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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
(MARK ONE)
(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
OR
( ) TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from ________ to ________
Commission File Number 0-25923
EAGLE BANCORP, INC
------------------------------------------------------
(Exact name of registrant as specified in its charter)
Maryland 52-2061461
- ------------------------------- -------------------
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
7815 Woodmont Avenue, Bethesda, Maryland 20814
- ---------------------------------------- ----------
(Address of principal executive offices) (Zip Code)
(301) 986-1800
----------------------------------------------------
(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 mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes [X] No [ ]
Indicate by check mark whether the registrant is an accelerated filer
(as defined in Rule 12b-2 of the Exchange Act Yes [ ] No [X]
Indicate the number of shares outstanding of each of the issuer's
classes of common stock, as of the latest practical date.
As of November 7, 2003, the registrant had 5,359,153 shares of Common
Stock outstanding.
Item 1 - Financial Statements
EAGLE BANCORP, INC.
CONSOLIDATED BALANCE SHEETS
SEPTEMBER 30, 2003 AND DECEMBER 31, 2002
(dollars in thousands)
ASSETS
September 30, December 31,
2003 2002
(unaudited)
------------ -----------
Cash and due from banks $ 24,838 $ 18,569
Interest bearing deposits with other
banks 4,351 6,119
Federal funds sold 2,000 3,012
Other cash equivalents 1,502 --
Investment securities available for sale 70,069 70,675
Loans held for sale 1,930 5,546
Loans 287,001 236,860
Less: allowance of credit losses (3,237) (2,766)
--------- ---------
Loans, net 283,764 234,094
Premises and equipment, net 4,226 3,601
Deferred income taxes 683 464
Other assets 8,358 5,749
--------- ---------
TOTAL ASSETS $ 401,721 $ 347,829
========= =========
LIABILITIES AND STOCKHOLDERS' EQUITY
LIABILITIES:
Deposits:
Noninterest-bearing demand $ 79,723 $ 64,432
Interest-bearing transaction 39,615 39,968
Savings and money market 102,127 92,324
Time, $100,000 or more 41,447 46,989
Other time 50,392 34,721
--------- ---------
Total deposits 313,304 278,434
Customer repurchase agreements 20,009 25,054
Other short-term borrowings 4,000 8,600
Other long-term borrowings 11,632 14,333
Other liabilities 875 1,380
--------- ---------
Total liabilities 349,820 327,801
STOCKHOLDERS' EQUITY:
Common stock, $.01 par value; 20,000,000
authorized, 5,359,153 (2003) 2,897,704 (2002)
issued and outstanding 53 29
Additional paid in capital 46,404 16,541
Retained earnings 5,466 3,066
Accumulated other comprehensive (loss) income (22) 392
--------- ---------
Total stockholders' equity 51,901 20,028
--------- ---------
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $ 401,721 $ 347,829
========= =========
See notes to consolidated financial statements
2
EAGLE BANCORP, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
NINE AND THREE MONTHS ENDED SEPTEMBER 30, 2003 AND 2002
(dollars in thousands, except per share amounts-unaudited)
Nine Months Nine Months Three Months Three Months
Ended Ended Ended Ended
Sept 30, 2003 Sept 30, 2002 Sept 30, 2003 Sept 30, 2002
------------- ------------- ------------- -------------
INTEREST INCOME:
Interest and fees on loans $11,894 $10,533 $ 4,111 $ 3,709
Taxable interest and dividends on
investment securities 1,280 1,497 364 643
Interest on balances with other banks 149 33 54 2
Interest on federal funds sold 37 61 13 15
------- ------- ------- -------
Total interest income 13,360 12,124 4,541 4,405
------- ------- ------- -------
INTEREST EXPENSE:
Interest on deposits 2,360 3,292 704 1,104
Interest on customer repurchase
agreements 68 182 10 74
Interest on short-term borrowings 257 105 113 57
Interest on long-term borrowings 363 297 79 127
------- ------- ------- -------
Total interest expense 3,048 3,876 906 1,362
------- ------- ------- -------
NET INTEREST INCOME 10,312 8,248 3,635 3,043
PROVISION FOR CREDIT LOSSES 730 675 305 182
------- ------- ------- -------
NET INTEREST INCOME AFTER PROVISION
FOR CREDIT LOSSES 9,582 7,573 3,330 2,861
------- ------- ------- -------
NONINTEREST INCOME:
Service charges on deposit accounts 892 764 313 274
Gain on sale of investment securities 214 143 -- 143
Gain on sale of loans 545 246 199 149
Other income 482 263 175 123
------- ------- ------- -------
Total noninterest income 2,133 1,416 687 689
------- ------- ------- -------
NONINTEREST EXPENSES:
Salaries and employee benefits 4,202 3,235 1,456 1,120
Premises and equipment expenses 1,498 1,219 564 424
Advertising 203 142 79 59
Outside data processing 407 354 143 125
Other expenses 1,610 1,270 562 449
------- ------- ------- -------
Total noninterest expenses 7,920 6,220 2,804 2,177
NET INCOME BEFORE INCOME TAXES 3,795 2,769 1,213 1,373
INCOME TAXES 1,395 1,024 435 525
------- ------- ------- -------
NET INCOME $ 2,400 $ 1,745 $ 778 $ 848
======= ======= ======= =======
INCOME PER SHARE:
Basic $ 0.70 $ 0.60 $ 0.17 $ 0.29
Diluted $ 0.65 $ 0.56 $ 0.16 $ 0.27
See notes to consolidated financial statements.
3
EAGLE BANCORP, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
FOR THE NINE MONTHS ENDED SEPTEMBER 30, 2003 and 2002
(dollars in thousands-unaudited)
Nine Months Nine Months
Ended Ended
Sept 30, 2003 Sept 30, 2002
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income $ 2,400 $ 1,745
Adjustments to reconcile net income to net cash
Provided (used) by operating activities:
Increase (decrease) in deferred income taxes (219) (178)
Provision for credit losses 730 675
Depreciation and amortization 504 405
Gain on sale of loans (545) (246)
Origination of loans held for sale (17,644) (2,585)
Proceeds from sale of loans held for sale 21,805 2,831
Gain on sale of investment securities (214) (143)
Increase in other assets (609) (526)
(Decrease) increase in other liabilities (505) 294
--------- ---------
Net cash provided (used) by operating activities 5,703 2,272
--------- ---------
CASH FLOWS FROM INVESTING ACTIVITIES:
Decrease (increase) in interest bearing deposits with other banks 1,758 (5,978)
Purchases of available for sale investment securities (278,773) (251,611)
Proceeds from maturities of available for sale securities 263,110 216,451
Proceeds from sale of available for sale securities 14,577 4,999
Increase (decrease) in federal funds sold 1,012 (7,002)
Net increase in loans (50,400) (34,143)
Bank premises and equipment acquired (1,129) (835)
--------- ---------
Increase in BOLI contracts (2,000) (4,000)
--------- ---------
Net cash used by investing activities (51,845) (82,119)
--------- ---------
CASH FLOWS FROM FINANCING ACTIVITIES:
Increase in deposits 34,870 70,965
(Decrease) increase in customer repurchase agreements (5,045) 13,108
(Decrease) increase in other short term borrowings (4,600) 8,400
(Decrease) increase in long-term borrowings (2,701) 5,658
Issuance of common stock 29,887 16
--------- ---------
Net cash provided by financing activities 52,411 98,147
--------- ---------
NET INCREASE IN CASH 6,269 18,300
CASH AND DUE FROM BANKS AT BEGINNING OF PERIOD 18,569 6,483
--------- ---------
CASH AND DUE FROM BANKS AT END OF PERIOD $ 24,838 $ 24,783
========= =========
See notes to consolidated financial statements
4
EAGLE BANCORP, INC
CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY
FOR THE NINE MONTHS ENDED SEPTEMBER 30, 2003 AND 2002
(dollars in thousands - unaudited)
Accumulated
Additional Other Total
Common Paid in Retained Comprehensive Stockholders
Stock Capital Earnings Income (loss) Equity
---------------------------------------------------------------
Balances at January 1, 2003 $ 29 $ 16,541 $ 3,066 $ 392 $ 20,028
--------
Net income 2,400 2,400
Other comprehensive income-
Unrealized loss on investment
securities available for sale (414) (414)
--------
Total comprehensive income 1,986
Proceeds from sale of 2,448,979 shares
of common stock 24 29,744 29,768
Exercise of options for 9,470 shares of
common stock 119 119
---------------------------------------------------------------
Balances at September 30, 2003 $ 53 $ 46,404 $ 5,466 $ (22) $ 51,901
---------------------------------------------------------------
Balances at January 1, 2002 $ 29 $ 16,515 $ 399 $ 189 $ 17,132
--------
Net income 1,745 1,745
Other comprehensive income-unrealized
loss on investment securities available
for sale 265 265
--------
Total comprehensive income 2,026
Exercise of options for 1,000 shares
of common stock 16 16
---------------------------------------------------------------
Balances at September 30, 2002 $ 29 $ 16,531 $ 2,144 $ 454 $ 19,158
===============================================================
See notes to consolidated financial statements.
5
EAGLE BANCORP, INC.
NOTES TO FINANCIAL STATEMENTS
1. BASIS OF PRESENTATION
General - The financial statements of Eagle Bancorp, Inc. (the "Company")
included herein are unaudited; however, they reflect all adjustments
consisting only of normal recurring accruals that, in the opinion of
Management, are necessary to present fairly the results for the periods
presented. The amounts as of December 31, 2002 were derived from audited
financial statements. Certain information and note disclosures normally
included in financial statements prepared in accordance with accounting
principles generally accepted in the United States of America have been
condensed or omitted pursuant to the rules and regulations of the
Securities and Exchange Commission. There have been no significant changes
to the Company's Accounting Policies as disclosed in the 2002 Annual
Report. The Company believes that the disclosures are adequate to make the
information presented not misleading. The results of operations for the
nine months ended September 30, 2003 are not necessarily indicative of the
results of operations to be expected for the remainder of the year, or for
any other period.
2. NATURE OF BUSINESS
The Company, through its bank subsidiary, provides domestic financial
services primarily in Montgomery County, Maryland and Washington, DC. The
primary financial services include real estate, commercial and consumer
lending, as well as traditional demand deposits and savings products.
3. INVESTMENT SECURITIES
Amortized cost and estimated fair value of securities available-for-
sale are summarized as follows:
(in thousands)
September 30, 2003
Gross Gross Estimated
Amortized Unrealized Unrealized Fair
Cost Gains Losses Value
--------- ---------- ---------- ---------
U.S. Government Agency securities $ 35,120 $ 27 $ (27) $ 35,120
Mortgage backed securities 31,126 214 (260) 31,080
Federal Reserve Bank and
Federal Home Loan Bank stock 1,580 -- -- 1,580
Other equity investments 2,277 31 (19) 2,289
-------- -------- -------- --------
$ 70,103 $ 272 $ (306) $ 70,069
======== ======== ======== ========
December 31, 2002
Gross Gross Estimated
Amortized Unrealized Unrealized Fair
Cost Gains Losses Value
--------- ---------- ---------- ---------
U.S. Treasury securities $ 5,501 $ 3 $ -- $ 5,504
U.S. Government Agency securities 19,961 153 (7) 20,114
Mortgage backed securities 42,782 493 43,268
Federal Reserve Bank and Federal Home
Loan Bank stock 1,564 -- -- 1,564
Other equity investments 274 -- (49) 225
-------- -------- -------- --------
$ 70,082 $ 649 $ (56) $ 70,675
======== ======== ======== ========
6
4. INCOME TAXES
The Company uses the liability method of accounting for income taxes as
required by SFAS No. 109, "Accounting for Income Taxes." Under the
liability method, deferred-tax assets and liabilities are determined based
on differences between the financial statement carrying amounts and the tax
bases of existing assets and liabilities (i.e., temporary differences) and
are measured at the enacted rates that will be in effect when these
differences reverse.
5. EARNINGS PER SHARE
Earnings per common share are computed by dividing net income by the
weighted average number of common shares outstanding during the period.
Diluted net income per common share is computed by dividing net income by
the weighted average number of common shares outstanding during the period,
including any potential dilutive common shares outstanding, such as options
and warrants. As of September 30, 2003 there were 2,454 shares excluded
from the diluted net income per share computation because the option price
exceeded the average market price and therefore, their effect would be
anti-dilutive.
6. STOCK-BASED COMPENSATION
The Company has adopted the disclosure-only provisions of SFAS No. 123
"Accounting for Stock-Based Compensation" and SFAS No. 148 "Accounting for
Stock-Based Compensation-Transition and Disclosure", but applies Accounting
Principles Board Opinion No. 25 and related interpretations in accounting
for its Plan. No compensation expense related to the Plan was recorded
during the three months ended September 30, 2003 and 2002. It the Company
had elected to recognize compensation cost based on fair value at the grant
dates for awards under the Plan consistent with the method prescribed by
SFAS No. 123, net income and earnings per share would have been changed to
the pro forma amounts as follows for the three and nine months ended
September 30.
Nine months Three months
ended Sept 30 ended Sept 30
-------------------- -------------------
2003 2002 2003 2002
------- ------- ------- -------
Net income, as reported $ 2,400 $ 1,745 $ 778 $ 848
Less pro forma stock-based compensation
expense determined under the fair value
method, net of related tax effects (173) (125)
------- ------- ------- -------
Pro forma net income $ 2,227 $ 1,620 $ 778 $ 848
------- ------- ------- -------
Net income per share:
Basic - as reported $ 0.70 $ 0.60 $ 0.17 $ 0.29
Basic - pro forma $ 0.65 $ 0.56 $ 0.17 $ 0.29
Diluted - as reported $ 0.65 $ 0.56 $ 0.16 $ 0.27
Diluted - pro forma $ 0.61 $ 0.52 $ 0.16 $ 0.27
7
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATION.
The following discussion provides information about the results of
operations, and financial condition, liquidity, and capital resources of the
Company and its subsidiary the Bank. This discussion and analysis should be read
in conjunction with the unaudited Consolidated Financial Statements and Notes
thereto, appearing elsewhere in this report.
This report contains forward looking statements within the meaning of
the Securities 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 such words as
"may", "will", "anticipate", "believes", "expects", "plans", "estimates",
"potential", "continue", "should", and similar words or phases. 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 in the future
may differ materially from those indicated herein. Readers are cautioned against
placing undue reliance on any such forward looking statements.
GENERAL
Eagle Bancorp, Inc. is a growing, one-bank holding company
headquartered in Bethesda, Maryland. We provide general commercial and consumer
banking services through our wholly owned banking subsidiary EagleBank, a
Maryland chartered bank which is a member of the Federal Reserve System. We were
organized in October 1997 to be the holding company for the Bank. The Bank was
organized as an independent, community oriented, full-service alternative to the
super regional financial institutions, which dominate our primary market area.
The cornerstone of our philosophy is to provide superior, personalized service
to our customers. We focus on relationship banking, providing each customer with
a number of services, becoming familiar with and addressing customer needs in a
proactive, personalized fashion. The Bank has five offices serving the southern
portion of Montgomery County and one office in the District of Columbia. The
Bank has entered into a lease for a new branch location on Rockville Pike in
Montgomery County and expects to open before the first of the year. The Bank is
also expects to conclude negotiations for a new branch office in the Dupont
Circle area in the District of Columbia and expects to open this proposed office
in the mid spring of 2004.
The Company offers full commercial banking services to our business and
professional clients as well as complete consumer banking services to
individuals living and/or working in the service area. We emphasize providing
commercial banking services to sole proprietors, small and medium-sized
businesses, partnerships, corporations, non-profit organizations and
associations, and investors living and working in and near our primary service
area. A full range of retail banking services are offered to accommodate the
individual needs of both corporate customers as well as the community we serve.
These services include the usual deposit functions of commercial banks,
including business and personal checking accounts, "NOW" accounts and savings
accounts, business, construction, and commercial loans, equipment leasing,
residential mortgages and consumer loans and cash management services. We have
developed significant expertise and commitment as an SBA lender, have been
designated a Preferred Lender by the SBA, and are one of the largest SBA
lenders, in dollar volume, in the Washington Metropolitan area.
In June 2003, the Company formed a second wholly owned subsidiary,
Bethesda Leasing, LLC ("Bethesda Leasing"). Bethesda Leasing was formed for the
purpose of acquiring an impaired loan from the Bank in order to effect more
efficient administration and collection procedures.
The income per share of $0.17 (basic) and $0.16 (diluted) for the three
months ended September 30, 2003 exceeds the $0.14 (basic) and $0.13 (diluted)
reported in the Company's press release and Form 8-K issued on October 15, 2003.
The difference results from a computational error in the earlier calculation
which has been corrected in this report. The computational error did not effect
the net income of the Company for the three month period ended September 30,
2003, or the net income or income per share calculations for the nine month
period ended September 30, 2003. Readers should note that due to the issuance of
a significant number of shares of common stock during the third quarter, the
quarterly per share earnings for 2003 do not add to the per share earnings for
the nine month period ended September 30, 2003.
8
CRITICAL ACCOUNTING POLICIES
The Company's consolidated financial statements are prepared in
accordance with accounting principles generally accepted in the United States of
America ("GAAP") and follow general practices within the industry in which it
operates. Application of these principles requires management to make estimates,
assumptions, and judgments that affect the amounts reported in the financial
statements and accompanying notes. These estimates, assumptions and judgments
are based on information available as of the date of the financial statements;
accordingly, as this information changes, the financial statements could reflect
different estimates, assumptions, and judgments. Certain policies inherently
have a greater reliance on the use of estimates, assumptions and judgments and
as such have a greater possibility of producing results that could be materially
different than originally reported. Estimates, assumptions, and judgments are
necessary when assets and liabilities are required to be recorded at fair value,
when a decline in the value of an asset not carried on the financial statements
at fair value warrants an impairment write-down or valuation reserve to be
established, or when an asset or liability needs to be recorded contingent upon
a future event. Carrying assets and liabilities at fair value inherently results
in more financial statement volatility. The fair values and the information used
to record valuation adjustments for certain assets and liabilities are based
either on quoted market prices or are provided by other third-party sources,
when available.
The allowance for credit losses is an estimate of the losses that may
be sustained in our loan portfolio. The allowance is based on two principles of
accounting: (a) Statement on Financial Accounting Standards ("SFAS") 5,
"Accounting for Contingencies", which requires that losses be accrued when they
are probable of occurring and are estimable and (b) SFAS No. 114, "Accounting by
Creditors for Impairment of a Loan", which requires that losses be accrued when
it is probable that the Company will not collect all principal and interest
payments according to the contractual terms of the loan. The loss, if any, is
determined by the difference between the loan balance and the value of
collateral, the present value of expected future cash flows, or values
observable in the secondary markets.
Three basic components comprise our allowance for credit losses: a
specific allowance, a formula allowance and a nonspecific allowance. Each
component is determined based on estimates that can and do change when the
actual events occur. The specific allowance is used to individually allocate an
allowance to loans identified as impaired. An impaired loan may show
deficiencies in the borrower's overall financial condition, payment record,
support available from financial guarantors and/or the fair market value of
collateral. When a loan is identified as impaired a specific reserve is
established based on the Company's assessment of the loss that may be associated
with the individual loan. The formula allowance is used to estimate the loss on
internally risk rated loans, exclusive of those identified as impaired. Loans
identified as special mention, substandard, doubtful and loss, as well as
impaired, are segregated from performing loans. Remaining loans are then grouped
by type (commercial, commercial real estate, construction, home equity or
consumer). Each loan type is assigned an allowance factor based on management's
estimate of the risk, complexity and size of individual loans within a
particular category. Classified loans are assigned higher allowance factors than
non-rated loans due to management's concerns regarding collectibility or
management's knowledge of particular elements regarding the borrower. Allowance
factors grow with the worsening of the internal risk rating. The nonspecific
formula is used to estimate the loss of non-classified loans stemming from more
global factors such as 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 loan review system and the effect of external factors such as
competition and regulatory requirements. The nonspecific allowance captures
losses whose impact on the portfolio have occurred but have yet to be recognized
in either the formula or specific allowance.
Management has significant discretion in making the judgments inherent
in the determination of the provision and allowance for credit losses, including
in connection with the valuation of collateral, a borrower's prospects of
repayment, and in establishing allowance factors on the formula allowance and
nonspecific allowance components of the allowance. The establishment of
allowance factors is a continuing exercise, based on management's continuing
assessment of the global factors discussed above and their impact on the
portfolio, and allowance factors may change from period to period, resulting in
an increase or decrease in the amount of the provision or allowance, based upon
the same volume and classification of loans. Changes in allowance factors will
have a direct impact on the amount of the provision, and a corresponding effect
on net income. Errors in management's perception and assessment of the global
factors and their impact on the portfolio could result in the allowance not
being adequate to cover losses in the portfolio, and may result in additional
provisions or charge-offs. For additional information regarding the allowance
for credit losses, refer to the discussion under the caption "Allowance for
Credit Losses" below.
9
RESULTS OF OPERATIONS
The Company reported net income of $2.40 million for the nine months
and $778 thousand for the three months ended September 30, 2003, as compared to
net income of $1.75 million for the nine months and $848 thousand for the three
months ended September 30, 2002. Income per basic share was $0.70 for the nine
months and $0.17 for the three months ended September 30, 2003, as compared to
$0.60 and $0.29 respectively for the same periods in 2002. Income per diluted
share was $0.65 for the nine months and $0.16 for the three months end September
30, 2003, as compared to $0.56 and $0.27 for the same periods in 2002. The
Company had a return on average assets of 0.88% and return on average equity of
11.50% for the first nine months of 2003, as compared to returns on average
assets and average equity of 0.84% and 12.99% respectively for the six months of
2002.
The reported net income for the nine months ended September 30, 2003,
represents an increase in earnings of 38% from the corresponding period in 2002,
$2.40 million from $1.74 million. The net income for the three months ended
September 30, 2003, represents a decrease of 8% from the corresponding period in
2002, $778 thousand from $848 thousand. The nine month results, when compared to
the same period in 2002, can be attributed to an increase of 25% in net interest
income, reflecting an increase of 29% in average earning assets offset by a
decline of 14 basis points in net interest margin. Net interest income increased
from $8.3 million to $10.3 million average earning assets increased from $261
million to $337 million. During the same period net interest margin declined
from 4.23% in 2002 to 4.09% in 2003 as market interest rates continued to fall
and the percentage of higher yielding loans declined from 78% of average earning
assets in the nine month period of 2002 to 76% of earning assets in the same
period of 2003. Comparing the nine month period, noninterest income increased
51%, $2.1 million from $1.4 million.
For the nine months ended September 30, 2003, the Company recorded a
provision for credit losses in the amount of $730 thousand. At September 30,
2003, the allowance for credit losses was $3.24 million, as compared to $2.77
million at December 31, 2002. The Company had net charge-offs of $259 thousand
during the first nine months of 2003 representing 0.1% of average loans on an
annualized basis. This compared to a provision for credit losses of $675
thousand for the first nine months of 2002, and net charge-offs of $119 thousand
for the same period, also representing 0.1% of average loans on an annualized
basis.
While the results of operations for the third quarter of 2003 compared
to the third quarter of 2002 were down, $778 thousand from $848 thousand,
earnings per share $0.17 from $0.29 and return on average equity 11.50% from
12.99% (see following table), management is pleased with the results. The
results for the third quarter of 2003 reflect the effect of the reduction in
interest rates by the Federal Reserve in late June 2003 and no security gains,
while $143 thousand of security gains were recognized in the third quarter of
2002. Earnings per share and return on average equity were also negatively
impacted as a result of the issuance of approximately 2.45 million additional
shares, and resulting $30 million increase in capital as a result of the
successful Company offering completed on August 1, 2003. The additional capital
and shares were treated on an average basis when computing the earnings per
share and return on equity.
The following table sets out the annualized returns on average assets, returns
on average equity and equity to assets (average) for the nine months ending
September 30, 2003 and 2002 and the year ending December 31, 2002:
September September December
2003 2002 2002
---- ---- ----
Return on average assets 0.88% 0.84% 0.91%
Return on average equity 11.50% 12.99% 14.51%
Average equity to average assets 7.66% 6.50% 6.28%
NET INTEREST INCOME AND NET INTEREST MARGIN
Net interest income is the difference between interest income on
earning assets and the cost of funds supporting those assets. Earning assets are
composed primarily of loans and investment securities. The cost of funds
represents interest expense on deposits, customer repurchase agreements and
other borrowings. Noninterest bearing deposits and capital are other components
representing funding sources. Changes in the volume and mix of assets and
funding sources, along with the changes in yields earned and rates paid,
determine changes in net interest income. Net interest income for the first nine
months of 2003 was $10.3 million compared to $8.2 million for the first nine
months in 2002.
10
The table labeled "Average Balances, Interest Yields and Rates and Net
Interest Margin" presents the average balances and rates of the various
categories of the Company's assets and liabilities. Included in the table is a
measurement of interest rate spread and margin. Interest spread is the
difference between the rate earned on assets less the cost of funds expressed as
a percentage. While spread provides a quick comparison of earnings rates versus
cost of funds, management believes that margin provides a better measurement of
performance. Margin includes the effect of noninterest bearing liabilities in
its calculation and is net interest income expressed as a percentage of total
earning assets. Interest spread decreased in the nine months of 2003 from the
first nine months of 2002 by 7 basis points, 3.71% from 3.78%; and margin
decreased 14 basis points, 4.09% from 4.23%. The decrease in both spread and
margin, from period to period, can be attributed to overall lower market
interest rates and the resulting refinancing or renegotiation of older debt and
the negotiation of lower competitive rates on new debt. In addition to lower
interest rates, the change in the mix of Company assets contributed to a decline
in margin. In the nine months ended September 30, 2002 loans made up 78% of
earning assets while in the first nine months of 2003 loans made up only 76% of
earning assets. The effect was a greater concentration of earning assets in
lower yielding investment instruments as compared to loans. From the first nine
months of 2002 to the first nine months of 2003, the yield on earning assets
declined 92 basis points while the average interest rate on interest bearing
liabilities declined 85 basis points.
The declines in both the yields on earning assets and interest bearing
liabilities from the first nine months of 2002 to the first nine months of 2003
reflect the continued impact of the significant rate reductions effected by the
Federal Reserve in 2001 and continued into 2002 with the last rate reduction
occurring in June 2003. The investment portfolio yield declined from 2002 to
2003 by 148 basis points as the Bank maintained a portfolio of short term fixed
rate securities and pass through mortgage backed securities. The yield on
mortgage backed securities declined as mortgage refinancing accelerated,
resulting in earlier repayment of mortgage backed securities, and reinvestment
of the proceeds at lower current market rates. In order to keep the investment
portfolio short for liquidity and expectations that rates would start to move
upward, and to obtain better short term yields, the Bank invested in interest
bearing deposits with other banks, in amounts which made them eligible for FDIC
insurance, in late 2002, currently yielding 2.24%, a relatively attractive rate
given their short term nature and low risk, as compared to the rates offered on
federal funds and U. S. Treasury bills.
The decline in the yield on the loan portfolio, while 69 basis points,
was less than the decline in the yield on other earning assets because
approximately 50% of the loan portfolio is composed of fixed rate loans. The
fixed rate loans stabilize the effects of rate reductions in repricable loans
thereby slowing the decline in the overall yield of the portfolio. Over time, of
course, market pressures and loan repayments and maturities will force the
portfolio yield down even when there may be no further market rate reductions.
On the liability side, management aggressively reduced rates on deposit
accounts. The reduction in the rate on total interest bearing liabilities from
the first nine months of 2002 to the first nine months of 2003 was 85 basis
points which compares to a reduction of 92 basis points in the yield on earning
assets over the same period. The reduction in the rates paid by the Bank reduced
the average rate on the cost of funds below 2% in the latter part of 2002.
It is anticipated that any further reductions in interest rates may
have a significant adverse effect on earnings as rates paid on interest bearing
liabilities, which are as low as 0.10% on NOW accounts, cannot continue to
decline at the same rate as yields on loans and investments.
11
AVERAGE BALANCES, INTEREST YIELDS, AND RATES, AND NET INTEREST MARGIN
NINE MONTHS ENDED SEPTEMBER 30,
2003 2002
---------------------------------- -----------------------------------
Average Average Average Average
Balance Interest Yield/Rate Balance Interest Yield/Rate
------- -------- ---------- ------- -------- ----------
ASSETS:
Interest earnings assets:
Interest bearing deposits with other banks $ 8,898 $ 149 2.24% $ 1,549 $ 33 2.84%
Loans 256,011 11,893 6.21% 204,145 10,533 6.90%
Investment securities 67,941 1,280 2.51% 50,190 1,497 3.99%
Federal funds sold and other 4,472 37 1.10% 5,015 61 1.63%
--------- --------- --------- ---------
Total interest earning assets 337,323 13,359 5.29% 260,899 12,124 6.21%
Total noninterest earning assets 28,657 17,289
Less: allowance for credit losses 2,933 2,362
--------- ---------
Total noninterest earning assets 25,724 14,927
--------- ---------
TOTAL ASSETS $ 363,047 $ 275,826
========= =========
LIABILITIES AND STOCKHOLDERS'
EQUITY:
Interest bearing liabilities:
NOW accounts $ 37,994 64 0.23% 258,331 66 0.31%
Savings and money market accounts 99,063 916 1.24% 76,779 1,197 2.08%
Certificates of deposit 77,392 1,380 2.38% 77,157 2,029 3.52%
Customer repurchase agreements 20,646 68 0.44% 17,075 182 1.43%
Short-term borrowing 7,476 177 3.17% 3,651 105 3.86%
Long-term borrowing 16,007 442 3.69% 9,984 297 3.98%
--------- --------- --------- ---------
Total interest bearing liabilities 258,578 3,047 1.58% 212,977 3,876 2.43%
--------- --------- --------- ---------
Noninterest bearing liabilities:
Noninterest bearing deposits 68,779 43,751
Other liabilities 1,325 1,180
Escrowed subscriptions received 6,539 --
--------- ---------
Total noninterest bearing liabilities 76,643 44,931
Stockholders' equity 27,826 17,918
--------- ---------
TOTAL LIABILITIES AND
STOCKHOLDERS' EQUITY $ 363,047 $ 275,826
========= =========
Net interest income $ 10,312 $ 8,248
========= =========
Net interest spread 3.72% 3.78%
Net interest margin 4.09% 4.23%
12
ALLOWANCE FOR CREDIT LOSSES
The provision for credit losses represents the expense recognized to
fund the allowance for credit losses. The amount of the allowance for credit
losses is based on many factors which reflect management's assessment of the
risk in the loan portfolio. Those factors include economic conditions and
trends, the value and adequacy of collateral, volume and mix of the portfolio,
performance of the portfolio, and internal loan processes of the Company and
Bank.
Management has developed a comprehensive review process to monitor the
adequacy of the allowance for credit losses. The review process and guidelines
were developed utilizing guidance from federal banking regulatory agencies. The
results of this review process, in combination with conclusions of the Bank's
outside loan review consultant, support management's view as to the adequacy of
the allowance as of the balance sheet date. During the first nine months of
2003, a provision for credit losses was made in the amount of $730 thousand
before net charge-offs of $259 thousand. Please refer to the discussion under
the caption, "Critical Accounting Policies" for an overview of the underlying
methodology management employs on a quarterly basis to maintain the allowance.
At September 30, 2003, the Company had one loan classified as
nonaccrual in the amount of $266 thousand which is considered impaired under
Statement of Financial Accounting Standards ("SFAS No. 114"). As part of its
comprehensive loan review process, the Bank's Board of Director's Loan Committee
and/or Board of Directors Credit Review Committee carefully evaluates loans over
thirty days past due. The Committee(s) makes a thorough assessment of the
conditions and circumstances surrounding each past due loan. The Bank's loan
policy requires that loans be placed on nonaccrual if they are ninety days past
due, unless they are well secured and in the process of collection.
The provision for credit losses of $730 thousand in the first nine
months of 2003 compared to a provision for credit losses of $675 thousand in the
first nine months of 2002. The higher provision in 2003 is attributable to the
level of growth in the loan portfolio from December 31, 2002 to September 30,
2003 and the greater amount of net charge-offs for the corresponding periods
$259 thousand in 2003 versus $118 thousand in 2002. The increase in the level of
charge-offs resulted primarily from one loan to a customer in bankruptcy and the
transfer of that loan and related collateral to a separate subsidiary on a fair
market value basis.
As the portfolio and allowance review process matures, there will be
changes to different elements of the allowance and this may have an effect on
the overall level of the allowance maintained. To date the Bank has enjoyed a
very high quality portfolio with minimal net charge offs and very low
delinquency. The maintenance of a high quality portfolio will continue to be
management's prime objective as it relates to the lending process and to the
allowance for credit losses.
Management, aware of the strong loan growth experienced by the Company
over its history and the problems which could develop in an unmonitored
environment, is intent on maintaining a strong credit review system and risk
rating process. In January 2003, the Company established a credit department to
perform interim analysis, manage classified credits and develop a credit scoring
system for small business credits. Over time, this department will increase its
review of credit analysis and processes. The Company is also reviewing its risk
rating systems and is exploring the implementation of additional analytical
procedures for risk ratings. The entire loan portfolio analysis process is an
ongoing and evolving practice directed at maintaining a portfolio of quality
credits and quickly identifying any weaknesses before they become irremediable.
13
The following table sets forth activity in the allowance for credit
losses for the periods indicated.
-------------------------------------------------------------------
Nine Months Ended Year Ended
-------------------------------------------------------------------
(dollars in thousands) September 30, December 31,
-------------------------------------------------------------------
2003 2002 2002 2001 2000
------- ------- ------- ------- -------
Balance at beginning of year $ 2,766 $ 2,111 $ 2,111 $ 1,142 $ 579
Charge-offs:
Commercial (318) (111) (192) -- --
Real estate - commercial -- -- -- -- --
Construction -- -- -- -- --
Home equity -- -- -- -- --
Other consumer (8) (35) (40) (23) (18)
------- ------- ------- ------- -------
Total (326) (146) (232) (23) (18)
------- ------- ------- ------- -------
Recoveries:
Commercial 64 -- 26 -- --
Real estate - commercial -- -- -- -- --
Construction -- -- -- -- --
Home equity -- -- -- -- --
Other consumer 3 28 18 13 --
------- ------- ------- ------- -------
Total 67 28 44 13 --
------- ------- ------- ------- -------
Net charge-offs (259) (118) (188) (10) (18)
------- ------- ------- ------- -------
Additions charged to operations 730 675 843 979 581
------- ------- ------- ------- -------
Balance at end of period $ 3,237 $ 2,668 $ 2,766 $ 2,111 $ 1,142
======= ======= ======= ======= =======
Ratio of net charge-offs during
the period to average loans
outstanding during the period 0.13% 0.08% 0.09% 0.01% 0.02%
The following table reflects the allocation of the allowance for credit
losses at the dates indicated. The allocation of the allowance to each category
is not necessarily indicative of future losses or charge-offs and does not
restrict the use of the allowance to absorb losses in any category.
(dollars in thousands) As of September 30, As of December 31,
----------------------------------------------------
2003 2002
----------------------------------------------------
Amount Percent (1) Amount Percent (1)
------- ----------- ------ -----------
Commercial $ 1,535 29.3% $ 1,134 27.5%
Real estate - commercial 791 47.3 862 48.5
Construction 316 10.6 231 9.8
Home equity 192 10.8 253 12.9
Other consumer 133 2.0 83 1.3
Unallocated 270 -- 203 --
------- --- ------- ---
Total allowance for credit losses $ 3,237 100% $ 2,766 100%
======= === ======= ===
(1) Represents the percent of loans in category to gross loans
NON-PERFORMING ASSETS
The Company's non-performing assets, which are comprised of loans
delinquent 90 days or more, non-accrual loans, and other real estate owned,
totaled $476 thousand at September 30, 2003 compared to $1.25 million at
September 30, 2002 and $965 thousand at December 31, 2002. The percentage of
non-performing assets to total assets was 0.16% at September 30, 2003, compared
14
to -0- non performing assets at September 30, 2002 and 0.28% at December 31,
2002.
Non-performing loans constituted all of the non-performing assets at
September 30, 2003, September 30, 2002 and December 31, 2002. Non-performing
loans at September 30, 2003 consist of one loan over ninety days delinquent of
$210 thousand and one impaired loan of $266 thousand compared to no non-accrual
loans and loans past due over ninety days of $1.25 million at September 30,
2002.
The Company had no other real estate owned at either September 30, 2003
or 2002.
The following table shows the amounts of non-performing assets at the
dates indicated.
September 30, December 31,
------------------ -------------
(dollars in thousands) 2003 2002 2002
------ ------ ------
Nonaccrual Loans
Commercial $ 266 $ -- $ 147
Consumer -- -- --
Real estate -- -- --
Accrual loans-past due 90 days
Commercial 210 1,250 818
Consumer -- -- --
Real estate -- -- --
Restructured loans -- -- --
Real estate owned -- -- --
------ ------ ------
Total non-performing assets $ 476 $1,250 $ 965
====== ====== ======
At September 30, 2003, there were no performing loans considered
potential problem loans, defined as loans which are not included in the past
due, nonaccrual or restructured categories, but for which known information
about possible credit problems causes management to be uncertain as to the
ability of the borrowers to comply with the present loan repayment terms.
NONINTEREST INCOME
Noninterest income primarily represents deposit account service charges
and fees, gains on the sale of loans, other noninterest loan fees, income from
bank owned life insurance ("BOLI") and other service fees. For the nine months
ended September 30, 2003 noninterest income was $2.13 million which included
$214 thousand in gains on the sale of investment securities. This compared to
$1.42 million of noninterest income for the nine months ended September 30, 2002
which included $143 thousand in gains on the sale of investment securities. For
the quarter ending September 30, 2003, the Company had $687 in noninterest
income, which included no gains on the sale of investment securities, this
compared to $689 thousand for the same period in 2002 which included $143
thousand in gains on the sale of investment securities. The Company has become a
significant SBA lender in its market area and during the quarter realized gains
on the sale of the insured portion of many of the loans it had originated. The
Company has also been active in the origination of mortgage loans, on a pre-sold
basis, and the historically low interest rate environment has made this a very
active program. These two sale activities contributed $545 thousand in the first
nine months of 2003 compared to $246 thousand in the first nine months of 2002.
For the quarter ending September 30, 2003, the Company had $199 thousand in
gains on the sale of loans compared to $149 thousand for the same period in
2002. Based on current activity the SBA income is expected to increase in the
third quarter while income from the sale of mortgage loans is expected to
decline due to the recent rise in mortgage interest rates. The gains from sales
of both of these types of credits are considered a continuing and regular
operating income source for the Bank.
Service charges on deposit accounts increased to $892 thousand in the first nine
months of 2003 compared to $764 thousand in the first nine months of 2002. The
increase of 17% is primarily attributable to an increase in the number of
deposit accounts over that period and the low interest rate environment. As
rates decline so do the earning allowances (which are used to offset service
charges) on demand deposit accounts so that an account, with the same activity,
which paid no service charge when interest rates were high may currently be
paying a charge because the earnings allowance is insufficient to cover activity
charges. For the quarter ending September 30, 2003, the Company had $313
15
thousand in service charge income compared to $274 thousand in the same period
of 2002, an increase of 14%. Other income increased 83% from $263 thousand in
the first nine months of 2002 to $482 thousand in the first nine months of 2003.
The significant component contributing to this increase was income from BOLI
contracts of $180 thousand compared to $31 thousand BOLI related income in 2002.
For comparative quarters ending 2003 and 2002, the income increase was 42%, $175
thousand from $123 thousand. BOLI income was the significant factor in this
increase contributing $68 thousand compared to $31 thousand in the third quarter
of 2002.
NONINTEREST EXPENSE
Noninterest expense was $7.9 million for the nine months ended September 30,
2003 compared to $6.2 million for the nine months ended September 30, 2002. This
represented a 27% increase from period to period. The increase for the quarter
ending September 30, of each year was 29%, increasing from $2.2 million to $2.8
million. Increases in noninterest expense primarily relate to increases in the
expense category salaries and employee benefits which increased 30% from the
first nine months of 2002 to the first nine months of 2003, $3.2 million to $4.2
million, and increased 30% for the respective quarters ending September 30, $1.1
million to $1.5 million. During the first quarter of 2003, to accommodate the
growth experienced by the Bank in 2002 and accommodate the growth anticipated in
2003, a number of additions to staff were made in the lending and operations
(customer service) areas. Management felt that these additions and the
associated expenses were necessary to assure a continued growth pattern and
quality of service which characterized the Company since its inception. The
increase of 23% in premises and equipment for the nine months, $1.2 million to
$1.5 million and 33% for the quarter from period to period, $424 thousand to
$564 thousand can be attributed to the expenses for the Bank's Shady Grove
Office, which opened in March of 2002, new loan administration offices in
Bethesda acquired to house an expanded lending staff and outsourcing of
information technology support in the third quarter required to maintain the
expanding technology needs of the Company. Other expenses which increased 27%
from $1.3 million to $1.6 million for the nine months ending September 30, 2003
compared to the nine months ending September 30, 2002, represent a number of
expense categories ranging from business development, office supplies to
charitable contributions. Management monitors these expenses closely and
believes that the increase in them is consistent with the needs of an
aggressively growing Company. For the quarters ending September 30, these
expenses increased 25%, $449 thousand to $562 thousand.
FINANCIAL CONDITION
As of September 30, 2003, assets were $402 million and deposits were $313
million. Assets grew from December 31, 2002 by $54 million and deposits by
approximately $35 million. The growth in deposits has been not been as strong as
management expected, in part due to the slow down in mortgage activity
attributable to higher mortgage rates and to a general slow down in economic
activity. The Bank has several deposit customers that are affected by mortgage
activity such as title companies and settlement attorneys.
During the nine months ended September 30, 2003, deposits grew $35 million and
assets grew $54 million with $20 million of that growth coming from the proceeds
of a $30 million stock offering, after retiring a line of credit loan which had
been used by the Company to fund capital needs of the Bank.
Loans
Total loans, excluding loans held for sale, increased approximately $50 million
from December 31, 2002 to September 30, 2003, from $237 million to $287 million.
Approximately $24 million of the increase in loans occurred during the third
quarter of 2003.
Loans, net of amortized deferred fees and costs, at September 30, 2003,
September 30, 2002 and December 31, 2002 are summarized by type as follows:
16
September 30, Percent September 30, Percent December 31, Percent
2003 of Total 2002 of Total 2002 of Total
------------- -------- ------------- -------- ------------ --------
Commercial $ 84,056 29.3% $ 54,404 24.5% $ 64,869 27.5%
Real estate - commercial 135,815 47.3% 108,132 48.6% 114,961 48.5%
Construction 30,339 10.6% 21,691 9.7% 23,180 9.8%
Home equity 31,167 10.8% 33,861 15.2% 30,631 12.9%
Other consumer 5,624 2.0% 4,422 2.0% 3,219 1.3%
--------- ---- --------- ---- --------- ----
Total loans 287,001 100% 222,510 100% 236,860 100%
Less: allowance for credit losses (3,237) (2,668) (2,766)
--------- --------- ---------
Loans, net $ 283,764 $ 219,842 $ 234,094
========= ========= =========
Deposits And Other Borrowings
The principal sources of funds for the Bank are core deposits,
consisting of demand deposits, NOW accounts, money market accounts, savings
accounts and relationship certificates of deposits, from the local market areas
surrounding the Bank's offices. The Bank's deposit base includes transaction
accounts, time and savings accounts and accounts which customers use for cash
management and which provide the Bank with a source of fee income and
cross-marketing opportunities as well as a low-cost source of funds. Time and
savings accounts, including money market deposit accounts, also provide a
relatively stable and low-cost source of funding.
For the nine months ending September 30, 2003 from December 31, 2002,
deposits grew $35 million, from $278 million to $313 million.
Approximately 29% of the Bank's deposits are made up of certificates of
deposits, which are generally the most expensive form of deposit because of
their fixed rate and term. Certificates of deposit in denominations of $100
thousand or more can be more volatile and more expensive than certificates of
less than $100 thousand. However, because the Bank focuses on relationship
banking and does not accept brokered certificates, its historical experience has
been that large certificates of deposit have not been more volatile or
significantly more expensive than smaller denomination certificates. It has been
the practice of the Bank to pay posted rates on its certificates of deposit
whether under or over $100 thousand. The Bank has paid negotiated rates for
deposits in excess of $500 thousand but the rates paid have rarely been more
than 25 to 50 basis points higher than posted rates and deposits also have been
negotiated at below market rates. In late 2000, to fund strong loan demand, the
Bank began accepting certificates of deposits, generally in denominations of
less than $100 thousand on a non brokered basis, from bank and credit union
subscribers to a wholesale deposit rate line. The Bank has found rates on these
deposits to be generally competitive with rates in our market given the speed
and minimal noninterest cost at which deposits can be acquired. However, it is
possible for rates to significantly exceed local market rates, although it has
not been the experience of the Bank. At September 30, 2003 the Bank held $28.8
million of these deposits at an average rate of 3.43% as compared to $17.7
million of these deposits, at an average rate of 4.08% at September 30, 2002.
With the strong core deposit growth experienced by the Bank in 2002, these
deposits were allowed to mature without renewal or replacement. However, during
the second quarter of 2003 management felt that there was an opportunity to
acquire longer maturities of these deposits at attractive interest rates and
again began accepting these deposits with three and four year maturities.
At September 30, 2003, the Company had approximately $80 million in
noninterest bearing demand deposits, representing a 25% of total deposits. This
compared to $64 million of these deposits at December 31, 2002. These are
primarily business checking accounts on which the payment of interest is
prohibited by regulations of the Federal Reserve. Proposed legislation has been
introduced in each of the last several sessions of Congress which would permit
banks to pay interest on checking and demand deposit accounts established by
businesses. If legislation effectively permitting the payment of interest on
business demand deposits is enacted, of which there can be no assurance, it is
likely that we may be required to pay interest on some portion of our
noninterest bearing deposits in order to compete with other banks. Payment of
interest on these deposits could have a significant negative impact on our net
income, net interest income, interest margin, return on assets and equity, and
indices of financial performance.
17
As an enhancement to the basic noninterest bearing demand deposit
account, the Company offers a sweep account, or "customer repurchase agreement",
allowing qualifying businesses to earn interest on short term excess funds which
are not suited for either a CD investment or a money market account. The
balances in these accounts were $20 million at September 30, 2003 compared to
$25 million at December 31, 2002. Customer repurchase agreements are not
deposits and are not FDIC insured but are secured by US Treasury and/or US
government agency securities. These accounts are particularly suitable to
businesses with significant change in the levels of cash flow over a very short
time frame often measured in days. Attorney and title company escrow accounts
are an example of accounts which can benefit from this product, as are customers
who may require collateral for deposits in excess of $100 thousand but do not
qualify for other pledging arrangements. This program requires the Company to
maintain a sufficient investment securities level to accommodate the
fluctuations in balances which may occur in these accounts.
At September 30, 2003, the Company had no outstanding balance under its
line of credit provided by a correspondent bank, having paid off the $9.9
million balance with the proceeds of the offering. The Company had $4.6 million
outstanding at December 31, 2002. At September 30, 2003, the Bank had $15.3
million of FHLB short and long-term borrowings, as compared to $18.3 million at
December 31, 2002. These advances are secured 50% by US government agency
securities and 50% by a blanket lien on qualifying loans in the Bank's
commercial mortgage loan portfolio. Through another subsidiary of the Company,
Bethesda Leasing LLC, there was long term borrowings outstanding of $299
thousand. This loan was obtained to fund the purchase of an impaired loan from
the Bank.
LIQUIDITY MANAGEMENT
Liquidity is the measure of the Bank's ability to meet the demands
required for the funding of loans and to meet depositor requirements for use of
their funds. The Bank's sources of liquidity consist of cash balances, due from
banks, loan repayments, federal funds sold and short term investments. These
sources of liquidity are supplemented by the ability of the Company and Bank to
borrow funds. The Company maintains a $10 million line of credit, with a
correspondent bank. There were no borrowings under this line at September 30,
2003. The Bank can purchase up to $12 million in federal funds on an unsecured
basis and enter into reverse repurchase agreements up to $10 million. At
September 30, 2003, the Bank was also eligible to take FHLB advances of up to
$70 million, of which it had advances outstanding of $15.3 million.
The loss of deposits, through disintermediation, is one of the greater
risks to liquidity. Disintermediation occurs most commonly when rates rise and
depositors withdraw deposits seeking higher rates than the Bank may offer. The
Bank was founded under a philosophy of relationship banking and, therefore,
believes that it has less of an exposure to disintermediation and resultant
liquidity concerns than do banks which build an asset base on non-core deposits
and other borrowings. The history of the Bank, while just under five years,
includes a period of rising interest rates and significant competition for
deposit dollars. During that period the Bank grew its core business without
sacrificing its interest margin in higher deposit rates for non-core deposits.
There is, however, a risk that some deposits would be lost if rates were to
spike up and the Bank elected not to meet the market. Under those conditions the
Bank believes that it is well positioned to use other liability management
instruments such as FHLB borrowing, reverse repurchase agreements and Bank lines
to offset a decline in deposits in the short run. Over the long term an
adjustment in assets and change in business emphasis could compensate for a loss
of deposits. Under these circumstances, further asset growth could be limited as
the Bank utilizes its liquidity sources to replace, rather than supplement, core
deposits.
Certificates of deposit acquired through the subscription service may
be more sensitive to rate changes and pose a greater risk of disintermediation
than deposits acquired in the local community. The Bank has limited the amount
of such deposits to 25% of total assets, an amount which it believes it could
replace with alternative liquidity sources, although there can be no assurance
of this.
The mature earning pattern of the Bank is also a liquidity management
resource for the Bank. The earnings of the Bank are now at a level that allows
the Bank to pay higher rates to retain deposits over a short period, while it
adjusts its asset base repricing to offset a higher cost of funds. The cost of
retaining business in the short run and the associated reduction in earnings can
be preferable to reducing deposit and asset levels and restricting growth.
At September 30, 2003, under the Bank's liquidity formula, it had $92
million of liquidity representing 22.9% of total Bank assets.
18
ASSET/LIABILITY MANAGEMENT AND QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT
MARKET RISK
A fundamental risk in banking, outside of credit risk, is exposure to
market risk, or interest rate risk, since a bank's net income is largely
dependent on net interest income. The Bank's Asset Liability Committee (ALCO) of
the Board of Directors formulates and monitors the management of interest rate
risk within policies established by it and the Board of Directors. In its
consideration of establishing guidelines for levels and/or limits on market
risk, the ALCO committee considers the impact on earnings and capital, the level
and direction of interest rates, liquidity, local economic conditions, outside
threats and other factors. Banking is generally a business of attempting to
match asset and liability components to produce a spread sufficient to provide
net income to the bank at nominal rate risk. The Company, through ALCO,
continually monitors the interest rate environment in which it operates and
adjusts rates and maturities of its assets and liabilities to meet the market
conditions. In the current low interest rate environment, the Company is keeping
its assets either variably priced or with short term maturities or short average
lives. At the same time it strives to attract longer term liabilities to lock in
the lower cost of funds. In the current market, due to competitive factors and
customer preferences, the effort to attract longer term fixed priced liabilities
has not been as successful as the Company's best case asset liability mix would
prefer. When interest rates begin to rise, the Company expects that it will seek
to keep asset maturities and repricing periods short until rates appear to be
nearing their peak and then extend maturities to extend the benefit of higher
rates. There can be no assurance that the Company will be able to successfully
carry out this intention, as a result of competitive pressures, customer
preferences and the inability to perfectly forecast future interest rates.
One of the tools used by the Company to manage its interest rate risk
is a static GAP analysis presented below. The Company also uses an earning
simulation model on a quarterly basis to closely monitor interest sensitivity
and to expose its balance sheet and income statement to different scenarios. The
model is based on current Company data and adjusted by assumptions as to growth
patterns, noninterest income and noninterest expense and interest rate
sensitivity, based on historical data, for both assets and liabilities. The
model is then subjected to a "shock test" assuming a sudden interest rate
increase of 200 basis points or a decrease of 200 basis points, but not below
zero. The results are measured by the effect on net income. The Company, in its
latest model, shows a positive effect on income when interest rates immediately
rise 200 basis points because of the short maturities of assets and a negative
impact if rates were to decline further. With rates already at historic lows, a
further reduction would reduce income on earning assets which could not be
offset by a corresponding reduction in the cost of funds.
The following table reflects the result of a "shock test" simulation on
the September 30, 2003, earning assets and interest bearing liabilities and the
change in net interest income resulting from the simulated immediate increase
and decrease in interest of 100 and 200 basis points. Also shown is the change
in the Market Value Portfolio Equity resulting from the simulation. The model as
presented is projected for one year.
Percentage change
Change in interest Percentage change in net Percentage change in in Market Value of
rates (basis points) interest income net income Portfolio Equity
-------------------- ------------------------ -------------------- ------------------
+200 +11.8% +26.5% +12.3%
+100 +6.9% +15.4% +6.9%
0 -- -- --
-100 -9.8% -21.9% -10.7%
-200 -22.9% -51.2% -20.7%
Certain shortcomings are inherent in the method of analysis presented
in the foregoing table. For example, although certain assets and liabilities may
have similar maturities or repricing periods, they may react in different
degrees to changes in market interest rates. Also, the interest rates on certain
types of assets and liabilities may fluctuate in advance of changes in market
interest rates, while interest rates on other types may lag behind changes in
market rates. Additionally, certain assets, such as adjustable-rate mortgage
loans, have features that restrict changes in interest rates on a short-term
basis and over the life of the loan. Further, in the event of a change in
interest rates, prepayment and early withdrawal levels could deviate
significantly from those assumed in calculating the tables. Finally, the ability
of many borrowers to service their debt may decrease in the event of a
significant interest rate increase.
19
GAP
Banks and other financial institutions are dependent upon net interest
income, the difference between interest earned on interest earning assets and
interest paid on interest bearing liabilities. In falling interest rate
environments, net interest income is maximized with longer term, higher yielding
assets being funded by lower yielding short-term funds; however, when interest
rates trend upward this asset/liability structure can result in a significant
adverse impact on net interest income. The current interest rate environment is
signaling steady to possibly higher rates. Management has for a number of months
shortened maturities in the Bank's investment portfolio and where possible also
has shorten repricing opportunities for new loan requests. While management
believes that this will help minimize interest rate risk in a rising
environment, there can be no assurance as to actual results.
GAP, a measure of the difference in volume between interest earning
assets and interest bearing liabilities, is a means of monitoring the
sensitivity of a financial institution to changes in interest rates. The chart
below provides an indicator of the rate sensitivity of the Company. A negative
GAP indicates the degree to which the volume of repriceable liabilities exceeds
repriceable assets in particular time periods. At September 30, 2003, the Bank
had a positive GAP of 19.5% out to three months and a cumulative negative GAP of
2.8% out to twelve months.
If interest rates were to continue to decline, the Bank's interest
income and margin may be adversely effected. Because of the positive GAP measure
in the 0 - 3 month period, continued decline in the prime lending rate will
reduce income on repriceable assets within thirty to ninety days, while the
repricing of liabilities may occur over future time periods and there may not be
an ability to reduce the cost of interest bearing liabilities to fully offset
the reduction in short term interest rates. This will result in a decline in net
interest income and net income. Management has carefully considered its strategy
to maximize interest income by reviewing interest rate levels, economic
indicators and call features of some of its assets. These factors have been
thoroughly discussed with the Board of Directors Asset Liability Committee and
management believes that current strategies are appropriate to current economic
and interest rate trends. The negative GAP is carefully monitored and will be
adjusted as conditions change. The following GAP table is presented on the basis
of the Bank only as inclusion of escrowed subscription assets and noninterest
bearing escrowed subscription liabilities would create a distorted
representation of the operating GAP.
GAP ANALYSIS
September 30, 2003
(dollars in thousands)
0-3 4-12 13-36 37-60 Over 60
Repriceable in: Months Months Months Months Months Total
----------------------------------------------------------------------------
ASSETS:
Investment securities $ 24,938 $ 8,769 $ 12,437 $ 12,166 $ 13,261 $ 71,571
Interest bearing deposits in other banks 91 3,369 891 -- -- 4,351
Loans 108,943 21,592 51,382 79,208 27,806 288,931
Federal funds sold 2,000 -- -- -- -- 2,000
----------------------------------------------------------------------------
Total repriceable assets 135,972 33,730 64,710 91,374 41,067 366,853
============================================================================
LIABILITIES:
NOW accounts -- 19,808 3,962 15,845 -- 39,615
Savings and Money Market accounts 39,681 32,685 19,841 9,920 -- 102,127
Certificates of deposit 17,826 51,935 20,432 1,646 -- 91,839
Customer repurchase agreements and
federal funds purchased 6,003 8,004 2,001 4,001 -- 20,009
Other borrowing-short and long term 1,000 3,000 11,632 -- -- 15,632
----------------------------------------------------------------------------
Total repriceable liabilities 64,510 115,432 57,868 31,412 -- 269,222
============================================================================
GAP $ 71,462 $ (81,702) $ 6,842 $ 59,962 $ 41,067 $ 97,631
Cumulative GAP 71,462 (10,240) (3,398) 56,564 97,631
Interval gap/earnings assets 19.48% (22.27)% 1.86 % 16.30% 11.19%
Cumulative gap/earning assets 19.48% (2.79)% (0.93)% 15.37% 26.61%
20
Although, NOW and MMA accounts are subject to immediate repricing, the
Bank's GAP model has incorporated a repricing schedule to account for the
historical lag in effecting rate changes and the amount of those rate changes
relative to the amount of rate change in assets.
CAPITAL RESOURCES AND ADEQUACY
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 needs 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 Company's wholly-owned subsidiary, 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 credit losses. Risk-based
capital ratios are calculated with reference to risk-weighted assets. The
leverage ratio compares Tier1 capital to total average assets. At September 30,
2003, the Company's and Bank's capital ratios were in excess of the mandated
minimum requirements.
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 additional borrowing, the sale of additional common
stock, the sale of preferred stock, or through the issuance of additional
qualifying equity equivalents, such as subordinated debt or trust preferred
securities. On August 1, 2003 the Company completed its offering with the sale
of 2,448,979 shares of common stock for gross proceeds of approximately $30
million.
CAPITAL
- -------
The actual capital amounts and ratios for the Company and Bank as of June 30,
2003 and 2002 are presented in the table below:
To Be Well
For Capital Capitalized Under
Company Bank Adequacy Prompt Corrective
In thousands Actual Actual Purposes Action Provisions**
As of September 30, 2003 Amount Ratio Amount Ratio Ratio Ratio
------- ----- ------- ----- ----------- ------------------
Total capital (to risk-weighted
assets) $55,137 17.1% $33,662 11.9% 8.0% 10.0%
Tier 1 capital (to risk-weighted
assets) $51,900 16.1% 30,436 10.0% 4.0% 6.0%
Tier 1 capital (to average
assets) $51,900 14.3% 30,436 8.3% 3.0% 5.0%
As of September 30, 2002
Total capital (to risk-weighted
assets) $21,372 9.0% $25,289 10.6% 8.0% 10.0%
Tier 1 capital (to risk weighted assets) $18,704 7.4% 22,621 9.4% 4.0% 6.0%
Tier 1 capital (to average assets) $18,704 6.8% 22,621 7.3% 3.0% 5.0%
** Applies to Bank only
Bank and holding company regulations, as well as Maryland law, impose certain
restrictions on dividend payments by the Bank, as well as restricting extension
of credit and transfers of assets between the Bank and the Company. At September
21
30, 2003, the Bank could pay dividends to the parent to the extent of its
earnings and so long as it maintained required capital ratios.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Please refer to Item 2 of this report, "Management's Discussion and
Analysis of Financial Condition and Results of Operations", under the caption
"Asset/Liability Management and Quantitative and Qualitative Disclosure About
Market Risk".
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 operation of the Company's disclosure controls and
procedures, as defined in Rule 13a-14 under the Securities and 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
From time to time the Company may become involved in legal proceedings.
At the present time there are no proceedings which the Company believes will
have an adverse impact on the financial condition or earnings of the Company.
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 of Exhibit
- ----------- ----------------------
3(a) Certificate of Incorporation of the Company, as amended (1)
3(b) Bylaws of the Company (2)
10.1 1998 Stock Option Plan (3)
10.2 Intentionally omitted
10.3 Employment Agreement between Thomas D. Murphy and the Bank (4)
10.4 Employment Agreement between Ronald D. Paul and the Company (4)
10.5 Consulting Agreement between Leonard L. Abel and the Company (4)
10.6 Employment Agreement between Susan G. Riel and the Bank (4)
10.7 Employment Agreement between Martha F. Tonat and the Bank(1)
11 Statement Regarding Computation of Per Share Income
21 Subsidiaries of the Registrant
31(a) Certification of Ronald D. Paul
31(b) Certification of Wilmer L. Tinley
32(a) Certification of Ronald D. Paul
32(b) Certification of Wilmer L. Tinley
- --------------
(1) Incorporated by reference to the exhibit of the same number to the
Company's Quarterly Report on Form 10-QSB for the period ended September
30, 2002.
(2) Incorporated by reference to Exhibit 3(b) to the Company's Registration
Statement on Form SB-2, dated December 12, 1997.
(3) Incorporated by reference to Exhibit 10.1 to the Company's Annual Report on
Form 10-KSB for the year ended December 31, 1998.
22
(4) Incorporated by reference to the exhibit of the same number in the
Company's Annual Report on Form 10-KSB for the year ended December 31,
2000.
(b) Reports on Form 8-K
On July 15, 2003, the Company filed a Current Report on Form 8-K, under
Items 5, 7, and 9 thereof, reporting earnings for the quarter ended June 30,
2003.
On October 15, 2003, the Company filed a Current Report on Form 8-K,
under Items 5, 7 and 9 thereof, reporting earnings for the quarter ended
September 30, 2003.
On October 27, 2003, the Company filed a Current Report on Form 8-K,
under Items 5, and 9 thereof, reporting the resignation of H.L. Ward.
23
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.
EAGLE BANCORP, INC.
Date: November 13, 2003 By: /s/ Ronal D. Paul
-----------------------------------------------
Ronald D. Paul, President and CEO
Date: November 13, 2003 By: /s/ Wilmer L. Tinley
-----------------------------------------------
Wilmer L. Tinley, Senior Vice President and CFO
24