considerations in
managing the Company's liquidity position include, but are not limited to,
scheduled cash flows from existing loans and investment securities, anticipated
deposit activity including the maturity of time deposits, and projected needs
from anticipated extensions of credit. The Company's liquidity position is
monitored daily by management to maintain a level of liquidity conducive to
efficiently meet current needs and is evaluated for both current and longer term
needs as part of the asset/liability management process.
The Company measures total liquidity through cash and cash equivalents,
securities available-for-sale, mortgage loans held-for-sale, other loans and
investment securities maturing within one year, less securities pledged as
collateral for repurchase agreements, public deposits and other purposes, and
less any outstanding federal funds purchased. These liquidity sources increased
$81.0 million, or 37.0%, from $218.8 million at December 31, 2002, to $299.8
million at June 30, 2003, as net loans, as a percentage of total deposits,
declined from 91.2% at December 31, 2002, to 82.2% at June 30, 2003.
Additional sources of liquidity available to the Company include the capacity to
borrow funds through established short-term lines of credit with various
correspondent banks, and the Federal Home Loan Bank of Atlanta. Available funds
from these liquidity sources were approximately $145.5 million and $118.8
million at June 30, 2003, and December 31, 2002, respectively. The Bank's line
of credit with the Federal Home Loan Bank of Atlanta, which requires the
pledging of collateral in the form of certain loans and or securities, is
approximately $119.5 million of the $145.5 million as of June 30, 2003. As of
June 30, $400 thousand was outstanding on this line of credit.
Capital
- -------
The assessment of capital adequacy depends on a number of factors such as asset
quality, liquidity, earnings performance, changing competitive conditions and
economic forces, and the overall level of growth. The adequacy of the Company's
current and future capital is monitored by management on an ongoing basis.
Management seeks to maintain a capital structure that will assure an adequate
level of capital to support anticipated asset growth and to absorb potential
losses.
The capital position of the Bank continues to meet regulatory requirements. The
primary indicators relied on by bank regulators in measuring the capital
position are the Tier 1 risk-based capital, total risk-based capital, and
leverage ratios. Tier 1 capital consists of common and qualifying preferred
stockholders' equity less goodwill. Total
19
risk-based capital consists of Tier 1 capital, qualifying subordinated debt, and
a portion of the allowance for loan losses. Risk-based capital ratios are
calculated with reference to risk-weighted assets. The leverage ratio compares
Tier 1 capital to total average assets for the most recent quarter end. The
Bank's Tier 1 risk-based capital ratio was 7.40% at June 30, 2003, compared to
6.69% at December 31, 2002. The total risk-based capital ratio was 11.28% at
June 30, 2003, compared to 10.33% at December 31, 2002. These ratios are in
excess of the mandated minimum requirement of 4.00% and 8.00%, respectively. The
Bank's leverage ratio was 6.35% at June 30, 2003, compared to 5.72% at December
31, 2002, and is also in excess of the mandated minimum requirement of 4.00%.
Based on these ratios, the Bank is considered "well capitalized" under
regulatory prompt corrective action guidelines. The Company's Tier 1 risk-based
capital ratio, total risk-based capital ratio, and leverage ratio was 10.13%,
11.46% and 8.59%, respectively, at June 30, 2003.
During 2002, the Company continued to borrow funds under a line of credit with a
correspondent bank in order to provide capital to fund growth and expansion at
the Bank. At June 30, 2002, the amount outstanding under the line of credit was
$8.0 million. As strong asset growth continued, the Company provided additional
capital through a $7.0 million rights offering to existing stockholders in July
2002. Although the offering was successful, the Company believed that additional
capital would be necessary to fund future growth. In November and December 2002
the Company formed two financing subsidiaries in order to issue $18.0 million in
trust preferred securities through a private placement to unrelated parties. As
the $18.0 million in proceeds were in excess of current needs, the Company
repaid the total amount outstanding on its line of credit. The Company continues
to maintain its line of credit; however, it is currently in a renegotiation
process. Until the process is completed further advances would require the
correspondent's approval.
The ability of the Company to continue to grow is dependent on its earnings and
the ability to obtain additional funds for contribution to the Bank's capital,
through borrowing, the sale of additional common stock, or through the issuance
of additional trust preferred securities. In the event that the Company is
unable to obtain additional capital for the Bank on a timely basis, the growth
of the Company and the Bank may be curtailed, and the Company and the Bank may
be required to reduce their level of assets in order to maintain compliance with
regulatory capital requirements. Under those circumstances net income and the
rate of growth of net income may be adversely affected. The Company believes
that its current level of capital is sufficient to meet anticipated growth,
although there can be no assurance.
Recent Accounting Pronouncements
- --------------------------------
In April 2003, the Financial Accounting Standards Board issued Statement No.
149, Amendment of Statement 133 on Derivative Instruments and Hedging
Activities. This Statement amends and clarifies financial accounting and
reporting for derivative instruments, including certain derivative instruments
embedded in other contracts (collectively referred to as derivatives) and for
hedging activities under FASB Statement No. 133, Accounting for Derivative
Instruments and Hedging Activities. This Statement is effective for contracts
entered into or modified after June 30, 2003, and is not expected to have an
impact on the Company's consolidated financial statements.
In May 2003, the Financial Accounting Standards Board issued Statement No. 150,
Accounting for Certain Financial Instruments with Characteristics of both
Liabilities and Equity. This Statement establishes standards for how an issuer
classifies and measures certain financial instruments with characteristics of
both liabilities and equity. It requires that an issuer classify a financial
instrument that is within its scope as a liability (or an asset in some
circumstances). Many of those instruments were previously classified as equity.
This Statement is effective for financial instruments entered into or modified
after May 31, 2003, and otherwise is effective at the beginning of the first
interim period beginning after June 15, 2003, except for mandatory redeemable
financial instruments of nonpublic entities. Adoption of the Statement did not
result in an impact on the Company's consolidated financial statements.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
In the normal course of business, the Company is exposed to market risk, or
interest rate risk, as its net income is largely dependent on its net interest
income. Market risk is managed by the Company's Asset/Liability Management
Committee that formulates and monitors the performance of the Company based on
established levels of market risk
20
as dictated by policy. In setting certain tolerance levels, or limits on market
risk, the Committee considers the impact on earnings and capital, the level and
general direction of interest rates, liquidity, local economic conditions and
other factors. Interest rate risk, or interest sensitivity, can be defined as
the amount of forecasted net interest income that may be gained or lost due to
favorable or unfavorable movements in interest rates. Interest rate risk, or
sensitivity, arises when the maturity or repricing of interest-bearing assets
differs from the maturity or repricing of interest-bearing liabilities and as a
result of the difference between total interest-bearing assets and
interest-bearing liabilities. The Company seeks to manage interest rate
sensitivity while enhancing net interest income by periodically adjusting this
asset/liability position.
One of the tools used by the Company to assess interest sensitivity on a monthly
basis is the static gap analysis that measures the cumulative differences
between the amounts of assets and liabilities maturing or re-pricing within
various time periods. It is the Company's goal to limit the one-year cumulative
difference to plus or minus 10% of total interest-earning assets in an attempt
to limit changes in future net interest income from sudden changes in market
interest rates. The following table shows a gap analysis reflecting the earlier
of the maturity or re-pricing dates for various assets and liabilities as of
June 30, 2003. At that point in time, the Company had a cumulative net liability
sensitive twelve-month gap position of $7.9 million, or a negative 1.04% of
total earning assets. This position would indicate that over a period of
one-year earnings should decline slightly in a rising interest rate environment
as more liabilities would re-price than assets and should increase slightly in a
falling interest rate environment. However, over a ninety-day time line the
Company has an asset sensitive position of $48.1 million, or 6.34% of total
earning assets. Due to this high short-term position and rates on the
deposit/interest-bearing liability side being at such low levels that further
downward repricing cannot occur at the same magnitude as it can on earning
assets, the Company expects a lower net interest margin in the third quarter
given the recent twenty-five basis point reduction in the federal funds target
rate at the end of June. Importantly, this measurement of interest rate risk
sensitivity represents a static position as of a single day and is not
necessarily indicative of the Company's position at any other point in time,
does not take into account the sensitivity of yields and costs of specific
assets and liabilities to changes in market rates, and does not take into
account the specific timing of when changes to a specific asset or liability
will occur. More accurate measures of interest sensitivity are provided to the
Company using earnings simulation models.
At June 30, 2003 Interest Sensitivity Periods
-----------------------------------------------------------------------------------
Within 91 to 365 Over 1 to 5 Over
(Dollars in thousands) 90 Days Days Years 5 Years Total
-----------------------------------------------------------------------------------
EARNING ASSETS
Securities, at amortized cost $ 30,015 $ 56,698 $ 8,636 $ 13,588 $ 108,937
Federal funds sold 45,430 -- -- -- 45,430
Loans, held-for-sale 23,851 -- -- -- 23,851
Loans, net of unearned income 240,388 80,817 234,225 25,195 580,625
- ---------------------------------------------------------------------------------------------------------------------------
Total earning assets $ 339,684 $ 137,515 $ 242,861 $ 38,783 $ 758,843
- ---------------------------------------------------------------------------------------------------------------------------
INTEREST-BEARING LIABILITIES
NOW accounts $ 125,366 $ 6,615 $ 17,730 $ -- $ 149,711
Money market accounts 70,934 10,130 6,686 -- 87,750
Savings accounts 17,218 4,587 12,292 -- 34,097
Time deposits 45,499 153,824 107,514 10 306,847
Securities sold under agreement to
repurchase and federal funds 32,539 -- -- -- 32,539
purchased
21
At June 30, 2003 Interest Sensitivity Periods
----------------------------------------------------------------------------------
Within 91 to 365 Over 1 to 5 Over
(Dollars in thousands) 90 Days Days Years 5 Years Total
----------------------------------------------------------------------------------
Other borrowed funds -- 400 -- -- 400
----------------------------------------------------------------------------------
Trust preferred capital notes -- 18,000 -- -- 18,000
- ---------------------------------------------------------------------------------------------------------------------------
Total interest-bearing liabilities $ 291,556 $ 193,556 $ 144,222 $ 10 $ 629,344
- ---------------------------------------------------------------------------------------------------------------------------
Cumulative maturity / interest $ 48,128 $ (7,913) $ 90,726 $ 129,499 $ 129,499
sensitivity gap
As % of total earnings assets 6.34% (1.04%) 11.96% 17.07%
- ---------------------------------------------------------------------------------------------------------------------------
In order to more closely measure interest sensitivity, the Company uses earnings
simulation models on a quarterly basis. These models utilize the Company's
financial data and various management assumptions as to growth and earnings to
forecast a base level of net interest income and earnings over a one-year
period. This base level of earnings is then shocked assuming a sudden 200 basis
points increase or decrease in interest rates. The most recent earnings
simulation model was run based on data as of June 30, 2003, and at that time the
model projected earnings would decrease by 13.44% if interest rates would
immediately increase by 200 basis points and would also decrease by 3.22% if
interest rates suddenly fell by 200 basis points. These results are consistent
with the Company's understanding of its interest rate risk sensitivity given the
gap positions discussed above. In addition, the Company also expects that should
long-term interest rates rise and short-term rates (federal funds and the prime
rate) remain low, earnings would be adversely effected as fees and net gains
from loans held-for-sale would decline due to lower levels of refinancing
activity, while higher yields on loans and federal funds sold would not be
obtained to help offset this lower level of non-interest income.
The Company has set a limit on this measurement of interest sensitivity to a
maximum decline in earnings of 20%. Since the earnings model uses numerous
assumptions regarding the effect of changes in interest rates on the timing and
extent of repricing characteristics, future cash flows and customer behavior,
the model cannot precisely estimate net income and the effect on net income from
sudden changes in interest rates. Actual results will differ from simulated
results due to the timing, magnitude and frequency of interest rate changes and
changes in market conditions and management strategies, among other factors.
ITEM 4. CONTROLS AND PROCEDURES
The Company's management, under the supervision and with the participation of
the Company's Chief Executive Officer and Chief Financial Officer, evaluated, as
of the last day of the period covered by this report, the effectiveness of the
design and operation of the Company's disclosure controls and procedures, as
defined in Rule 13a-15(e) under the Securities Exchange Act of 1934. Based on
that evaluation, the Chief Executive Officer and Chief Financial Officer
concluded that the Company's disclosure controls and procedures were adequate.
There were no changes in the Company's internal control over financial reporting
(as defined in Rule 13a-15 under the Securities Act of 1934) during the quarter
ended June 30, 2003 that has materially affected, or is reasonably likely to
materially affect, the Company's internal control over financial reporting.
PART II. OTHER INFORMATION
Item 1. Legal Proceedings - None
Item 2. Changes in Securities and Use of Proceeds-None
Item 3. Defaults Upon Senior Securities - None
22
Item 4. Submission of Matters to a Vote of Security Holders
On April 30, 2003, the annual meeting of shareholders of the Company was
held for the purpose of (1) electing eight (8) directors to serve until
the next annual meeting and until their successors are duly elected and
qualified; (2) to vote on an amendment to the Company's Articles of
Incorporation increasing the number of authorized shares of common stock
to 20,000,000; and (3) to vote on an amendment to the Company's 1998
Stock Option Plan to increase the number of shares available under the
plan by 150,000.
The name of each director elected at the meeting, and the votes cast for
such persons, who constitute the entire Board of Directors in office
following the meeting, are set forth below.
Name For Against/Withheld Abstentions Broker Non-votes
---- --- ---------------- ----------- ----------------
Leonard Adler 3,246,972 -0- 207 none
Peter A. Converse 3,246,772 200 207 none
Frank L. Cowles 3,209,155 37,817 207 none
W. Douglas Fisher 3,246,972 -0- 207 none
David M. Guernsey 3,246,972 -0- 207 none
Robert H. L'Hommedieu 3,234,896 12,076 207 none
Norris E. Mitchell 3,243,575 3,397 207 none
Arthur L. Walters 3,231,499 15,473 207 none
The vote on the amendment to the Articles of Incorporion was as
follows:
For Against/Withheld Abstentions Broker Non-votes
--- ---------------- ----------- ----------------
3,171,858 53,648 21,673 none
The vote on the amendment to the 1998 Stock Option Plan was as follows:
For Against/Withheld Abstentions Broker Non-votes
--- ---------------- ----------- ----------------
3,119,935 99,329 27,915 none
Item 5. Other Information - None
Item 6. Exhibits and reports on Form 8-K
a) Exhibits
Exhibit No. Description
----------- -----------
3.1 Articles of Incorporation of Virginia Commerce Bancorp, Inc.
3.2 Bylaws of Virginia Commerce Bancorp, Inc. (1)
4.1 Junior Subordinated Indenture, dated as of November 15, 2002
between Virginia Commerce Bancorp, Inc. and The Bank of New
York, as Trustee (2)
4.2 Amended and Restated Declaration of Trust, dated as of
November 15, 2002 among Virginia Commerce Bancorp, Inc., The
Bank of New York, as Property Trustee, The Bank of New York
(Delaware), as Delaware Trustee, and Peter A. Converse,
William K. Beauchesne and Marcia J. Hopkins as
Administrative Trustees (2)
4.3 Guarantee Agreement dated as of November 15, 2002, between
Virginia Commerce Bancorp, Inc. and The Bank of New York, as
Guarantee Trustee (2)
4.4 Junior Subordinated Indenture, dated as of December 19, 2002
between Virginia Commerce Bancorp, Inc. and The Bank of New
York, as Indenture Trustee (2)
4.5 Amended and Restated Declaration of Trust, dated as of
December 19, 2002 among Virginia Commerce Bancorp, Inc., The
Bank of New York, as Property Trustee, The Bank of New York
(Delaware), as Delaware Trustee, and Peter A. Converse,
William K. Beauchesne and Marcia J. Hopkins as
Administrative Trustees (2)
23
Exhibit No. Description
----------- -----------
4.6 Guarantee Agreement dated as of December 19, 2002, between
Virginia Commerce Bancorp, Inc. and The Bank of New York, as
Guarantee Trustee (2)
10.1 1998 Stock Option Plan (1)
11 Statement Regarding Computation of Per Share Earnings
See Note 4 to the Consolidated Financial Statements
included in this report
21 Subsidiaries of the Registrant:
Virginia Commerce Bank-Virginia
VCBI Capital Trust I-Delaware
VCBI Capital Trust II-Delaware
Subsidiaries of Virginia Commerce Bank:
Northeast Land and Development Corporation-Virginia
Virginia Commerce Insurance Agency, L.L.C.-Virginia
31(a) Certification of Peter A. Converse, President and Chief
Executive Officer
31(b) Certification of William K. Beauchesne, Treasurer and Chief
Financial Officer
32(a) Certification of Peter A. Converse, President and Chief
Executive Officer
32(b) Certification of William K. Beauchesne, Treasurer and Chief
Financial Officer
(1) Incorporated by reference to the same numbered exhibit to the Company's
Annual Report on Form 10-KSB for the year ended December 31, 1999
(2 Not filed in accordance with the provisions of Item 601(b)(4)(iii) of
Regulation SK. The Company agrees to provide a copy of these documents to
the Commission upon request.
b) Form 8-K
On April 14, 2003, the Company filed a current report on Form 8-K, under item 5
thereof, reflecting the announcement of earnings for the period ended March 31,
2003.
On April 22, 2003, the Company filed a current report on Form 8-K, under item 5
thereof, reflecting the announcement of the declaration of a two for one stock
split in the form of a 100% stock dividend, payable May 30, 2003, to holders of
record on May 5, 2003.
24
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
Date: August 14, 2003 BY /s/ Peter A. Converse
-----------------------------------------------
Peter A. Converse, President and Chief Executive
Officer
Date: August 14, 2003 BY /s/ William K. Beauchesne
------------------------------------------
William K. Beauchesne, Treasurer and Chief
Financial Officer
25