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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 September 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 November 10, 2003 the number of outstanding shares of registrant's common
stock, par value $1.00 per share was: 7,849,558
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
September 30, December 31,
2003 2002
------------- ------------
ASSETS
Cash and due from banks $ 17,638 $ 19,907
Securities (fair value: 2003, $166,761; 2002, $71,766) 166,123 71,231
Federal funds sold 13,859 24,071
Loans held-for-sale 9,877 18,948
Loans, net of allowance for loan losses of $6,968 in 2003 and
$5,924 in 2002 614,403 516,900
Bank premises and equipment, net 6,376 6,517
Accrued interest receivable 2,817 2,489
Other assets 9,737 2,824
-------- --------
Total assets $840,830 $662,887
======== ========
LIABILITIES AND STOCKHOLDERS' EQUITY
DEPOSITS
Non-interest bearing demand deposits $125,777 $ 98,575
Savings and interest-bearing demand deposits 299,172 190,811
Time deposits 309,886 277,610
-------- --------
Total deposits $734,835 $566,996
Securities sold under agreement to repurchase and federal funds
purchased 32,779 32,081
Other borrowed funds 400 400
Trust preferred capital notes 18,000 18,000
Accrued interest payable 1,255 1,271
Other liabilities 1,688 2,289
Commitments and contingencies -- --
-------- --------
Total liabilities $788,957 $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, 7,819,219; 2002, 3,739,330 7,819 3,739
Surplus 17,624 19,623
Retained earnings 26,326 17,807
Accumulated other comprehensive income 104 681
-------- --------
Total stockholders' equity $ 51,873 $ 41,850
-------- --------
Total liabilities and stockholders' equity $840,830 $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 Nine Months Ended
September 30, September 30,
2003 2002 2003 2002
--------------------------------------------
INTEREST AND DIVIDEND INCOME:
Interest and fees on loans $ 10,458 $ 9,329 $ 30,318 $ 25,977
Interest and dividends on investment securities:
U.S. Treasury securities and agency obligations 1,001 690 2,523 2,077
Other securities 179 94 473 275
Interest on federal funds sold 120 112 325 278
-------- -------- -------- --------
Total interest and dividend income $ 11,758 $ 10,225 $ 33,639 $ 28,607
INTEREST EXPENSE:
Deposits $ 3,255 $ 3,462 $ 9,728 $ 9,975
Securities sold under agreement to repurchase
and federal funds purchased 31 61 91 202
Other borrowed funds 6 120 18 406
Trust preferred capital notes 204 -- 630 --
-------- -------- -------- --------
Total interest expense $ 3,496 $ 3,643 $ 10,467 $ 10,583
-------- -------- -------- --------
NET INTEREST INCOME: $ 8,262 $ 6,582 $ 23,172 $ 18,024
Provision for loan losses 323 571 1,087 1,414
-------- -------- -------- --------
Net interest income after provision for loan losses $ 7,939 $ 6,011 $ 22,085 $ 16,610
-------- -------- -------- --------
NON-INTEREST INCOME:
Service charges and other fees $ 475 $ 408 $ 1,289 $ 1,181
Fees and net gains on loans held-for-sale 1,892 947 4,746 2,619
Gain (loss) on sale of securities -- -- -- (1)
Other 90 13 154 30
-------- -------- -------- --------
Total non-interest income $ 2,457 $ 1,368 $ 6,189 $ 3,829
-------- -------- -------- --------
NON-INTEREST EXPENSE:
Salaries and employee benefits $ 3,322 $ 2,510 $ 9,398 $ 7,300
Occupancy expense 814 756 2,380 2,143
Data processing expense 332 242 923 748
Other operating expense 1,013 727 2,730 2,224
-------- -------- -------- --------
Total non-interest expense $ 5,481 $ 4,235 $ 15,431 $ 12,415
-------- -------- -------- --------
Income before taxes on income $ 4,915 $ 3,144 $ 12,843 $ 8,024
Provision for income taxes 1,651 1,058 4,324 2,700
-------- -------- -------- --------
NET INCOME $ 3,264 $ 2,086 $ 8,519 $ 5,324
-------- -------- -------- --------
Earnings per common share, basic (1) $ 0.42 $ 0.28 $ 1.10 $ 0.76
Earnings per common share, diluted (1) $ 0.38 $ 0.25 $ 1.00 $ 0.68
(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 nine months ended September 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 -- -- -- 5,324 $ 5,324 5,324
Other comprehensive income, net of tax
Unrealized holding gains on securities
available-for-sale arising during the
period (net of tax of $288) 558
--------
Other comprehensive income, net of tax -- -- -- -- 558 558 558
--------
Total comprehensive income -- -- -- -- -- $ 5,882 --
========
Issuance of common stock: -- -- --
25% stock split -- 680 (680) -- -- --
Rights offering, net of costs of $45 -- 291 6,666 -- -- 6,957
Stock options/warrants exercised -- 16 145 -- -- 161
Cash paid in lieu of fractional shares -- -- -- (7) -- (7)
------------------------------------------------------ --------
Balance, September 30, 2002 $ -- $ 3,708 $ 19,321 $ 15,455 $ 729 $ 39,213
======== ======== ======== ======== ======== ========
Balance, January 1, 2003 $ -- $ 3,739 $ 19,623 $ 17,807 $ 681 $ 41,850
Comprehensive Income:
Net Income -- -- -- 8,519 $ 8,519 8,519
Other comprehensive income (loss), net
of tax
Unrealized holding losses on securities
available-for-sale arising during the
period (net of tax of $297) (577)
--------
Other comprehensive income (loss), net
of tax -- -- -- -- (577) (577) (577)
--------
Total comprehensive income -- -- -- -- -- $ 7,942 --
========
Issuance of common stock-
Stock options/warrants exercised -- 186 1,895 -- -- 2,081
100% stock split -- 3,894 (3,894) -- -- --
------------------------------------------------------ --------
Balance, September 30, 2003 $ -- $ 7,819 $ 17,624 $ 26,326 $ 104 $ 51,873
======== ======== ======== ======== ======== ========
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)
Nine Months Ended
September 30,
-----------------------
2003 2002
---- ----
CASH FLOWS FROM OPERATING ACTIVITIES:
Net Income $ 8,519 $ 5,324
Adjustments to reconcile net income to net cash
provided by operating activities:
Depreciation and amortization 758 746
Provision for loan losses 1,087 1,414
Deferred tax benefit (414) (511)
Amortization of security premiums and (accretion) of discounts (9) 2
Loss on sale of securities available-for-sale -- 1
Origination of loans held-for-sale (249,307) (135,102)
Sales of loans 258,378 134,866
Changes in other assets and other liabilities:
Increase in accrued interest receivable (328) (150)
Increase in other assets (6,202) (94)
(Decrease) increase in other liabilities (618) 483
-----------------------
Net Cash Provided by Operating Activities $ 11,864 $ 6,979
CASH FLOWS FROM INVESTING ACTIVITIES:
Net increase in loans (98,589) (94,314)
Purchase of securities available-for-sale (118,501) (45,694)
Purchase of securities held-to-maturity (41,143) (4,371)
Proceeds from sales of securities available-for-sale -- 1,350
Proceeds from principal payments on securities available-for-sale 6,713 4,968
Proceeds from principal payments on securities held-to-maturity 4,104 1,724
Proceeds from calls and maturities of securities available-for-sale 48,070 24,000
Proceeds from calls and maturities of securities held-to-maturity 5,000 502
Purchase of bank premises and equipment (617) (1,243)
-----------------------
Net Cash (Used In) Investing Activities $(194,963) $(113,078)
CASH FLOWS FROM FINANCING ACTIVITIES:
Net increase in deposits $ 167,839 $ 140,065
Net increase (decrease) in repurchase agreements 698 (11,835)
Net decrease in other borrowed funds -- (3,000)
Net proceeds from issuance of capital stock 2,081 7,118
Cash paid in lieu of fractional shares -- (7)
-----------------------
Net Cash Provided by Financing Activities $ 170,618 $ 132,341
Net (Decrease) Increase In Cash and Cash Equivalents (12,481) 26,242
CASH AND CASH EQUIVALENTS - BEGINNING OF PERIOD 43,978 15,155
-----------------------
CASH AND CASH EQUIVALENTS - END OF PERIOD $ 31,497 $ 41,397
=======================
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 September 30, 2003 and
December 31, 2002, the results of operations for the three and nine months
ended September 30, 2003 and 2002, and statements of cash flows and
stockholders' equity for the nine months ended September 30, 2003 and
2002.
Operating results for the three and nine month periods ended September 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 September 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 $ 109,012 $ 583 $ (493) $ 109,102
Domestic corporate debt obligations 6,000 5 (5) 6,000
Obligations of states and political subdivisions 1,209 68 -- 1,277
Restricted stock:
Federal Reserve Bank 758 -- -- 758
Federal Home Loan Bank 1,355 -- -- 1,355
Community Bankers' Bank 55 -- -- 55
-------------------------------------------------------
$ 118,389 $ 656 $ (498) $ 118,547
HELD-TO-MATURITY:
U.S. Government Agency obligations $ 39,561 $ 451 $ -- $ 40,012
Obligations of states and political subdivisions 7,529 158 (31) 7,656
Domestic corporate debt obligations 486 60 -- 546
-------------------------------------------------------
$ 47,576 $ 669 $ (31) $ 48,214
=======================================================
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:
September 30, 2003 December 31, 2002
----------------------------------------
(In Thousands of Dollars)
Commercial $ 62,871 $ 44,559
Real estate-one-to-four family residential 81,767 67,061
Real estate-multi-family residential 32,561 29,269
Real estate-non-farm, non-residential 299,358 265,694
Real estate-construction 141,404 111,333
Consumer 6,165 6,941
--------- ---------
Total Loans 624,126 524,857
Less unearned income (2,755) (2,033)
Less allowance for loan losses (6,968) (5,924)
--------- ---------
Loans, net $ 614,403 $ 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 nine months ended September 30, 2003, have been adjusted to
give effect to a two-for-one stock split in the form of a 100% stock
dividend in May 2003.
Nine Months Ended
-----------------
September 30, 2003 September 30, 2002
------------------ ------------------
Per Per
Share Share
Shares Amount Shares Amount
------ ------ ------ ------
Basic earnings per share 7,764,536 $1.10 6,999,798 $0.76
----- -----
Effect of dilutive securities:
Stock options 680,104 555,889
Warrants 33,397 330,014
--------- ---------
Diluted earnings per share 8,487,037 $1.00 7,885,701 $0.68
========= ===== ========= =====
5. STOCK COMPENSATION PLAN
At September 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 nine months ended September 30, 2003, and
2002 had the fair value recognition provisions of FASB Statement No. 123,
Accounting for Stock-Based Compensation, been adopted.
NINE MONTHS ENDED
- ----------------------------------------------------------------------------------------------------
(Dollars in thousands except per share amounts) SEPTEMBER 30, 2003 SEPTEMBER 30, 2002
- ----------------------------------------------------------------------------------------------------
NET INCOME, AS REPORTED $ 8,519 $ 5,324
Deduct: total stock-based employee compensation
expense determined based on fair value
method of awards, net of tax (273) (314)
PRO FORMA NET INCOME $ 8,246 $ 5,010
BASIC EARNINGS PER SHARE:
As reported $ 1.10 $ 0.76
Pro forma $ 1.06 $ 0.72
DILUTED EARNING PER SHARE:
As reported $ 1.00 $ 0.68
Pro forma $ 0.97 $ 0.64
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 28.63% 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 September 30, 2003 with the
minimum regulatory guidelines is as follows:
Minimum Minimum to be
Actual Guidelines "Well-Capitalized"
------ ---------- ------------------
Total Risk-Based Capital:
Company 11.41% 8.00% --
Bank 11.22% 8.00% 10.00%
Tier 1 Risk-Based Capital:
Company 10.26% 4.00% --
Bank 7.51% 4.00% 6.00%
Leverage Ratio:
Company 8.18% 4.00% --
Bank 6.11% 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 September 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
10
114, Accounting by Creditors for 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 $177.9 million, or 26.8%, from $662.9 million at December
31, 2002, to $840.8 million at September 30, 2003, as total deposits grew $167.8
million, or 29.6%, from $567.0 million at December 31, 2002, to $734.8 million.
Other funding sources were mostly unchanged during the nine month period ended
September 30, 2003.
Loans, net of allowance for loan losses, increased $97.5 million, or 18.9%, from
$516.9 million at December 31, 2002, to $614.4 million at September 30, 2003,
and represented 83.6% of total deposits at September 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 $33.7 million, or 12.7%, from
$265.7 million at December 31, 2002, to $299.4 million at September 30, 2003.
Real estate construction loans represented the second largest dollar increase
rising $30.1 million, or 27.0%, from $111.3 million at December 31, 2002, to
$141.4 million at September 30, 2003, while commercial loans rose $18.3 million,
or 41.1%, from $44.6 million at December 31, 2002, to $62.9 million at September
30, 2003. One-to-four family residential real estate loans increased $14.7
million, or 21.9%, from $67.1 million at December 31, 2002, to $81.8 million at
September 30, 2003. Growth in the various loan categories is reflective of the
Company's emphasis on commercial real estate and single-family construction
lending along with recent efforts to increase commercial lending and home equity
lines-of-credit.
Loans held-for-sale, composed of one-to-four family residential real estate
loans originated on a pre-sold basis to various investors, decreased $9.0
million, or 47.9%, from $18.9 million at December 31, 2002, to $9.9 million at
September 30, 2003, due to greater efficiency in processing sales. Originations
were up $114.2 million, or 84.5%, from $135.1 million during the nine months
ended September 30, 2002, to $249.3 million during the current nine month period
11
due to a higher level of refinancing activity. Of the $249.3 million in
originations year-to-date, $194.1 million, or 77.8%, 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, and
consequently mortgage loan rates, rise.
With the increase in loans trailing deposit growth during the nine month period,
investment securities increased $94.9 million, or 133.2%, from $71.2 million at
December 31, 2002, to $166.1 million at September 30, 2003. With long term
interest rates at historically low levels the 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,
for most of the year. However, recent increases in long-term interest rates
provided the Company with some opportunity for higher yields, and as a result
approximately $30 million in U.S. Government Agency obligations were added to
the held-to-maturity portfolio. The overall strategy to avoid investments on the
long end of the yield curve is expected to provide the Company with greater
flexibility and opportunities when interest rates rise, although it does serve
to compress the Company's 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 in
order to help offset rising employee benefit costs. These policies were recorded
on the balance sheet under other assets and have contributed $137 thousand in
income, on an after-tax basis, year-to-date.
Deposit growth occurred in all categories with non-interest bearing demand
deposits increasing $27.2 million, or 27.6%, from $98.6 million at December 31,
2002, to $125.8 million at September 30, 2003. Savings and interest-bearing
demand deposits increased $108.4 million, or 56.8%, from $190.8 million to
$299.2 million, and time deposits grew by $32.3 million, or 11.6%, from $277.6
million at December 31, 2002, to $309.9 million at September 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 $32.3 million in time deposit growth was attracted from
out-of-market financial institutions; however, they bear the same interest rates
paid by the Bank on comparable deposits from local consumers and businesses, and
those rates are generally near the top of the local market.
For the three months ended September 30, 2003 total assets increased $40.8
million, or 5.1%, from $800 million at June 30, 2003 to $840.8 million at
September 30, 2003, total deposits increased $36.6 million, or 5.2%, from $698.2
million to $734.8 million, and loans, net of allowance for loans losses, grew
$40.4 million, or 7.0%, from $574.0 million to $614.4 million. Investment
securities also increased rising $56.3 million, or 51.2%, while fed funds sold
declined by $31.6 million.
For the nine months ended September 30, 2003, net income of $8.5 million
reflected an increase of 60.0% compared to $5.3 million for the nine months
ended September 30, 2002, as net interest income increased $5.2 million, or
28.6%, non-interest income rose $2.4 million, or 61.6%, and non-interest expense
was up $3.0 million, or 24.3%. Provisions for loan losses decreased $327
thousand from $1.4 million for nine months ended September 30, 2002, to $1.1
million for the nine months ended September 30, 2003, due to a decline in net
charge-offs, a drop in the level of non-performing assets, and slightly lower
third quarter loan growth. 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 $1.00 were up $0.32, or 47.1%, from $0.68 for the comparable period in
2002. The Company's annualized return on average assets and return on average
equity were 1.50% and 24.17% for the current nine month period compared to 1.26%
and 23.00% for the nine months ended September 30, 2002.
For the three months ended September 30, 2003, net income of $3.3 million
increased $1.2 million, or 56.5%, compared to $2.1 million for the same period
in 2002 as net interest income rose $1.7 million, non-interest income increased
by $1.1 million and non-interest expenses were up $1.3 million. Diluted earnings
per share increased $0.13, or 52.0%, from $0.25 for the three months ended
September 30, 2003, to $0.38 for the three month period ended September 30,
2003. The return on average assets and return on average equity were 1.54% and
25.80% for the three months ended September 30, 2003, compared to 1.37% and
22.85% for the same period in 2002.
12
Overall, while the net interest margin declined for both the three and nine
month periods ended September 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,
while increases in non-interest expense were generally limited to compensation
associated with high loan production levels. As a result, the Company's
efficiency ratio improved from 56.6% for the nine months ended September 30,
2002 to 52.3% for the current nine-month period.
For the nine months ended September 30, 2003, stockholders' equity increased
$10.0 million, or 23.9%, with $8.5 million in earnings, $2.1 million in proceeds
and tax benefits from the exercise of stock options and warrants by Company
directors and officers, and a decline in other comprehensive income of $577
thousand, net of tax. 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 $5.2 million, or 28.6%, from $18.0 million for the nine months
ended September 30, 2002, to $23.2 million for the nine month period ended
September 30, 2003, and increased $1.7 million, or 25.5%, from $6.6 million for
the three months ended September 30, 2002, to $8.3 million for the three months
ended September 30, 2003. Increases for both periods were due to significant
growth in earning assets as the Company's net interest margin declined from
4.44% in the third quarter of 2002 to 4.04% for the current three-month period
and from 4.42% for the nine months ended September 30, 2002, to 4.24%
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 eighty-eight basis points from 7.06% for the
nine months ended September 30, 2002, to 6.18% for the nine months ended
September 30, 2003, while the average rate paid on interest-bearing liabilities
fell eighty-two basis points from 3.17% to 2.35%. For the three month period
ended September 30, 2003, the yield on earning assets fell one hundred sixteen
basis points to 5.77% and the cost of interest-bearing liabilities fell
ninety-five basis points to 2.11%, as compared to the three month period ended
September 30, 2002. Due to increases in loans and investment securities in the
later part of the third quarter, and a resulting lower level of fed funds sold,
the Company expects that its yield on earning assets will be slightly higher in
the fourth quarter of 2003 as compared to the third quarter.
The following table shows the average balance sheets for each of the three and
nine-month periods ended September 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 $522 thousand and $507 thousand for the three month period ended
September 30, 2003 and 2002, respectively, and totaled $1.5 million and $1.3
million for the nine month periods.
13
-------------------------------------------------------------------------------
Three months ended September 30,
-------------------------------------------------------------------------------
2003 2002
------------------------------------- ----------------------------------
Interest Average Interest Average
Average Income- Yields Average Income- Yields
(Dollars in thousands) Balance Expense /Rates Balance Expense /Rates
------------------------------------ -----------------------------------
ASSETS
Securities (1) $131,375 $ 1,180 3.72% $ 62,996 $ 784 5.14%
Loans, net of unearned income 617,821 10,458 6.62% 490,643 9,329 7.44%
Federal funds sold 52,984 120 0.89% 26,226 112 1.66%
------------------------------------ -----------------------------------
TOTAL INTEREST-EARNING ASSETS $802,180 $ 11,758 5.77% $579,865 $ 10,225 6.93%
Non interest-earning assets 35,706 25,276
-------- --------
TOTAL ASSETS $837,886 $605,141
======== ========
LIABILITIES AND STOCKHOLDERS' EQUITY
Interest-bearing deposits:
NOW accounts $173,408 $ 646 1.48% $ 87,974 $ 485 2.19%
Money market accounts 90,940 331 1.44% 59,266 356 2.38%
Savings accounts 32,671 39 0.48% 12,347 57 1.84%
Time deposits 306,325 2,239 2.89% 272,344 2,564 3.74%
------------------------------------ -----------------------------------
Total interest-bearing deposits $604,344 $ 3,255 2.14% $431,931 $ 3,462 3.18%
Securities sold under agreement to
repurchase and federal funds purchased 33,621 31 0.36% 32,336 61 0.75%
Other borrowed funds 400 6 5.93% 8,400 120 5.54%
Trust preferred capital notes 18,000 204 4.44% -- -- --
------------------------------------ -----------------------------------
TOTAL INTEREST-BEARING LIABILITIES $656,365 $ 3,496 2.11% $472,667 $ 3,643 3.06%
Demand deposits and other non-interest
bearing liabilities 131,334 96,253
-------- --------
TOTAL LIABILITIES $787,699 $568,920
Stockholders' equity 50,187 36,221
-------- --------
TOTAL LIABILITIES AND STOCKHOLDERS'
EQUITY $837,886 $605,141
======== ========
Interest rate spread 3.66% 3.87%
Net interest income and margin $ 8,262 4.04% $ 6,582 4.44%
(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 to increase
tax-exempt interest income to a tax-equivalent basis.
14
-------------------------------------------------------------------------------
Nine Months Ended September 30,
-------------------------------------------------------------------------------
2003 2002
------------------------------------- ----------------------------------
Interest Average Interest Average
Average Income- Yields Average Income- Yields
(Dollars in thousands) Balance Expense /Rates Balance Expense /Rates
------------------------------------ -----------------------------------
ASSETS
Securities(1) $101,012 $ 2,996 4.12% $ 59,811 $ 2,352 5.39%
Loans, net of unearned income 579,436 30,318 6.90% 453,968 25,977 7.55%
Federal funds sold 40,714 325 1.05% 22,150 278 1.66%
------------------------------------ -----------------------------------
TOTAL EARNING ASSETS $721,162 $ 33,639 6.18% $535,929 $ 28,607 7.06%
Non-earning assets 37,089 27,344
-------- --------
TOTAL ASSETS $758,251 $563,273
======== ========
LIABILITIES AND STOCKHOLDERS' EQUITY
Interest-bearing deposits:
NOW accounts $143,052 $ 1,730 1.62% $ 86,534 $ 1,378 2.13%
Money market accounts 91,707 1,023 1.49% 50,979 891 2.34%
Savings accounts 22,647 151 0.89% 15,261 159 1.40%
Time deposits 285,928 6,824 3.08% 248,193 7,547 4.07%
------------------------------------ -----------------------------------
Total interest-bearing deposits $543,334 $ 9,728 2.39% $400,967 $ 9,975 3.33%
Securities sold under agreement to
repurchase and federal funds purchased 32,245 91 0.38% 34,168 202 0.79%
Other borrowed funds 400 18 5.93% 10,605 406 5.04%
Trust preferred capital notes 18,000 630 4.62% -- -- --
------------------------------------ -----------------------------------
TOTAL INTEREST-BEARING LIABILITIES $593,979 $ 10,467 2.35% $445,740 $ 10,583 3.17%
Demand deposits and other non-interest
bearing liabilities 117,153 86,581
-------- --------
TOTAL LIABILITIES $711,132 $532,321
Stockholders' equity 47,119 30,952
-------- --------
TOTAL LIABILITIES AND STOCKHOLDERS'
EQUITY $785,251 $563,273
======== ========
Interest rate spread 3.83% 3.89%
Net interest income and margin $ 23,172 4.24% $ 18,024 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 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 nine months ended September 30, 2003, net
charge-offs totaled $43 thousand, or 0.01% of average loans compared to $81
thousand, or 0.02% for the same period in 2002, while the provision for loan
loss expense for the nine months ended September 30, 2003, was $1.1 million
compared to $1.4 million in 2002. As a result, the total allowance for loan
losses increased $1.0 million, or 17.6%, from $5.9 million at December 31, 2002,
to $6.9 million at September 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 $2.1 million at September 30,
2002, to $1.6 million at September 30, 2003, and a drop in non-performing assets
and past due loans from $2.4 million at December 31, 2002 to $1.2 million at
September 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:
Nine Months Nine Months Twelve Months
Ended Ended Ended
September 30, 2003 September 30, 2002 December 31, 2002
---------------------------------------------------------------------
(In Thousands of Dollars)
Allowance, at beginning of period $ 5,924 $ 4,356 $ 4,356
Provision charged against income 1,087 1,414 1,678
Recoveries:
Consumer loans 11 33 40
Commercial loans 1 4 5
Losses charged to reserve:
Consumer loans (25) (63) (68)
Commercial loans (30) (55) (87)
------- ------- -------
Net (charge-offs) recoveries (43) (81) (110)
Allowance, at end of period $ 6,968 $ 5,689 $ 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, restructured
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 51.4% from $2.4 million at December 31, 2002 to $1.2
million at September 30, 2003, and decreased $235 thousand, or 16.8%, from $1.4
million at September 30, 2002. The decrease during the nine months ended
September 30, 2003, was due to the payoff of a $1.0 million non-accrual loan on
a single-family residential property.
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 0.19% at
September 30, 2003, and decreased from 0.28% at September 30, 2002. As noted
above, the decrease in the ratio from December 31, 2002, to September 30, 2003,
was due to the payoff of a $1.0 million non-accrual loan on a single-family
residential property. The Company expects its ratio of non-performing assets to
total loans to remain low relative to its peers; however, it could increase from
its current level. This expectation of a continuing low ratio is based on
identified other potential problem loans on September 30, 2003. As of September
30, 2003, there were $1.6 million of loans for which management has identified
risk factors which could impair repayment in accordance with their terms,
compared to $1.9 million at December 31, 2002 and $2.1 million at September 30,
2002. 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 September 30, 2003, September 30, 2002, and
December 31, 2002, the Company held no foreclosed real properties.
Total non-performing assets consist of the following:
September 30, 2003 September 30, 2002 December 31, 2002
---------------------------------------------------------------------------
(In Thousands of Dollars)
Non-accrual loans $ 247 $ 67 $1,943
Impaired loans 15 255 444
Troubled debt restructurings 875 -- --
------ ------ ------
Total non-performing assets $1,137 $ 322 $2,387
Loans past due 90 days and still
Accruing 23 1,073 --
Total non-performing assets and
loans past due 90 days and
still accruing $1,160 $1,395 $2,387
====== ====== ======
As a percentage of total loans 0.19% 0.28% 0.44%
As a percentage of total assets 0.14% 0.22% 0.36%
17
Concentrations of Credit Risk
- -----------------------------
At September 30, 2003, the Company had $473.3 million, or 75.8%, 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 $141.4 million at
September 30, 2003, represented 22.7% of total loans, loans secured by
multi-family residential properties of $32.6 million represented 5.2% of total
loans, and loans secured by non-farm, non-residential properties of $299.4
million represented 48.0%.
Construction loans at September 30, 2003, included $98.7 million in loans to
commercial builders on single family residential property and $14.9 million to
individuals on single family residential property in the Northern Virginia
market, representing 15.8% and 2.4% of total loans, respectively, and together
representing 18.2% 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 $27.8 million of construction loans on non-residential commercial
property at September 30, 2003, representing 4.5% of total loans. Total
construction loans of $141.4 million include $50.2 million in land acquisition
and or development loans on residential property and $21.6 million in land
acquisition and or development loans on commercial property, together totaling
$71.8 million, or 11.5% 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 September 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 as substantially all loan collateral is
within the Metropolitan Washington, D.C. 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 $2.4 million, or 61.6%, from $3.8 million for the
nine months ended September 30, 2002, to $6.2 million for the same period ended
September 30, 2003. Fees and net gains on loans held-for-sale were the
contributing factor increasing $2.1 million, or 81.2%, from $2.6 million in
2002, to $4.7 million for the nine months ended September 30, 2003, as
originations increased $114.2 million, or 84.5%, from $135.1 million for the
nine months ended September 30, 2002, to $249.3 million for the comparable
period in 2003. Sales also increased rising $123.5 million from $134.9 million
in 2002, to $258.4 million for the nine months ended September 30, 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
September 30, 2003 non-interest income increased $1.1 million, or 79.6%, with an
increase in fees and net gains on loans held-for-sale of $945 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 September 30, 2003, non-interest expense increased
$1.3 million or 29.4%, compared to the same period in 2002, and increased $3.0
million, or 24.3%, from $12.4 million for the nine months ended September 30,
2002, to $15.4 million for the nine months ended September 30, 2003. Salaries
and benefits expense for the three and six month periods ended September 30
accounted for $812 thousand and $2.1 million, or greater than 65% of the total
increases in non-interest expenses. Incentive compensation associated with
increases in total loans, commissions on loans originated for sale, and staff
18
increases due to overall growth, were the main reason for the increase in
salaries and benefits expense. Commissions on loans originated for sale were
$791 thousand and $1.9 million for the three and six months ended September 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 $58 thousand, or 7.7%, and $237 thousand, or 11.1%, for the
three and nine month periods ended September 30, 2003, while other operating
expenses increased $286 thousand and $506 thousand for the three and nine months
ended September 30, 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
53.1% for the three months ended September 30, 2002, to 50.9% for same period in
2003, and fell from 56.6% for the nine months ended September 30. 2002 to 52.3%
for the nine months ended September 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% on
the first $10 million in income and 35% on amounts above that. Provision for
income taxes totaled $2.7 million and $4.3 million for the nine months ended
September 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
$42.3 million, or 19.3%, from $218.8 million at December 31, 2002, to $261.1
million at September 30, 2003, as net loans, as a percentage of total deposits,
declined from 91.2% at December 31, 2002, to 83.6% at September 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 $147.6 million and $118.8
million at September 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 $125.6 million of the $147.6 million total as of September 30,
2003. As of September 30, 2003 $400 thousand was outstanding on this line of
credit.
Off-Balance Sheet Transactions
- ------------------------------
The Company enters into certain financial transactions in the ordinary course of
performing traditional banking services that result in off-balance sheet
transactions. The off-balance sheet transactions recognized as of September 30,
2003, and December 31, 2002, were commitments to extend credit, which include
unfunded lines of credit, and standby letter of credit only.
19
Commitments to extend credit, which amounted to $216.8 million at September 30,
2003, and $143.1 million at December 31, 2002, represent legally binding
agreements to lend to a customer as long as there is no violation of any
condition established in the contract. Commitments generally have fixed
expiration dates or other termination clauses and may require payment of a fee.
Since many of the commitments are expected to expire without being drawn upon,
the total commitment amounts do not necessarily represent future cash
requirements.
Standby letters of credit are conditional commitments issued by the Company
guaranteeing the performance of a customer to a third party. Those guarantees
are primarily issued to support public and private borrowing arrangements. At
September 30, 2003, and December 31, 2002, the Company had $10.8 million and
$11.3 million, respectively, in outstanding standby letters 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 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
7.51% at September 30, 2003, compared to 6.69% at December 31, 2002. The total
risk-based capital ratio was 11.22% at September 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
6.11% at September 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 10.26%, 11.41% and 8.18%,
respectively, at September 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 September 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 no longer maintains this line of credit.
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 November 2002, the FASB issued FASB Interpretation No. 45, "Guarantor's
Accounting and Disclosure Requirements for Guarantees, Including Indirect
Guarantees of Indebtedness of Others" ("FIN 45"). The Interpretation elaborates
on the disclosures to be made by a guarantor in its financial statements under
20
certain guarantees that it has issued. It also clarifies that a guarantor is
required to recognize, at the inception of a guarantee, a liability for the fair
value of the obligation undertaken in issuing the guarantee. The Interpretation
requires disclosure of the nature of the guarantee, the maximum potential amount
of future payments that the guarantor could be required to make under the
guarantee, and the current amount of the liability, if any, for the guarantor's
obligations under the guarantee. The recognition requirements of the
Interpretation were effective beginning January 1, 2003. Management does not
anticipate that the recognition requirements of this Interpretation will have a
material impact on the Company's consolidated financial statements.
In January 2003, the FASB issued FASB Interpretation No. 46, "Consolidation of
Variable Interest Entities" ("FIN 46"). This Interpretation provides guidance
with respect to the identification of variable interest entities and when the
assets, liabilities, noncontrolling interests, and results of operations of a
variable interest entity need to be included in a corporation's consolidated
financial statements. The Interpretation requires consolidation by business
enterprises of variable interest entities in cases where the equity investment
at risk is not sufficient to permit the entity to finance its activities without
additional subordinated financial support from other parties, which is provided
through other interests that will absorb some or all of the expected losses of
the entity, or in cases where the equity investors lack one or more of the
essential characteristics of a controlling financial interest, which include the
ability to make decisions about the entity's activities through voting rights,
the obligations to absorb the expected losses of the entity if they occur, or
the right to receive the expected residual returns of the entity if they occur.
The Interpretation applies immediately to variable interest entities created
after January 31, 2003, and applies to previously existing entities beginning in
the fourth quarter of 2003. Management is currently evaluating the applicability
of FIN 46 but the adoption of this Interpretation is not expected to have a
material impact on the Company's consolidated financial statements.
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.
Internet Access To Company Documents
- ------------------------------------
The Company provides access to its SEC filings through the Bank's Web site at
www.vcbonline.com. After accessing the Web site, the filings are available upon
selecting "about us/stock information/financial information." Reports available
include the annual report on Form 10-K, quarterly reports on Form 10-Q, current
reports on Form 8-K, and all amendments to those reports as soon as reasonably
practicable after the reports are electronically filed or furnished to the SEC.
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 as dictated by policy. In setting certain
tolerance levels, or limits on market risk, the Committee considers the impact
21
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
September 30, 2003. At that point in time, the Company had a cumulative net
liability sensitive twelve-month gap position of $17.2 million, or a negative
2.12% of total earning assets. This position would generally 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. 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 September 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 $ 48,538 $ 61,805 $ 28,969 $ 26,653 $ 165,965
Federal funds sold 13,859 -- -- -- 13,859
Loans, held-for-sale 9,877 -- -- -- 9,877
Loans, net of unearned income 270,220 84,523 242,026 24,602 621,371
- --------------------------------------------------------------------------------------------------------------
Total earning assets $ 342,494 $ 146,328 $ 270,995 $ 51,255 $ 811,072
- --------------------------------------------------------------------------------------------------------------
INTEREST-BEARING LIABILITIES
NOW accounts $ 164,222 $ 6,169 $ 16,532 $ -- $ 186,923
Money market accounts 77,315 8,995 5,937 -- 92,247
Savings accounts 1,600 5,000 13,402 -- 20,002
Time deposits 44,475 147,024 118,377 10 309,886
Securities sold under agreement to
repurchase and federal funds purchased 32,779 -- -- -- 32,779
Other borrowed funds 400 -- -- -- 400
------------------------------------------------------------------
Trust preferred capital notes 18,000 -- -- -- 18,000
- --------------------------------------------------------------------------------------------------------------
Total interest-bearing liabilities $ 338,791 $ 167,188 $ 154,248 $ 10 $ 660,237
- --------------------------------------------------------------------------------------------------------------
Cumulative maturity / interest $ 3,703 $ (17,157) $ 99,590 $ 150,835 $ 150,835
sensitivity gap
As % of total earnings assets 0.46% (2.12)% 12.28% 18.60%
- --------------------------------------------------------------------------------------------------------------
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
22
points increase or decrease in interest rates. The most recent earnings
simulation model was run based on data as of September 30, 2003, and at that
time the model projected earnings would decrease by 15.25% if interest rates
would immediately increase by 200 basis points and would also decrease by 2.46%
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 and the impact that rising
long-term interest rates will have on fees and net gains from loans
held-for-sale, as originations would be expected to decline due to lower levels
of refinancing activity.
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 September 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
Item 4. Submission of Matters to a Vote of Security Holders- 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)
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)
23
Exhibit No. Description
----------- -----------
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)
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)
10.2 2003 VCBI Employee Stock Purchase Plan (4)
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.
(3) Incorporated by reference to the same numbered exhibit to the Company'
Quarterly Report on Form 10-Q for the quarterly period ended June 30,
2003.
(4) Incorporated by reference to Exhibit 4 to the Company's Registration
Statement on Form S-8 (No. 333-109079)
b) Form 8-K
On July 15, 2003, the Company filed a current report on Form 8-K, under item 5
thereof, reflecting the announcement of earnings for the period ended June 30,
2003.
On August 11, 2003, the Company filed a current report on Form 8-K, under item 5
thereof, reflecting the announcement of a correction to its level of
nonperforming assets previously reported on the Form 8-K noted above which was
on July 15, 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: November 10, 2003 BY /s/ Peter A. Converse
--------------------------------------
Peter A. Converse, President and Chief
Executive Officer
Date: November 10, 2003 BY /s/ William K. Beauchesne
--------------------------------------
William K. Beauchesne, Treasurer and
Chief Financial Officer
25